Optimizing Profits Through Budgeting

Apr 12

With a thousand things to do, many business owners can downplay the importance of a budget. Common comments we hear are:

“Things are changing so fast. A budget will be outdated by the time we get it done.”

“We’ve never used a budget and been just fine. “

“Our team is already stretched. They need to focus on getting things done – not spreadsheets and looking at the past.”

We get it. Especially when your clients are…

in a business that is currently robust and cash flow is positive
in a fast-paced mode - whether that is growth or pivoting or dealing with staff turnover
going to land potentially big contracts – but those are not signed
ready to expand – team, space, offers

Except…that’s when your clients need a roadmap more than ever. And odds are…these business owners are going to look to you as the financial expert on their team to get this done. It can seem like an uphill battle when the budget hasn’t been a core part of a business in the past. Here’s how you can navigate that.

Reframing Budget Beliefs

No one likes a budget – or at least they don’t like adhering to one. That’s especially true of visionary business owners who have big plans. If these are your clients, you can help them reframe seeing a budget as a tool to help them move faster. It’s a way to ensure that the profits are generated steadily and sustainably so the business energy can be on the big plans and not on cash-flow firefighting.

That’s why we like to think of your budget as a more of a roadmap than an absolute mandate. A budget (or a forecast) is a tool that helps you and your clients know where the business is headed and helps find course corrections along the way. We also like to separate this into two key pieces: the sales forecast (and related cost of goods sold) and the operating expense budget.

Other things you need to decide before you start:

Timeframe. Is this for the next quarter? The next year? This is a key place to keep the big picture in mind. If your clients are going through rapid periods of change (or expect to). An annual budget is probably not the best solution.
Key drivers. What 3-5 items in the budget must be locked in? Common one are revenue, cost of goods or services sold and payroll. Another way to think about this: if you only got these 3-5 things right, the budget would be 80-90% accurate (which pretty golden).
Level of detail. Is this a summary or zero-based budgeting with all the details?
Inputs. Whether it’s hard historical data, a contract pipeline or staff knowledge, know where the information is going to come from.

Sales Budgeting and Forecasting (without a crystal ball)

Without a doubt, budgets and forecasts can get complicated. Your primary job as a financial expert is to create a usable, actionable and timely budget or forecast that your client’s will actually use.

The sales forecast is a projection of anticipated revenue that will be generated over the time frame selected. No more, no less. It is also one of the areas that needs to be as good as you can get it. We like to include cost of goods or services as part of this calculation as well since these costs generally move in step with revenue. And also…product-based businesses are made and broken on gross profit. There has to be both enough volume and enough profit margin to cover the operating expenses. As much as everyone likes to think that they can “just cut costs,” it doesn’t really work that way if the pricing and fulfillment model is off.

Spend 80% of your time helping your clients get their revenue, pricing and customer mix dialed in. It will save them sleepless nights and stop you from getting frantic phone calls. Things to consider in the revenue and cost of goods sold model:

How flexible is the pricing of the products or services? If your client is in a commodity business, there is very little flexibility unless it is driven by raw material costs that are impacting the whole industry.
Are there supply chain or inflation issues with the raw inputs/materials?
Are there staffing considerations?
What is the customer mix – and is it changing?
What is the average purchase of a customer – and is it changing?
Are there five customers that make up 50% of the revenue or hundreds of smaller ones?

Service-based businesses can answer these same questions. The “raw material” is then often limited to labor. Beyond that, you may review past sales trends (for seasonality and cycles), other key business drivers and industry trends.

That can be a lot to consider – and that may be all you need to do is consider it. It may not need to be included as an actual calculation so much as a way to ensure that you and your clients are making assumptions in a bubble.

Operating Overhead

Here’s the other 20% of the effort. In our profit-focused frameworks, we see operating expenses are more fixed in nature – or at least not directly correlated to revenue. These are things like rent, utilities, salaries for administrative staff, professional fees and insurance.

The ones that are a little less clear are items such as advertising and sales commissions. These are generally not fixed but are also not directly supportive of generating revenue. If these are key elements of your client’s company, they may be on the income statement as operating expenses but get calculated in connection with the revenue projections.

Outside of advertising and commissions, operating overhead expenses are generally easy to project. Rent is the same every month or has defined escalation clauses that can be incorporated. Utilities, professional fees and salaries can be estimated on a straight-line basis. As long as you have identified your key three to five big impact lines, these other minor lines will take care of themselves. Said differently, you can get these other lines nearly 100% wrong and still have a solid budget.