Most small businesses have December 31st fiscal year end. To maximize your profit potential in 2014, the best thing to do is prepare a 2014 budget. Many times this budget is an afterthought; just add 5% to revenues or just add 7% to expenses. Doing this “throw a dart at a dartboard” budgeting does a small business more harm than good.
Why? Because you haven’t thought through how you will increase revenues. You haven’t thought through why those expenses will increase. Some may not increase at all.
Budgeting and financials are often the hardest part for many business owners. It’s the area you resist the most because it is “foreign to you” and it appears hard. Actually, it’s not hard. It’s just learning a few new vocabulary terms, addition, subtraction, multiplication and sometimes a little division…and you have spread sheets and calculators to help you!
So, what if you did “Bottom Up” budgeting? Many owners decide what revenues they want to generate each year and then discover what the profit is at those revenue levels. If they don’t like the profits, then they increase the revenues. So, they actually are determining the profits they want in their heads and then adjusting the revenues to meet the profits.
What if you first decided what profit you wanted in 2014 and then determined the revenues that you needed to generate those profits? What if you started at the bottom of your 2014 profit and loss statement and worked up?
Once you know the revenue you need you can determine how to generate them. This is bottom up budgeting. Here’s how you do it:
- Write down your company’s profit seasonality. You might lose money in January, February, and March. You might earn great profits in June, July, and August. These are the percentages that you earn each month. And yes, there can be negative months. However, what if you had zero profit those months rather than a negative profit those months?
- Once you know the percentages each month, determine the total profit dollars you want to generate in 2014. Multiply each month’s percentage by the total dollars. Then you know the total dollars you will earn each month.
- Determine your monthly overhead. Look at your actual 2013 monthly overhead, add the amount of salary increases, insurance increases, and other additions for 2014, and you have your monthly overhead estimates for 2014.
- Add the monthly net profit and overhead.
- This gives you the monthly gross profit you must earn.
- Look at your 2013 monthly gross margins. (Gross margin is gross profit divided by sales). These should be fairly consistent from month to month.
- Divide your monthly budget gross profit by monthly gross margins. This is the revenue that you must generate each month.
Now, figure out how to generate that revenue!
Then, every month when you get your financial statements, compare the actual results to budgeted results. Where were you higher? Lower? And most important, why were your higher or lower? If your revenues were higher than expected, what can you do to continue this trend? If your expenses were higher than budgeted, what do you need to do decrease the expenses in future months?
Email me (rking@ontheribbon.com) if you’d like an excel spread sheet to make the calculations. All you have to do is fill in the blanks!
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