3 Key Points in this Episode:
- Personal budgets for the business owner must be kept separate from the businesses budget.
- Your budget should include fixed expenses, variable expenses, one-time expenses, and profit/savings.
- Your budget should reflect reality, not wishful thinking.
Have you checked out the Build a Better Business Podcast Facebook page?
Let’s get started with episode 106.
I would like to remind everyone that this podcast is for information only, you are responsible for all your own decisions, and I highly recommend that you get advice from professionals before making any financial decisions in your business.
Today, I am going to share with you the many lessons I have learned about how to create a budget for your business. For many people, the whole subject of budgeting and cash flow is very overwhelming but since a lack of cash flow is one of the most common reasons for business failure, it is important that we get a handle on our finances.
I’m going to start with sole proprietors and after the break, we will focus on the annual budget process that most larger businesses go through and we will talk about the common mistakes executive teams make when preparing annual budgets.
Okay, all you sole proprietors out there let me know if this sounds familiar:
- You transfer money from your business account into your personal account when you need money.
- Your businesses cash flow is unpredictable.
- Your profit always seems to get spent.
- You’re using credit cards at times to cover variable expenses.
- You’ve missed opportunities to purchase equipment, inventory, or other assets that would help you expand your business because you didn’t have the money.
- Paying taxes every year is stressful.
- Starting a business was supposed to help you make more money, but you feel like a conduit for cash.
Well if this describes your situation, I want to let you know that you are not alone. I speak to small business owners in every industry and I hear the same stories repeatedly. In fact, when I owned and operated my business, I experienced all these things until I figured out something out that changed everything.
You may remember that in the past I have mentioned that my wife and I struggled for years until we incorporated a budget, expense report, and cash flow statement into our financial system.
As a sole proprietor, the government really doesn’t look at you and your business as separate entities. In Canada, the only way to create that separation is to start an incorporated business but even then, by and large, if your business is small you are still basically your business. In the US, I commonly hear people talk about creating an LLC and I assume it is similar.
The real problem is more the owner of the business doesn’t look at their business and personal life as separate. This is where you get the problem of business owners transferring money from their business account whenever they personally need more money.
The solution is to create a budget that clearly separates your personal budget from your business budget. The way I like to do this is to use an excel spreadsheet and at the top of the spreadsheet, I have my personal budget.
This is where I list all my fixed expenses, like my mortgage payment, car payments, insurance payments, utilities if you’re on an equal payment plan, and perhaps your cell phone, internet, Netflix or cable bill.
Next, on the personal budget, I list all my variable expenses, things like food, personal products, home care products, vehicle maintenance, entertainment, clothing, and other expenses that fluctuate from one month to the next.
Finally, I like to list my savings on the budget, this should include your retirement savings, in Canada we have RRSP’s and in the US I believe it is your 401k, your savings account, in Canada TFSA’s are common, your children’s education, in Canada we have RESP’s, and I recommend you have an unexpected expenses fund. These amounts should be fixed, and contributions should be made automatically at least each month.
Once you have all your personal expenses, fixed and variable, and your savings accounted for you can total them and get a monthly amount you need to make to live your life.
Next, just below this, you create a business budget following the same process. First, you list all your fixed business expenses, things like lease, rent, or mortgage payments, utilities, internet, government or banking fees, telecommunications, web hosting, accounting, and legal services, and insurance. I also like to have a maintenance line in the budget that puts money away for unexpected business expenses. This is a fixed amount that you put aside every month.
Next, you list all your variable expenses, things like raw materials, sub-contractor wages, commissions, advertising and other marketing costs, transportation, travel and events, and printing services. You may also want to list one-time expenses like purchasing a computer, software, printers, or furniture for your office.
Now I like to add your employees to the budget.
Even if you are a sole proprietor, I want you to add yourself as the first employee. Create a formula that automatically takes the total amount of your personal budget above and puts that amount in this spot on the budget. That way when you update your personal budget it will automatically update your business budget. This will stop you from taking money out of the business account and transferring it to your personal account when you need money.
Now add the rest of your employees and below this make sure to add in the employee expenses like income tax, pensions, and workers compensation. You can create formulas that will calculate these amounts automatically for you based on the salaries you are paying yourself and your employees.
The last step on your business budget is to add the amount of profit you will save. This is important for several reasons, one it gives you a target to aim for and helps you make pricing and other decisions related to how much you spend on specific expenses. Two, this makes sure that profit is on purpose and not a happy accident. Three, it allows you to create a profit-sharing model that rewards performance.
Guess who the primary recipient of this reward should be?
I believe it should be you the owner. Imagine writing yourself and your employees a bonus check every quarter. That is when all the hard work and sacrifice becomes fun.
Okay, so now you total all your business expenses, which includes your salary as the owner and the profit you are planning to make. The number that you get is the minimum revenue your business must earn for you and your business to be successful.
Now the final step is to make 12 columns beside the column with your budget. Label them January through December and input the real numbers each month as the year progresses. This will allow you to see how you are doing financially and will alert you to trends which will empower you to make better decisions.
The final thing I do on this kind of budget is to put a row below the business budget where you can input your actual revenue and that will allow you to calculate profit or loss each month.
If you create a comprehensive budget like this and stick to it all your bases are covered. The business will be profitable, you will have money in the bank for unexpected business and personal expenses, and you will personally have money your children going to university or college, your retirement, and you will have liquid cash that will insulate you from unexpected challenges and empower you to capitalize on opportunities.
One of the by-products of doing all this consistently over time is that your business will grow. Once your business becomes a corporation and scales in size the budgeting process becomes more of an accounting function and you will need a more sophisticated financial system.
After the break, I want to talk about the common mistakes that executive teams make when preparing annual budgets.
This episode is sponsored by:
This episode is sponsored in part by the Build a Better Business Weekly Email, I want to encourage you to join my email list by going to jamieirvine.ca/email. I send out one email a week on Friday where I share valuable information that you won’t find on my blog, podcast or anywhere else.
The Problem with Most Corporate Budgets
We are back from our break, I want to talk about the common mistakes that executive teams make when preparing annual budgets. Sole proprietors need to pay attention to this part because one day you will face these same challenges.
Okay, all you CEO’s and VP’s out there tell me if this sounds familiar:
- You create an operating budget predicting expected revenue and expenses for the year.
- You create a cash flow budget that maps out when your business can expect payments and when you will have to pay bills.
- You have meetings with your branch managers and sales managers, and you create plans for them which include their budgets that their performance will be measured against.
- Everyone is on the same page and seems to clearly understand their role in achieving the results necessary to satisfy the board’s expectations.
- Two months into the year everything falls apart and it seems like no one is doing what they said they are going to do.
If this is your experience, I know how frustrating it can be.
After spending 21-years working with executive teams and being the CEO of my own business, I believe that there is a common denominator that causes this annual budget process to be less than effective.
Arbitrary Growth Expectations
The problem is arbitrary growth expectations regardless of market size or market share potential. I have heard so many executives proudly say, “we are a growth company” like that means something.
What many executives fail to do is accurately measure the total size of the marketplace in a given area and establish a reasonable percentage of market share that branch managers and salespeople will be expected to achieve and then maintain.
Do you want to know how a salesperson view this?
Okay, but you might not like what you are about to hear so brace yourself.
The first thing an experienced sales person will do is calculate the size of the market in their territory and the reasonable market share that they expect they can achieve with the existing infrastructure the company has in place within that territory.
Next, the salesperson will look at this year’s sales budget and if the budget represents a smaller percentage of market share then the company currently has, they will plan to grow their territory so that they can earn a commission. Now many so-called “sales organizations” place a cap on the amount of commission that a salesperson can make. I personally think this is crazy, but it is the reality most salespeople must deal with.
The salesperson will sell up to the cap and then they will stop trying to grow because every dollar they sell above the cap will make the next year more difficult because the salesperson knows that the budget will be an arbitrary percentage of growth on the sales created the year before.
This will continue until the salesperson achieves what they believe to be the maximum market share they can achieve in their territory with the existing infrastructure the company has in place.
Once the salesperson hits the market share cap the salesperson knows that they will not be able to achieve the budget, never mind the commission cap and they will either coast until the sales fall below the market share cap and they can make commission again or they quit and move on. Therefore, salespeople on average in all industries only work for companies for three years.
Branch managers often play a similar game by holding back invoices until the next month or year if possible and inflating expenses on a month or year that they know they will not achieve their budgets so that the next year they can hit their numbers and get their bonuses.
I believe that the solution is relatively simple, but it requires a shift in mindset from annual growth that compounds over time to achieving and maintain market share percentage.
Imagine that we are on an executive team of a company with 50 locations.
The first thing we would do is establish the size of the market that each location operated in.
The second thing we would do is establish the percentage of market share each location could reasonably be expected to achieve and maintain.
Once we understood those metrics, we would establish a budget for expenses and targets for sales and profit that correlates with the percentage of market share we expected that location to achieve and maintain.
If we expected the location to achieve and maintain a 5% market share in their location, we would immediately establish a sales target. If the market was worth $500 Million and we expected that location to achieve and maintain 5% market share their sales target would be $25 Million.
Once we created a budget for expenses, we would immediately get a profit target. All we would have to do is take our sales target of $25 Million and subtract the expenses, let’s say our annual expenses for that location totaled $20 Million, that would create an annual profit target of $5 Million.
Now the final thing we would create is a bonus structure for managers, a commission structure for salespeople, and a profit-sharing structure for the other employees based on these numbers with no caps. Meaning that the sky is the limit. If a location achieves 8% market share when they are budgeted for 5% great, they should be rewarded for every bit of additional market share they have achieved and maintained. If a location achieved and maintained their 5% market share, they would get a bonus, commission, and profit sharing every year.
It is unrealistic to expect a location to grow every year because eventually, that location will hit their market share limit. When you have the annual growth model and commission cap in place you literally penalize employees for doing a great job because they know that the more they sell this year, the harder it is going to be next year. Also, people don’t like it when this year they get a commission or bonus check for achieving a certain target and when they do the same amount of work the next year, they get nothing because the goal posts are constantly being moved.
Conversely, when you operate with the market share model with no commission caps you encourage growth, but you acknowledge that there are limits with the existing infrastructure and you are willing to pay people for holding on to that market share and consistently earning that profit.
With the market share model, once you achieve and maintain your market share the only way that you achieve growth is by investing in infrastructure to achieve that growth. This runs completely contrary to the annual growth model which asks for employees to grow first and then get additional infrastructure.
CEO’s, VP’s, and business owners I want you to think deeply about this because it is entirely up to you what kind of results you achieve and how your employees respond to your efforts to establish budgets and create profitability.
This concludes episode 106 and if you would like to get a copy of the Build a Better Business Budget for Sole Proprietors go to jamieirvine.ca/smallbusinessbudget. This will provide you with a sample budget that you can use to help you achieve the financial success you have been dreaming about.
If you would like to establish a market share model in your business please feel free to reach out to me directly by email, [email protected], to discuss how I can help you make this model work for you.
On Tuesday, I am going to introduce you to Roger Nierenberg who has developed a truly unique way to conceptualize the challenges in your business that is preventing you from achieving your dream for your business.
This podcast sponsored by:
If you are hiring a new employee, I highly recommend that you use the Screen2Fit recruitment platform by Pro.File.
I use FreeeUp to find high-quality freelancers to help me run my business and you should as well.
Every business needs a website and I have used Gerrit and Trackstar Web Design since 2012 and so should you.
I use Process Street to create systems in my business and I highly recommend that you use Process Street as well.
Thank you for listening and I look forward to talking with you soon.