Budget and profit planning
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by: taxaccountingpayroll
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Date: Mon, 28 Nov 2011 Time: 12:54 PM
Once your mind is clear on the outcome you’re trying to achieve, you can move on to the next stage. This is where budgeting and profit planning come into the mix in a big way. Both involve understanding your business, and working to ensure its sustainability and success.
A budget is a forecast of what the business position and performance will be at/over a specific period of time. For established businesses, there would be some form of history to look back at and base a budget on; but budgeting for start-ups is much more of a thumb-suck. While people may tell you to start by projecting your sales, I’d advise starting with your expenses, as these are often easier to gauge.
Focus on your expenses
Reduced to their simplest form, you’ll have two distinct types of expenses: fixed and variable. A fixed expense (also called an overhead) is one that is incurred regardless of what output or activity occurs. These would be things like rental, basic salaries, most types of insurance, etc. If you were to sit around and twiddle your thumbs, these bills would still need to be paid. Variable expenses, however, fluctuate. These would generally increase with increased outputs or sales of goods and/or services. Examples here could be telephone expenses, sales commission, fuel, and material costs. If you were producing more, these costs would go up on a similar trajectory.
Now when drawing up a budget, you should be able to put figures to most expenses. You know what your fixed expenses will be. Speak to suppliers, and find out how they structure their prices. Do they give discounts for volume purchases? This will help you to narrow down what it will cost to produce or offer the goods or services that you do. Record your fixed costs, and then explore a couple of scenarios for variable ones – these will be tied to your sales and revenue forecasts.
Guess your revenue
Unless you have guaranteed orders as far ahead as you can see, projecting sales and revenue is always more of a blind man’s guess when compared to estimating your expenses. Work up a couple of permutations of how things could pan out, and examine each of these.
Start by projecting a worst-case scenario, a best-case scenario, and then a more realistic scenario somewhere in the middle. Remember to take any industry-specific, macro, or micro factors into account (seasonality of demand, effect of potential interest rate changes, results from marketing campaigns, etc.) Multiplying your projected sales numbers by selling price will give you your revenue numbers. Be sure to then tie these sales figures/unit numbers to your variable expenses as well, to give you as realistic a view as possible. Remember that in a sustainable business your revenue must exceed your expenses.
Price for profit
Right, now the magic question is: How much do I charge? While I couldn’t possibly answer this comprehensively (every situation is different), there are some basic principles.
First always ensure that your sales price covers your variable costs for that unit, as well as its fixed cost allocation. Take Sandy as an example. Sandy produces hand-woven baskets from recycled metal and weaves them herself. She doesn’t employ anyone, and can make 50 baskets a month. Her fixed costs are rental for her workspace of R3000/month, and R500/month for computer and ADSL rental. She needs R35 worth of metal for each basket, and R2 for industrial glue and clips to hold each basket together – these are her variable costs. Each basket, therefore, has a variable cost of R37.
The fixed cost allocation is calculated by spreading her fixed costs over the amount of product made. If she makes 50 in a month, her fixed costs of R3500/month must be split over 50 baskets – coming to R70 a basket. Sandy works a standard 160 hours a month, and would want to be paid R8000 a month if she worked anywhere else. This cost also needs to be factored into the baskets, as she is giving up her potential earnings elsewhere. This means an extra R160 a basket. We now have a cost per basket of R267 (R37 + R70 + R160).
This means that she should sell her baskets for R267. Right? Well, while she could sell them at that price, it wouldn’t be a smart move as all that she would be doing is compensating herself for her time. As a business owner, you want more than that; you want to create wealth, which comes from profit. So, the lesson is to always factor profit into your pricing – not just expenses and a liveable salary. In Sandy’s case, if she were to sell her baskets at R350, an element of profit would be generated. Theoretically, she could employ someone else to make the baskets, pay them the equivalent salary of R8000, and still make money. Another lesson: Always try and generate wealth using OPT (other people’s time).
While this is a light brush over some aspects of financial management, applying the principles of effective goal-setting, budgeting, and profit planning correctly will bring you exponentially closer to your overall business goals. Here’s to your success!
About the Author
ABTAPS – Accounting, Payroll, Tax
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