Why Do a Budget?
To most trades business owners the mention of budgeting makes their eyes glaze over or reject the idea outright. “I can’t predict what is going to happen next week, let alone in 6 months or more!” is a common response. But it doesn’t need to be that way. A budget is the best way I know to gain a greater feeling of control over your business and therefore your life. Knowledge is power, so they say, and the knowledge you will gain about your business and what you need to do in order to change it, is an empowering process. A budget also ensures that you know before the year starts what you need to do to earn the return on your investment that you expect.
How to Put a Budget Together.
Next year’s budget typically builds on what happened last year. It is essentially an exercise in year-on-year comparisons and then extrapolating out. But where do you start when looking forward? The following is a rough outline of how I go about a high-level Budget Overview process with my clients. But before we begin just remember, budgeting is an inexact process. You don’t need to be exact. Just start with your best estimate and adjust from there.
1. What Net Profit Do I Need?
In a smaller business this figure is likely to be the shareholder salary that you target as a return. Not many small businesses make significant profits above this, however once a business has been established for a few years it is healthy to be generating a 5 – 10% net profit AFTER shareholder/manager salaries. You then own a REAL business.
2. What “Manager” Salary is reasonable?
In many smaller trades businesses the owner is still mostly on the tools and generates most of their income for the business this way. After hours work pricing, talking to clients or prospects or generally working ON the business is assumed to be done for free. It is healthy to add an allowance for manager-time into the budget however and so as the business grows and the owner spends more time in the office, the habit of budgeting for this cost is already in place.
3. What Overheads Are Required?
How much does it cost to run the business? These are the overhead costs that are incurred pretty much regardless of what sales volume you achieve. Costs like: phone, rent, accounting fees, ACC, fixed advertising, admin wages, etc. Adding the net profit, the manager salary allowance and overheads together you arrive at Gross Profit required to have your business at a successful and sustainable level.
4. What Sales Volume Is Required?
Take your Gross Profit dollar figure and divide it by your Gross Profit percentage figure (your Gross Margin) and you have a reasonable estimate of what your sales figure needs to be in order to generate this profit.
The question you then need to ask yourself is, “Does this look reasonable in view of what we have done in the past and what I know about the market?” Stepping back for a moment allows you to look from the top down and the bottom up and gauge whether your assumptions are reasonable. Realise that the process is a circular one and there are no fixed rules saying you must build a budget from the top down, or the bottom up.
5. What do Different Gross Margin numbers do?
The Gross Margin % is a critical number in a trades business and indicates how efficiently your core operations are performing. Look at what TRUE Gross Margin results you have achieved in the past and run the sales calculation with a higher Gross Margin to see what happens to the target sales figure. Again, step back and see if this margin percentage looks reasonable, based on past performance and industry benchmarks, if you can get them. It should be a key target to make small, sustainable improvements in this number as small gains here translates to big gains in Net Profit.
6. What Job Cost figure Is Indicated?
The difference between Sales and Gross Profit represents your direct job costs, or Cost of Goods Sold (COGS), as your accountant probably calls them. In here you should budget for the cost of: materials, direct labour (including your own if you are on the tools) sub contractors, machinery hire and any other cost that you normally on-charge to a client. The percentage of sales that this COGS represents will vary depending on what type of work you do, but typically will be between 75% to 85% of the total sales figure. Making improvements and savings here is how you achieve a better gross profit and thereby BIG gains in net profit and owner salary
7. What Are Monthly Fluctuations?
A high-level budget overview for the year is good, but breaking this down into monthly figures is even better. This way you can run monthly reports and see how you are tracking. You can then make small adjustments to your operation, which are easier to implement and keep you on track to achieve your annual goals.
Once you have done one budget, look to run different scenarios. The first version is a best-case scenario and includes everything they would like to be able to provide, including vacations and other benefits for employees, training, new tools, and vehicles — the works. Alongside this prepare a pessimistic version; cut the frills and focus on covering the basics — salaries, compliance, legal and accounting fees, rent, office supplies and computer equipment upkeep, plus phone and basic utilities.
Have a go! It doesn’t need to be a complicated budget and any figures are better than none. I think you will find the process very empowering and also will give you the chance to stop and think about the way you are running things and maybe come up with a couple of improvements to implement over the next year. The first time you do this you may need some help. Get in touch to book a financial review for your business and be on the path to a more empowered year through knowledge.