If you are like many entrepreneurs, budgeting is an annual exercise that you may prefer to do without. However, your budget is a powerful tool for ensuring the success of your business, so it’s worth the time and effort to prepare one.
I’ve found that there is a different way of looking at the budgeting process that can help make it less painful while creating better results.
Your budget is essentially the numerical representation of your annual operating plan. So the trick is to create your annual plan first, then translate the written plan into a numerical budget. Some companies call this "profit planning" as opposed to budgeting.
Here are some tips for creating an annual plan and budget that will guide your business to enhanced profitability.
Always Start with Your Sales Plan for the Year
It’s not enough to just plan and budget your expenses. As any successful salesman will tell you, you also have to plan your sales!
Based upon what you know about your market, economic trends and other influences, make some realistic assumptions in terms of units sold, customers served and average sales prices for the next year. If you’ve been in business for a while, your historical numbers are a good starting point. If your business is newer, you’ll need to base this plan on your market research.
It’s important to plan in detail here. Don’t just set a dollar figure for total sales — it won’t give you the information you need to prepare the rest of your plan. You will want to answer the following questions:
- What is your goal for total number of customers?
- What amount do you expect each customer will purchase of each of your products or services?
- What price will each customer pay?
You can then compute the expected sales dollars that the business will bring in when your sales goals are met.
Create Your Manufacturing, Purchasing, or Service Provision Plan
Depending on what kind of business you are in, this is where you’ll likely spend most of your planning time. Based on the expected unit sales of each of your products and/or services, prepare a schedule of how many units you will need to manufacture, purchase or provide to fulfill customer demand.
Then, calculate the expected unit cost for each sold “unit,” multiply, and you have your “Cost of Goods Sold” budget. This represents the direct cost of making those sales before general, sales and administrative expenses. (This can get tricky if you’re paying employees to provide services. Be sure to allow for unbillable time in your cost calculations.)
Calculate and Analyze Gross Profit
It’s wise to pause at this point and verify that your gross profit percentage is projected to be where it should be for your industry:
Sales Dollars – Cost of Goods Sold = Gross Profit
Gross Profit divided by Sales Dollars = Gross Profit Percentage
If your gross profit percentage is low, you may need to revisit your pricing or figure out how to cut your costs of goods or services.
Plan for Selling, General and Administrative Activities
Selling, general and administrative activities (SG&A) form the infrastructure that your business requires to succeed.
I suggest you start with sales and marketing activities, since without those, nothing else really matters. Plan what needs to happen to achieve your sales goals and who needs to do it; don’t use dollars yet.
Then do the same exercise with the other “back office” functions of your business such as accounting, insurance, legal, office space, phone and Internet requirements, and all of the other activities and supplies that you’ll need — again, not in dollars, but in a more descriptive way using organization charts, job descriptions and whatever else is necessary to understand what needs to happen behind the scenes to support the level of sales you are expecting.
Once your analysis is complete, you can prepare a schedule of necessary employee and overhead costs based on your operating plan. Break this down into two sections: sales and marketing, and general and administrative. Don’t forget your own salary!
Now ask yourself this question: What percentage of sales are you projecting to spend on each of these two overall categories? Is it in line with your industry? Are you spending enough on sales and marketing, for example?
Pulling it All Together
At this point you’ll have a sales forecast; a manufacturing, purchasing or service provision plan; an SG&A plan that is sufficient to support the business; and financial budgets to support each of them. If you’ve worked through this correctly, hopefully you’re projecting a profit.
Congratulations! You have written an operating plan, determined that it can be profitable, and produced sound budget numbers which, when you compare them to your actual results, will guide you in the decisions you need to make to ensure your business meets its sales goals and runs profitably.
JoAnne Berg, CPA is the founder/CEO of Peer Coaching Network, Inc. in Carlsbad, California. She is a trusted business advisor with over 30 years of experience as an entrepreneur, CFO/COO, and CPA/advisor to closely held businesses. Read her blogs at The Art of Small Business. You can follow her on Twitter @JoAnneBerg and on Facebook.