So you sit down with your financial adviser or consultant, prepare for the brain-numbing task of setting your budget and out comes the routine question - "How much money do you need to make this year?"
If only it were that simple.
Hummmmm...Let me see. You want to make $200,000. Said and done. All you have to do is fill out a bunch of numbers on this sheet and it will all come true? Isn't that how the typical budget is created? Figure out how much money you want to make at the end of the year, predict your margin, and calculate the sales you need to generate?
Now, I don't know about you, but that strikes me as an over simplification of the most difficult part of running a business: landing a bunch of profitable work. I've worked for multiple companies that tried to budget this way and it never came out right. We would have been much more successful by assuming last year's performance would repeat itself.
Before I share a simple and effective budgeting approach, a little ground work is in order.
What Role Does A Budget Perform?
The purpose of your budget is to operationalize your strategic plan. In other words, your budget is a financial projection of what you plan to do this year. Your strategic plan should have identified new sales opportunities and the efforts required to take advantage of them.
Assuming improvement from last year without constructing a strategic plan that uncovers profit opportunities is folly.
It's very hard to START the budgeting process at the net income level. Not saying it's impossible, just very, very difficult...and often very confusing.
The budgeting process should give you great clarity on performance targets and milestones. It should give you great clarity on how you are going to run your company this year. Starting with a goal that has no foundation destroys the process.
When you work the process right - which I am going to show you how to do just that in a few moments - you gain incredible clarity on how your business runs. Clarity of how the volume of leads, the number and size of jobs and your gross margins affect your bottom line.
It also gives you new insight into your business.
So, if starting at the bottom line is the wrong starting place, where should you start? Believe it or not, you should start your budgeting process by focusing on your field labor costs.
The Secret to a Successful Budget
We're going to do a little math here, probably not your favorite subject (but at least more fun than English Lit!).
Here's the business formula you know so well: S - DC - OH = P
S = sales revenue
DC = direct field costs
OH = overhead expense
P = profit
We need to break down DC further.
DC = L + M + E + Sb
L = field labor
M = material
E = equipment
Sb = subcontracted work
The secret to budgeting is to focus on your labor costs (L).
How Much Work Are You Going To Do This Year?
Start your budgeting process by estimating how many hours your crews are going to work this year. Yes, believe it or not, the key to budget accuracy is accurately predicting how many HOURS your crews will work this year. It may be easier than you think
Pull up your payroll reports from the last three years and look at the trend. Did it bounce around? Did it increase yearly? Did it go down yearly? What affect do you expect the economy to have on your work opportunities and work hours this year?
Make a decision. Actually, make two decisions. How many straight time hours will you be paying for and how many overtime hours will you be paying for?
Now, are your wage rates going up? Factor that in and land at a labor cost for the amount of work you're going to do this year.
Material, Equipment, and Subcontracted Costs
Now that you know how much work you plan on doing (think in number of work days) you should be able to estimate the amount of material and equipment you will need.