It is that time of year when plans need to be formulated so your business can make a profit. Budgeting involves looking into the future to see what must be sold to pay the bills, to provide a great salary for you and your spouse, and gain enough profit for re-investment. Budgets should be prepared for a 12 month cycle and when you complete one month, add one month to the end. Prepare yearly budgets, but focus on monthly budgets and sales goals. Too many contractors try to embrace yearly goals and forget they are losing money this month.
To prepare a budget, do not start with projected sales, but do start with projected profit. What is more important to the business, sales or profits? We want to calculate the profit we need to exist, then project the sales needed to get the profit we want.
In a company, we want a return on our investment. We have put assets and time into a company (called our net worth on the balance sheet) and want a return (profit). Return on investment, commonly called ROI, is analogous to interest at a bank. At a bank, we put monies (principal) into a savings account and after a certain time period we earn monies (interest) on the account. The percentage we earn is called interest rate at a bank and return on investment in a contracting company. When we develop a budget for our company, we want a return greater than in a bank or we would not own a contracting company.
To create a budget for 2021, use the following formula:
Return on Investment for 2021= Net profit wanted at end of 2021
Net worth at beginning of 2021
Change the formula to read:
ROI for 2021 X Net worth at beginning of 2021=Net profit at end of 2021
Most contracting companies average about 15% return on their investment each year, compared to the interest rate on CD’s or Savings of 3%. As a consultant, you should start the budgeting process with an ROI of at least 20%. Next, look on your year end balance sheet for 2021 and find the value for Net Worth (Sole Proprietorship or Equity). Multiply the ROI X Net Worth to get the profit wanted at the end of the year.
For example, Company A has a net worth of $200,000 and wants a ROI of 20%. Multiplying $200,000 times 20% achieves a value for net profit wanted of $40,000. If the company can achieve a profit of $40,000, it will have earned an ROI of 20% on its investment of $200,000. So, the next question is, How much do I need to sell to achieve this profit goal?
Sales volume can be budgeted based on calculated profit goals. In our example above, our profit goal is $40,000. The financial formula to budget sales volume is:
Sales volume needed in 2021= Profit goal for 2021
Profit % for 2021
My profit goal is $40,000 so what is my profit % for 2021? Look at your last years profit and loss and see if you were satisfied with your profit goal and profit %. If not, use a profit % goal of 8%. Most contractors can make an 8% bottom line in the service replacement business if they control their company and manage it well. All contractors should try to achieve 10% or better, but if you are focused in construction it will be very difficult.
If we take our profit goal of $40,000 and divide by our profit % of 8%, we get a projected sales budget of $500,000. Compare this calculated value with your sales from the previous year+20%. Use the higher sales value and rework the formulas.
For example using the company above, let’s say the company did $600,000 in sales last year. Add 20% to $600,000 to get a value of $720,000. Which is larger, $720,000 or the calculated sales budget of $500,000? User the higher value of $720,000 and rework the formula:
Sales volume $720,000=???profit for 2021
Profit %=8% or
Sales volume of $720,000 X 8% equals profit goal of $57,600.
Instead of earning a profit of $40,000, the company now predicts a profit of $57,600. How does this change our ROI?
If ROI equal Profit/net worth, then $57,600 divided by our net worth of $200,000 equal an ROI of 28.8% which is better than our first projected return. Now our budget shows Sales projected to be $720,000 and a projected net profit of $57,600 or 8% of sales.
Create you annual budget, then divide the budget into monthly budgets and let the budget drive your costs and sales. Track actual values spent on costs and actual sales to see if you have a gap or gain. Modify your budget if necessary, but work only one month at a time. If you make money every month, you’ll make money for the year.
www.profittrackersoftware.com has a great program to produce annual and monthly budgets, cash flow projections and estimate jobs.