Budget is not a Four-Letter Word

While budget is not a four-letter word, you’d think it was from the reactions and grumblings I get from clients as we work through their financial records, record keeping systems, and deciding how to best leverage their strengths, knowledge, and skills to increase their income and profitability.

Your budget is just one part of your financial picture. It starts with your financial history: a summary of what you’ve made in the past, what you have to show for your efforts, the strengths of your products and services, and a snapshot of how you’ve spent the money you made. Your history summarizes your past performance.

Your projections point the way to what you want/expect to make in the future. They are often referred to as sales projections, what you hope/expect to sell. And, if you’ve done your homework, you will factor in both business and market conditions, the national/local economy, your competitor’s activities and strengths, and personal, new baby, sick parents, relocation, issues, challenges, and concerns.

Most of us base our budget on our history, and our sales on our projections. When you switch them, you head for trouble. By basing your budget on sales projections, you can overshoot your income and spend or commit money you don’t yet have. By basing your projections just on your history, you can miss emerging opportunities, and undershoot, or miss lurking challenges and overshoot.

Protect your mental health: budget on history, what you have made, and your sales on projections, what this next year will most likely bring.

Look at Categories before Numbers….

Carefully assemble a list of all the types of income and spending you have. Some people use the categories on their Schedule C, others rely on the chart of accounts their accountants give them. Whatever the list of categories you use, be sure you make notes about what’s included in each. Don’t be surprised if the same kind of expense, i.e. travel shows up in a couple of different areas.

For example, lots of consultants and speakers find travel appropriate in both cost of goods and professional development. And, in reimbursed expenses too.

Be sure you know how to account for your expenses, especially if you have expenses directly related to work projects.

Direct costs, costs of goods, are those costs and expenses directly related to producing your income. It can be travel to a site, materials fees, money you pay subcontractors, equipment costs, or rentals. If you need it to do the job, you have a cost of sales or direct cost.

Direct costs will fluctuate according to how much of what you sell. By subtracting them from your income, you’ll get your gross profit. Other costs are overhead, or indirect. Any expense you need whether you sell a service or not is overhead. Overhead includes rent, insurance, marketing, and utilities. Usually overhead is pretty stable, from month to month.

Both numbers, direct costs and overhead are needed to calculate your Net Profit. Calculate your Net Profit by subtracting your overhead from your Gross Profit. It’s what is left after you’ve really accounted for all your expenses. Reorder the categories for your budget in two groups: direct costs first, then overhead.

Time to plug your numbers into your budget….

Print out a running yearly summary from your software accounting package by choosing category summaries. Then use these numbers to decide on a good number for each budget category. If you find either income or expenses categories in your software accounts that aren’t in your budget be sure to either add a new category or include it in an existing category.

If you’re like most people, this can be a sobering exercise. It forces you to see what you’ve actually been doing. And, decide if this is the way you want to continue allocating your money.

There are usually two categories that aren’t included in most budgets. You might want to consider an item for repair and/or replacement of larger equipment and tools. And, be sure to include a category for investing money so you can move up to the next level.