Is it worth it?  Create a Budget to Find out.

Budgeting is the one thing that most owners hate.  Many owners hate it so much, they never do it.  “I’ll wait till my taxes are done to see how much money I made.”  “Sales are going up, must be doing something right.”  “Money in the bank, it’s all good.”

If things are going along well, why bother?  Why bother going through the mental gymnastics of planning your finances with a budget?  For me, that’s the perfect time to plan your finances.  Because we have all been in the position of working harder and longer and questioning is it worth it.  And often we forget that dollars in the bank is not the only measure of success.

Building a solid budget allows us anticipate issues before they happen and think about ways to avoid them.  It helps us answer the question “Is it worth it?”.  A budget is a tool to help you focus on your priorities and avoid distraction.  It provides a focus for your business.

One of the reasons managers don’t create a budget is because it is hard to look into the future, let alone pull all of the numbers together.  Here is a thought process to help you develop a strong budget.

Start with your historical profit and loss statements, hopefully at least 3 years.  Break your cost down to a cost per unit value.  For a detailed post on how to calculate your per unit cost of production, click here: https://successscorecard.com/2018/02/28/managing-by-the-numbers-per-unit-cost-of-production/.  Average the cost per unit for the time period you have and look at the trends per year and what your plans for the next year on before deciding on a good value to use.

The next step is to break the accounts into fixed and variable costs and recreate a yearly budget based upon how much you think you can sell the next year, multiplying the variable costs per unit by your projections and keeping the fixed costs level.  With a bit of Excel magic, you can tie all of the variable costs back to one cell that you can change and quickly see what happens to your bottom line when you change your sales projections.  I always like to do a good, bad, and ugly scenario because as optimistic humans, we tend to think sales will always go up, a bad assumption all too often.

This process is particularly useful when your business is changing.  It gives us a projection tool that helps us answer the question “Is it worth it?”  as you take on more responsibilities and work.  Take your time, run the numbers and make a good decision based upon numbers.

Are your profits growing at the same pace as sales?

Sales growth is wonderful, and what most of us like to see happening.  But the real indicator to keep your eye on is profit.  During growth periods, there are people coming and going on your payroll, new product lines, tools and computers bought, bigger offices, more phone lines, the list goes on and on.  But the question remains – are you better off with or without the sales growth?

You don’t need to wait for your taxes to get done to answer this questions.  By merging sales data with your profit and loss, you can look at income and expenses on a standardized per unit basis, allowing you to compare how things were to how things are.  QuickBooks has a nifty export to Excel feature that make life much easier to make the calculations.

Need help with the process?  That’s what we are here for.  In person or by Skype, we give you the numbers to make better decisions.

It’s all about the numbers

I have been working with a maple syrup producer recently.  It is a very seasonal business with large fluctuations in production driven by the weather.  They have been selling wholesale and looking at increasing their profit margins by moving into the retail markets by developing an online store.  Everything was on track until Mother Nature decided to throw a curve ball.  The crazy spring weather reduced production by 35% from last year.  There was barely enough production to cover the wholesale orders.

The retail expansion plans were shelved until next year.  At least until we started looking at the numbers a bit more.  We had been looking at equipment purchases to package for the retail market and had some solid cost numbers on the equipment and the cost of production for each stage of the operation.

The aha moment came when we asked the question “What if we bought high quality syrup on the wholesale market instead of producing it ourselves?”  When we compared our costs to wholesale prices, we found that not only could we make money by buying wholesale and packaging for retail, but we could make as much money as producing it ourselves.

By shifting our focus and looking at different ways of reaching our goals, we came up with a way to continue the growth rate.  The original focus was always produce as much as possible and sell what you make.  Shifting the focus to finding a way to sell maple syrup instead of produce as much as possible seems like a small change, but it will mean the difference between an average year and a very good year.

The question is, what small changes in your thinking can have big impacts to your business?

Your taxes are done, now what?

You spent all this time gathering information for your CPA to do taxes.  Income, Expenses, Capital Purchases, Depreciation, and every other detail your CPA wanted you to dig up.  And then you paid Uncle Sam a nice chunk of money.  Most people don’t want to look at financials any more for another year, but this is exactly when you should be delving into the nuts and bolts of your business to assess your strengths and weaknesses.  What do all these numbers mean and where do you start?

When I am asked to look at the health of a business, I start with this list.

  1. EBITA  – Earnings before Interest, Taxes, and Amortization.  A look at how your efficient your business is without taxes or debt
  2. D/A – Debt to asset Ratio – how dependent upon debt is your business.
  3. ROA – Return on Assets – What percentage did you make on the total assets of your business
  4. ROI – Return on Investment – How much did you make on YOUR investment
  5. Owners hourly rate – often owners pay themselves a salary, but breaking it down to an hourly rate can give you a different perspective
  6. Cost of production per unit, compare to previous years.  Are you making improvements in cost control of critical areas.
  7. Budget vs Actual – look for how accurate your plans were.
  8. Profit and Loss, compare previous years.
  9. Inventory Adjustments  – make sure inventory purchases and use are not artificially inflating or deflating profit.
  10. Accrual vs Cash Profit and Loss comparisons- in particular, I am looking for big changes in AR and AP, Inventory values
  11. Profit and Loss, with percent of income and expenses.  Look at the big expenses and see if small changes can make a big impact on the bottom line.
  12. Develop or tweak budgets – now is the time the numbers are fresh.  Look at your plans for growth or cutting unprofitable areas of your business.  Incorporate marketing plans with financial plans.  Plan your profit levels.
  13. Balance Sheet – Look at changes in Net Worth

Ideally, you would be looking at these indicators on a quarterly or monthly basis.  Minor adjustments to spending or income timing can have big impacts on your total tax bill.  The trick is to know you need to make adjustments in the same tax year, not 3 months after.

It is a long list, and it takes time and thought to go through.  But the payoffs are there.  Don’t be intimidated by numbers!

Turn things around

So you have finally come to grips with the fact that you are in over your head financially. What is your first step? STOP DIGGING. Stop. Spending. Money. Now.

Then start answering these questions.

First of all, where do you stand financially? Who do you owe money to, who owes you money. What assets do you have, what liabilities do you have? What contracts do you have with clients?

The next question is where did you spend the money – cash, credit, barter, checks, debit cards – all of it. Don’t hide anything, you are only lying to yourself. It is important to know how you got to your current situation.

Third, find out where can you make the most money the fastest. If you don’t know your margins, you don’t know where to focus your efforts. Focus on high margin products until you are stabilized. Look at both the income and expense side of the equation, sometimes it is easier to increase income than cut costs.  Keep in mind that 10 hours of work at $40 per hour is much better than 40 hours of work at $10 per hour.  You may not have the $40 per hour work available when you need cash, but work towards that type of work.  You will be much better off in the long run.

Third, develop a realistic budget. A budget not only shows cash inflows and outflows, but what your priorities are. By making a conscious decision on what to fund and what to ignore, you have set your priorities. Any time you deviate from your budget, you should question if the purchase fits your priorities. If your priority is to stop bleeding cash, then you should probably cancel the spring break trip to Florida.

Financial turn arounds happen every day. But it takes a concerted effort to change the habits that got you there in the first place. Make a commitment, enlist help, and develop a plan to make it happen. It is your choice!

A business without a budget

I have been having a running conversation with a person who wants to open up a storefront.  Very good ideas, and he was ready to move fast.  So when I said, “Not to be forward, but what do your budgets show for sales and expenses?”  I was met with silence.  Then a quiet “I don’t have a budget yet”.  Sadly, that is a common response.  And while the business idea may be solid, I really prefer to make mistakes on paper.

Asking about a budget did not shake his confidence in the business.  It actually took a bit more than that.  I shared a customized budget template with him and filled in a few numbers based upon conversations with him.  When he started seeing how much sales he would need to cover cost of goods sold, rent, gas, electric, internet, and that pesky thing called owner draw (that’s your pay by the way!) he started thinking about the volume needed to carry a storefront.  It was only then that he slowed down and started to see the benefits of a solid business plan.

After using this template as a framework to look at his business idea, he backed off from signing a 12 month lease.  And that’s a good thing.  He has not lost sight of his dream, but is now focusing on building up his web sales before investing in the overhead of a storefront.  Now his focus is clearly defining his target market, building up his list of potential customers and finding out not only what they want and need, but how much they are willing to pay.  Those numbers are plugged those numbers into his budget, making an even better plan.

I have often heard that a business plan rarely survives first contact with customers, and I agree wholeheartedly!  But that does not mean that you ignore the basics of finance and sales.  Instead, focus on the needs and wants of your customers as you develop your budgets and business plan at the same time.  A business plan is much more robust when you approach the process by focusing on the customer first.  Take the time to work through the numbers first – whether it is a brand new business, or an expansion of an existing business, it pays to make the mistakes on paper first.

Need help developing a financial framework to look at your business?  Want to see the sample Excel budget that helped him change his path?  Send me an email and I will be happy to share it with you!

Too busy for training?

Sometimes training seems expensive, until you take into account the savings in time.  Bear with me on the math (I’m a numbers based person!), but if 4 employees are averaging $35,000 per year, and take an 8 hour class that saves them 30 minutes per day, it takes under 2 months to pay off the class and the time spent in the class.  I have seen equipment payoffs of over 3 years in some cases!  After that, the money goes right to your bottom line.

The lesson to learn is that it pays to assess your skill sets on a regular basis and find out where you can get big payoffs.  Spend time where it is important.

 

Annual Wages  $35,000.00
Working Weeks 50
Hours per Week 40
Labor Overhead – Taxes & Benefits 50%
Dollars per hour (wages/weeks/hrs per week)*labor overhead  $26.25
Course Time (hours) 8
Per Student Labor cost during training (dol per hour * course time)  $210.00
Number of people in class 4
Total Student Labor Cost (per student cost * num students)  $840.00
Instructor Cost in Dollars per hour $125
Instruction cost (Instr. $per hour * course time)  $1,000.00
Total Cost – Student and Instructor (instr. cost + student labor cost)  $1,965.00
Total Cost of training per student (*student & Instr. cost / # students)  $491.25
Hours Saved per week as result of training 2.5
Annual Savings (hrs saved per week * working weeks * labor $ per hour)  $13,125.00
Net Savings (savings – cost)  $11,160.00
Months to recoup investment (total cost / annual savings / 12 months) 1.797

 

Is it worth monitoring?

I used to be over zealous about monitoring and tracking EVERYTHING. Now I am just zealous. It took me a while, but I have learned that if you are not using the information, why are you spending time to track it? For a numbers junkie like me, that is a very difficult conclusion to reach. However, after years of tracking everything under the sun, I have found the power of a simple and focused management metric system to be an incredibly effective management tool. It allows you to focus your management time on what you have identified as the most important variables in your business and effectively communicate that information to your people.

Don’t get me wrong; it is vitally important to track information in your business, and critical that you collect the correct building blocks of an information management system. It is much easier to enter a few pieces of data once a day than to try and recreate 6 months worth of data, just because you didn’t think it would be useful. But there needs to be a balance. I have seen accounting setups for small businesses with 150 expense account codes and setups with 4 expense codes. It doesn’t matter if you are drowning in information or starving for information, either scenario is ineffective.

So where do you start with figuring out what data to collect? With the goals for your business.

Lesson Learned: Analyze what you have and what you need, then strike a balance a to make it happen.

Focus on the Numbers: Per Unit Cost of Production

What is a per unit cost of production and why should I care?  A per unit cost of production allows you to examine your business over time as the size of the business changes, giving you a much more objective way of measuring performance.  Think of it this way, if you add 5 employees to your payroll and your net income goes up, you won, right?  Maybe, maybe not.

If you take your profit and loss statement and divide each line item by the number of employees for that same time period, you can come up with a per unit (in this case, per employee) cost.  Now when you want to look at two time periods and ask are we doing better or worse, you can reliably answer by each line item.  So if in 2016 first Quarter, you employed 10 people and made 10,000 widgets, you would expect 2016 Second Quarter with 15 people to be able to produce 15,000 widgets.  If you actually produced 12,000 widgets, you better start digging into the numbers more.  If you increased production to more than 15,000 widgets, you may deserve a pat on the back!

Now there are a ton of variables that can affect the per unit cost of production – economy, new equipment, training programs, input cost increases – all will affect the per unit costs.  But at least now you have a tool to help you objectively monitor your business by line item on your P&L.  The fun part is in asking the question why.

Per employee is not the only way to look at your production facility – I have seen managers look at per unit cost by total production, employee, per thousand dollars of investment, and many other ways, searching for the best way of describing their individual business.

Here is a  really cool trick for you to play with:  export a report from QuickBooks into Excel.  Now it is just a matter of adding a column to the spreadsheet, figuring out what per unit you want to look at, and creating a formula to do all the work for you.

Piece of cake… I know!  But that’s another day’s blog post…

Why do we have managers who can’t manage finance?

The failure rate of startups has always dismayed me. In my consulting, I see two main reasons for business failure. First, people don’t have a firm grasp of their financials. They just don’t know their numbers. Second, people underestimate the toll on their physical and mental health. Depression, divorce, heart attacks and strokes from stress are all too common and dismantle many companies that have everything else going for them.

Let’s look at the first reason for failure – Managers who can’t manage finances. The bulk of our entrepreneur class consists of people who start a business out of passion – I love to bake, to farm, to fix computers – but they don’t have any business background. How do they get their start? They are disgruntled employees who are so fed up with the way their boss does things that they quit and start their own business, with the barest of plans.

If you think about it, the entire restaurant industry has managers who do nothing but sooth irate customers and make sure people show up for work. Manufacturing is no different. From line managers to shift managers, financials are hidden from people. The focus is make your production numbers, or we will find someone who can. Anyone who has had a sales job knows it is all about hitting the sales quota. Just sell more, more, more. Rarely does anyone get to see the whole financial picture.

Is it any wonder todays entrepreneurs are missing critical skill sets? Budgeting. Reading financials. Financial controls. Cash flow. Profit and loss. Balance Sheet. Net Worth. Top that off with the misconception that having a CPA do their taxes once a year is more than enough and you have a small business at a disadvantage.

Here is a news flash. If you can’t put your hands on rock solid financial numbers to back up a decision and plan for the future, you are not managing. You are working hard and hoping for the best. Maybe it’s time to start working smarter, not harder. Focus on your financials.