All organizations, irrespective of size or industry, have been influenced by COVID-19. We recommend looking forward to evaluating what is possible in this post-pandemic economy and creating a financial roadmap for your organization that mirrors this new world order. Many small business owners don’t take the time to create a business budget, but the process of analyzing your business and making a financial roadmap for future growth are the keys to a maintainable business model.
Begin from the bottom up (net profit)
Building a high-level business budget should begin by taking a good look at your bottom-line profit, usually known as your net profit. The first step in building a business budget is determining how much profit you predict making in the next 12 months after everything has been paid, including operating expenses, direct expenses and salaries. The reason to start at the bottom is to make sure the business is commercially practical. Using history to specify the future, particularly in the current environment, is a faulty process.
Review your operating expenses
Next, do a profound dive into your operating expenses. An operating expense is any expense you have in your normal business operations. For instance, rent, administration expenses, insurance, phone and internet.
Not all expenses should be included in operating expenses. You must exclude all Costs of Goods Sold (COGS) from operating expenses. This is an expense you incur that directly helps to make or sell your product or service. Precisely classifying expenses as either an operating expense or cost of goods sold assists to validate your pricing strategy and budgeting for growth.
An easy but strong visualization tool that is used in the Business Growth Program is called the “Power of One”. This tool shows the effect of 1% changes across your financial model. This is essential for building ‘what if’ scenarios.
As part of the budgeting process, you should look meticulously at your operating expenses. Consider what you can decrease, eliminate, or renegotiate. Is your landlord presenting rent reductions or rent holidays in response to the crisis? Have staffing levels been modified to suit current demand? You need to include all of these in your overall anticipation. Small changes can result in considerable impacts on your business budget.
Reclassify direct expenses
Your next duty is to reclassify costs as COGS or direct expenses. Can you see why it’s significant to know financial terminology? The easiest way to specify if an expense is an operating expense or a direct expense is to examine if the expense tends to increase as you sell more products or deliver more services. We find many business owners have not precisely categorized direct expenses in their Profit and Loss Statement.
Determining all direct expenses is very important because you need to consider all the expenses of delivering your product or service to make sure you are pricing your product or service accurately. If you do not have enough gross profit margin in your business, you will not be able to create adequate net profit for the business to be commercially practical. Calculate your gross profit margin by employing this method:
Income – direct expenses = gross profit.
Your gross profit must be enough to cover all your operating costs (and leave you with a profit).
If your gross profit is not covering all operating expenses and leaving you a profit, you must alter the business’ pricing strategy. These businesses experience a situation known as growing broke. They are growing their top-line income without receiving enough money to cover all direct and operating expenses to deliver a bottom-line profit.
Set realistic goals to make way for change
Finally, you need to calculate a top-line income goal. If you have followed this process, easily add your profit goal plus operating expenses plus direct expenses. This will show the top-line income needed.
For instance, this year you want to make a profit of $180,000. Your operating expenses are $200,000 and your direct expenses are $300,000. To deliver this profit, your annual income must be $680,000.
We suggest breaking this annual income into monthly goals and considering any seasonal adjustments. Consider if these income targets are realistic, particularly in the current economic environment. If they are not realistic or accessible, then alter the numbers. Do you need to decrease expenses, increase prices or lessen your profit goal?
In this post-pandemic world, it’s more significant than ever to remain close to your numbers when considering your business budget. Creating a financial roadmap means you have determined business targets and goals to strive towards a visible path to help you get there. Regularly reviewing your financial data means you can reply, adjust and reforecast targets and decrease expenses. Having more insight into your financial data will let you be in control of your financial decisions.