“A budget is telling your money where to go instead of wondering where it went.”
–John C. Maxwell
There’s nothing worse than getting to the end of the year and wondering where all the money went. Between payroll, taxes, and rising expenses across the board, no wonder there’s never as much left as you anticipated.
Before you close this article because you think “budget” is a four-letter word, consider that awesome John C. Maxwell quote above. Don’t you want to boss your money around, starting with profit?
I’m a huge fan of Profit First by Mike Michalowicz, one of the best books you could read on how to pay yourself first. Too many entrepreneurs and business owners work for free or for very little because they’ve let expenses run the show instead of making profit run the show.
So how exactly do you put profit first? It’s much simpler than you think.
Start by determining your big expense buckets.
For most businesses, these will be some combination of:
- Payroll: Often the largest expense.
- Cost of Goods Sold: All expenses required to actually deliver the product or service.
- Operating Expenses: Facilities, office snacks, you name it that isn’t required to deliver the product or service.
- Marketing & Sales: What brings the money in.
- Profit: Traditionally, what’s left over.
Depending on your type of business, you may have other big buckets like capital expenses, R&D, etc.
Now let’s flip this model on its head and assign percentages to each bucket. Ultimately, these five buckets (plus any others you add) have to add up to 100% of the revenue. Here’s how I’d order them from most to least important:
- Profit: Traditionally, what’s left over but now your #1 priority.
- Cost of Goods Sold: All expenses required to actually deliver the product or service.
- Payroll: Often the largest expense.
- Marketing & Sales: What brings the money in.
- Operating Expenses: Facilities, office snacks, you name it that isn’t required to deliver the product or service.
If we commit to Profit First, you start by assigning a profit margin appropriate for your industry and business size. For the sake of this example, let’s say you are forecasting $1M in revenue next year and you want to make an industry-standard, respectable 20% profit margin. Once you assign $200,000 to profit, you have $800,000 left to allocate to your other categories, again using industry-standard benchmarks:
Ideal:
- Income: $1 million
- Profit: 20% or $200,000
- Cost of Goods: 10% or $100,000
- Payroll: 45% or $450,000
- Marketing & Sales: 10% or $100,000
- Operating Expenses: 15% or $150,000
Now let’s say your payroll will actually be $500,000 and your operating expenses are forecasted at $250,000. That’s $150,000 more expenses than ideal, industry-standard, and leaves you only $50,000 in profit.
- Income: $1 million
- Profit: 5% or $50,000
- Cost of Goods: 10% or $100,000
- Payroll: 50% or $500,000
- Marketing & Sales: 10% or $100,000
- Operating Expenses: 25% or $250,000
Do you cut the profit? No! You cut the expenses. Why is payroll so high, and can you increase production to create more revenue and higher margins? Why are there so many random software expenses? Is it time to renegotiate some of your vendor contracts?
The bottom line: Do you want to own your business, or let your business own you? By putting profit first and creating a budget with allocated percentages across broad categories that fall in line with your industry’s benchmarks, you can actually plan for – and realize – the profit you want, not the profit you end up with after every other dollar is spent.
We help small businesses proactively plan, budget, forecast, and increase profits with our Virtual CFO services. Schedule a free strategy session today to find out if this is a good fit for you and your business.
