Building Your Budget

Why You Need a Budget

Without a budget, it’s difficult to measure business performance (an essential for survival). Having a budget also allows you to produce a cash flow forecast and examine profitability. Then, from there, you’ll be working with your accountant to plan tax.

A budget is typically done in accrual mode, i.e., when an invoice is produced and when a supplier invoice is received. Remember: cash flow is when the actual money moves.

Questions your budget will answer:

• What is my cost of sales percentage and how do I compare to others in the market?
• Are my office expenses moving and will that affect my profit?
• Am I meeting my sales/revenue targets?
• Can I afford to invest in my next big idea?
• I’ve just got a big new customer, what will that do to my budget?
• How much money will I make out of the business?
  

Steps for Building a Budget:

1. Assess Potential Revenue

Where is your money coming from?

When assessing potential revenue, you need to consider single sources of income, look at contracts, potential competition, and opportunities to grow.

To estimate you may like to keep a track of leads and proposals and the percentage likelihood of winning each deal to calculate an estimated revenue. Alternatively, it may be a planned regular increase in sales that you use as an estimate.

Note: this is always a guesstimate. If you end up under or over-achieving your revenue budget then find the cause, address this within the business plan, and adjust your ongoing budget. Again, your budget does not have to be fixed in concrete. Business environments change.
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2. Direct Costs

Put simply, direct costs concern anything directly affecting the movement in sales revenue. E.g. permanent or contract labour, materials and supplies, external services, or payment fees.

More specific examples; you’re only incurring fees if the customer pays by credit card, you’re only buying supplies to fulfil sales, or labour is only incurred to deliver what the customer ordered.

A lot of industries have standards that you can measure against which can be helpful in looking at your plan and performance. Or you may choose to keep an eye on this to ensure it doesn’t vary too much.
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3. Operating Expenses 

These are your fixed expenses such as insurance, rent, vehicles, lighting, power & heating, subscriptions, website, IT costs, and phone costs. 

We have a chart of accounts specific to your industry that offers a great guide to refer to. Contact us to chat about it.
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4. Bottom-Up Budgeting

Bottom-up budgeting means to start with the net profit you need and then work backwards to calculate how much revenue you need to achieve that profit.

Steps:

1. How much revenue do you need for your income and to service debt?
2. What are your monthly average operating expenses (found on your existing P&L).
3. Add the two together to get your required gross profit.
4. Work out your direct cost % (for variable goods and services required against the sales). Again, you can see this on your P&L (take 12 months and average it).
5. Calculate your gross profit % (100 - direct cost % from step 4)
6. Calculate your sales target by taking the gross profit from step 3 and dividing by the gross profit % from step 5.
   

Example:

1. You want $20,000 per month in income.
2. Your P&L shows your operating expense is on average $55,000 per month.
3. Your gross profit needs to be $75,000 (step 1 + step 2).
4. Your P&L shows your average direct cost % is 40% of sales income.
5. If direct cost is 40% then gross profit must be 60% of sales income.
6. If our gross profit needs to be $75,000 and we know this will be 60% of the sales income, our sales income becomes $75,000/0.6 = $125,000 per month.

Worked example:
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$125,000     Sales Income Required

-$50,000     Cost of Sales (40%)

__________

$75,000       Gross Profit

-$55,000     Average operating expenses

_________

$20,000   Net Profit – Income to you and money to service debt.