Budgets! Yuck, that word can imply a lot to many people…like, extra work, restrictions (who wants limits in business?!), confusion (where do I start?), and procrastination (who has time at this time of year?)
With all that in mind, for those of you that are ready to create a budget for 2020, here are some simple guidelines…
Starting with a blank Excel or Google sheet is usually the best tool to use to create your budgets.
Know Your Fixed Costs
The starting point for all budgets is your fixed costs. You will determine these from looking at the general expenses on your Income Statement for the past 12 months.
These are the easiest expenses to know, as they re-occur every month, regardless of your sales volume.
They include things like rent, insurance, office and management salaries and wages (**production wages can be treated as part of your cost of goods sold), telephone, bank charges, vehicle expenses, and marketing.
Note that some expenses here, like marketing as an example, are what we call discretionary expenses, in that you may decide to spend (or not) depending on your marketing goals.
Rent is a true fixed cost as it usually relates to a lease.
To determine your budgeted fixed costs, go through your fixed overhead expenses for the past 12 months and either take a monthly average or slot them into the month they occur. (For instance, if insurance is $3,000 and is paid in June 2020, then you can budget for it in that month).
Take the time here to review each item to see if you are still getting good value for your expense and if there is an opportunity to change suppliers to save money or get more value.
Know Your Other Balance Sheet “Costs”
There will be other items you must consider in your budget that are not going to show up on your Income Statement.
Capital expenditures for things like vehicles, equipment, computers, and furniture.
The principal portion of loan re-payments.
Dividend distributions to the owners.
Know Your Gross Margin
The next number to know is your gross margin percentage.
This is where good accounting, and record keeping comes in. If you haven’t correctly allocated all your variable costs to the correct category – cost of goods sold in this case – then you may not have an accurate gross margin percentage.
Assuming you are comfortable with your average gross margin percentage then you are closer to determining what, your break-even sales must be.
Oh, and by the way, the gross margin percentage is simply the difference between your sales and your cost of goods sold (direct variable expenses like products sold, direct labour, shipping, commissions) expressed as a percentage.
Here is how you calculate it:
Sales – $100
Cost of sales – $40
Gross Profit – $60 ($100 – $40)
Gross Profit percentage = 60% ($60 gross profit divided by $100 sales)
How Much Profit Do You Want to Earn
The next step is to decide how much profit you plan to earn next year.
Let’s say that you have $120,000 in fixed costs ($10,000 per month).
Also, we will assume you have additional monthly costs as follows:
- Dividends of $60,000
- Principal payments on loans of $10,000
- Expected capital expenditures of $20,000 for the year
- Retained cushion (an amount you want to retain in your business for future expansion) = $60,000
Total of above = $150,000
So, using the above numbers our total outflows for the year will be $120,000 in fixed costs plus $150,000 in other items as above for a grand total of $270,000, or $22,500 per month.
Your gross margin is 60%.
Your break-even sales (with enough to cover all fixed costs plus dividends, loan re-payments, cushion, etc.) is then $270,000 divided by 60% (fixed costs plus other items divided by gross margin percentage), or $450,000.
To prove it, you can work backwards, as follows:
Cost of sales (40%) (180,000)
Gross profit (60%) $270,000
Fixed Costs ($120,000)
Net profit $150,000 (33%)
Capital expenditures ($20,000)
Principal on loans ($10,000)
The Final Number – Break-even Sales
Now that you have this final number – break-even sales – you can allocate to the pattern of seasonal sales you have for each month, or just divide by 12 and allocate evenly to each month.
This is your drop-live number – the number you must get each month, or risk falling further and further behind for each month that you do not attain the break-even sales required.
Share it with your Team, post that Target Sales number in your Team Meeting room. Make sure your sales Team knows your targets!
Here is a brief summary of the above steps –
Step 1 – Determine fixed costs ($120,000 for the year in our example)
Step 2 – Determine how much you need for loan payments, dividends to the shareholders and capital expenditures, plus a projected cushion ($150,000 in our example above)
Step 3 – Know your Gross Margin percentage (60% as above)
Step 4 – Determine Your Break-Even Sales ($450,000 in this example)
The break-even sales are your magic number. If you maintain a consistent gross margin and keep to your fixed cost expenditures plus loan re-payments and dividends you should have a very healthy business.
In closing, Merry Christmas to each of you and your families, and all the very best for a great start into 2020. Kindly note there will be no Blog next week, Friday, December 27, 2019. The next one will be January 3, 2020!
Thanks for reading….