“Creating A Budget” Without “Creating A Budget”
Creating a comprehensive budget can be overwhelming and intimidating. As a former CFO of a multi-million dollar company with 200+ employees and many service lines, it can be painstaking effort. Creating a comprehensive budget requires:
- reviewing historical data, identifying recent trends
- projecting future growth
- pricing for each product and service line
- analyzing each expense
A budget is critical to successfully achieving the business and financial goals of the organization. Without a budget, how does an organization measure success? How does an organization plan for tomorrow? The budget is an organization’s financial road map and will improve cash flow.
Many small business owners do not have the patience or desire to spend the time it takes to create a comprehensive budget.
Creating a comprehensive budget requires access to historical data (typically 24 months). Think about your units sold or billed and the associated revenue. A thorough review of the company’s expenses and contractual commitments, such as office space, equipment leases and installment loans.
As the famous Tony Horton said during one of his P90X workouts, “you can do anything for 30 seconds.” Now, I’m not suggesting that someone can create a budget in 30 seconds. However, you can create a useful budget in a few hours that allows you to evaluate your company’s monthly performance.
So, let’s get started with creating a baseline monthly budget “for and by” the business owner.
The following link allows you to enter the data in a spreadsheet that helps perform the calculations.
Step 1: Calculate Revenue
- determine the number of billable hours for the month or the number of products expected to sell for the month
- multiply the number of billable hours by the average hourly rate and/or multiply the number of products sold by the average sales price
Generate a revenue or billing report which covers the last 12 months and reflects the number of items sold (or hours billed), gross sales, receipts and unpaid amounts (accounts receivable). Combine the receipts and estimated collectible accounts receivable. This amount represents the company’s revenue. Divide the revenue by the number of products sold (or billable hours charged). Sales from a service repair company will include a labor and parts sales. Separate the two categories to calculate the average sales price and then combine the two amounts. This is the organization’s average sales price (or hourly rate).
Step 2: Calculate Cost of Goods Sold (COGS)
- multiply the revenue by the gross margin percentage, or
- multiply the number of items sold by the average cost of the item produced
Cost of goods sold are expenses that are specifically used to produce items sold or merchandise purchased for resale.
Calculate the gross margin for purchased merchandise.
In this example, “Company X” has a 45% markup on inventory purchased for resale. Divide the markup amount by the sales price, then subtract it from 100% to arrive at the gross margin percentage. Company X paid $50,000 for merchandise which will be resold. The sales price for the combined merchandise is $72,500 ($50,000 + $50,000 x 45%). The markup amount of $22,500 / $72,500 = 31%. 100% – 31% = 69% which is the gross margin percentage. Multiply the gross margin percentage of 69% to the revenue in arriving at the costs of goods sold.
Calculate the average cost of the item produced.
In this example, “Company Z” produces items for sale. The expenses classified as costs of goods sold are the direct labor and materials used to create the product. The amount of direct costs will vary depending on how many items are produced.
Do not include indirect costs in this calculation. Indirect costs are not tied directly to the specific item produced but are “indirectly” incurred to create the product. Examples include the rent of the production plant, equipment depreciation and repairs used in production, manufacturing supplies, and utilities.
Combine the direct labor and materials used for production for the month. Divide the total of these two costs by the number of items produced to arrive at the direct average cost per item produced.
Step 3: Calculate Operating Costs
These expenses include; salaries and wages (amounts not included in cost of goods sold), employee benefits, rent, phone, utilities, office supplies, advertising, insurance, maintenance and bank fees
- Locate these expenses on your Income Statement. Divide the total of the non-COGS expenses by the number of months the Income Statement covers. If an Income Statement is not available, refer to the latest tax return. The expenses are reported on the line labeled “Total Deductions.”
- Corporations – Form 1120, page 1, line 27
- S corporation or Limited Liability Company – Form 1120S, page 1, line 20
- Partnership or Limited Liability Company – Form 1065, page 1, line 21
- Sole Proprietor – Form 1040, Schedule C, line 28
- Divide the amount by 12 months
This amount should remain consistent from month to month unless staffing levels change and/or operations are expanded (or your business went through a COVID-19 shutdown)