Your budget: Helping ensure that reality meets expectations
by Warren RutherfordBudgeting is a management tool for dealing with the future. It helps you turn expectations into reality. More often than not, businesses don’t prepare an annual budget, and then wonder why reality does not meet their expectations.
So, let’s get started. Collect all your fixed costs and your variable costs for the past year.
Regardless of sales, fixed costs stay the same. Several examples of fixed expenses are insurance, rent, taxes on property, wages paid to salaried employees, depreciation of equipment, interest on borrowed money, building maintenance costs, office salaries, and office expenses.
Variable costs vary with sales. In some businesses, the cost of labor is the biggest factor. Sales commissions, payroll taxes, insurance, advertising and delivery expenses are other examples of variable expenses.
Break them out and organize them on a monthly basis. Only then can you look at how these fixed and variable costs can create a budget, and, more importantly, lead to the creation of a more profitable business.
From these three figures – profit, fixed expenses and variable expenses – you can determine your “hoped for” total income.
When the figures are all together, you have answers to questions such as: What sales will I need to achieve the desired profit? What fixed expenses will be necessary to support these sales? What variable expense will be incurred in producing the product or services?
Because business is not a cut-and-dried affair, the first budget often will uncover issues and suggest choices to you. Working up alternative budgets will help you decide what changes you will need to consider in order to have a workable plan.
Think about your plan, your goal and the steps to achieve it
A budget in its simplest form is a plan that enables you to set a goal and list the steps that are necessary to reach that goal. A budget helps you think about what you want your business to do in the future; and by planning, you are in a better position to act to prevent problems from developing.
A budget is a detailed plan of future receipts and expenditures – a projected profit and loss statement. Once the period for which you have budgeted is completed, you can compare actual results with anticipated goals. If, for example, some of your expenses are higher than you expected, you can start looking for ways to reduce them. Conversely, if you have fallen short of your goal, you may want to look for ways to increase your income.
You can start either with a forecast of sales and work down, or with a forecast of profits and work up. Most businesses use the latter method. In other words, you decide what profit you want to make and then list the expenses that you will incur in order to make that predetermined profit. You will need to realistically answer two questions: Can I achieve this goal? How will I achieve this goal?
Before you can use a budget as a plan for increased profit, you have to be sure that your present profit is what it should be. In a business, the year-end profit should be large enough to make a return on your investment and a return on your own work-pay. This may seem difficult to determine, but if you have collected your expense data, you are well on your way to identifying this.
For those business owners who are skilled craftspeople – you are kidding yourself if your companies’ profits are less than what you could earn working for someone else. Your net profit after taxes should be at least as much as you can earn if you worked at your trade for a weekly paycheck.
So, after you review your fixed and variable expenses, prepare your forecast for the year – a forecast of sales or a forecast of profit. Spend some time preparing your assumptions for the forecast – and write them down.
How to judge a successful budget
• By now, you should have collected and analyzed your fixed and variable expenses and prepared a profit forecast – either based on sales or on profit. Your year-end profit is too low if it does not also include a return on your investment. That investment includes the money you put into the company when you started it and the profit of prior years that you left in the company – often called retained earnings.
• After you know what you made last year, you can set a profit goal for the next year. Be sure that your goal includes a return on your services and a return on your investment.
• Once you have decided on your profit target, the next step is to determine whether you can achieve this. To do this, you need to project your fixed expenses and your variable expenses. From these three figures – profit, fixed expenses, and variable expenses - you can determine your “hoped for” total income.
• In reviewing the data collected, keep in mind that without accurate information, planning becomes guessing. If you have never budgeted before, you may wish to review your record-keeping system. Changes in your system may be needed to provide the necessary budget information. It may be that your present accounting software or system does not break costs down into fixed and variable expenses, or it may be that you need to have a profit and loss (or income) statement at more frequent intervals to determine the seasonal fluctuations of your revenues and expenses.
• If you have the ability to conduct a good analysis, then your expected income contribution is the difference between sales and the variable expenses that are necessary to produce these sales. When this difference equals fixed expenses and the desired profit, you have a workable budget.
• Then, break your budget down into fiscal quarters. This type of breakdown allows you to check for any discrepancies that may not show up readily in a 12-month budget. When many items are added together, it is easy for an error to creep into the totals. During the year, this quarterly division provides a handle for managing expenses and other activities and also helps you to understand expense and income variations.
• By looking at next quarter’s budget you can anticipate peak periods and schedule stock and labor to handle peak sales volume. You can plan vacations, special promotions and inventory-taking for the slow periods.
• A monthly and quarterly profit and loss statement allows you to keep the items in your budget in line with operations. Then compare the actual and the planned revenues and expenses on the income statement.
Once you run through this process several times, you will be better able to pinpoint and work on the problems that have occurred during the month or the quarter. Your objective is to guide your activities toward the most profitable type of operations.
Successful businesses make budgeting a regular habit. The more regular the habit, the more successful your business will be.
Warren J. Rutherford is president of Rutherford Advisors Inc. and is an Accredited Associate, Institute for Independent Business International. He provides business consulting and coaching to small and medium-sized business, provides B2B solutions through his Alignment Marketing program, alignmentmarketing.com, and performs market research for businesses. Rutherford also is business development officer for Coastal Community Capital. He can be reached at rutherfw@comcast.net.
Published in Cape Business Sept/Oct 2007
Warren Rutherford Warren Rutherford founded Rutherford Advisors Inc. in 1997, and has more than 26 years experience providing management advisory services to business and government. He is an accredited Executive Associate for the Institute for Independent Business, an international nonprofit organization established in 1984. He also performs market research for businesses and is an Associate Reseller with MapInfo Corporation. 
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