In Minor's League: Jan. 2001

ANSWER: A budget is the single most important financial tool you can use when managing your business. Think about it this way. When you go on a trip to an unfamiliar location, what is the one thing that you need? You need a map. The same is true for your business.

When you are making plans for the coming year, that map is your budget and plan. The budget tells you where you are going to go, how you are going to get there and gives you a vehicle to monitor your progress.

Where does budget planning begin? First, create a detailed chart of accounts. I would strongly encourage using one consistent with other contractors, that way you can benchmark against your peers. Trade associations have good sample models.

Next, break down the budget into different areas. First, code revenue by department, and any department that generates more than 25 percent of the company’s revenue should be tracked to the bottom line.

The next area is direct costs (labor and materials). The difference between revenue and direct costs is gross margins. These should be actual numbers categorized by department.

Then, you have variable costs, fixed costs and operating profit before tax. Other income and expenses, like insurance, rebates and interest income, should be below the operating profit line to avoid skewing the numbers. This is because expenses are tracked as they relate to core business.

To make these numbers into a budget, begin gathering data approximately three months before the end of your fiscal year. You should have actual financial statements for your first nine months. Then add adjusted projections for the final three months to come up with projected year-end figures. This is your benchmark.

Next, collect the past two years of actual numbers so you can reference some historical figures.

Analyze past sales, but recognize that precision is impossible. This is probably the most difficult area to work through. Evaluate annual sales by product line, location, services rendered or sales people. Add any known adjustments to the contracts along with current anticipated contracts.

Clearly, having historical sales information is beneficial. But don’t forget to take into consideration the economy, competitors, price increases, new lines, markets, growth strategies to pursue, number of sales people and their quotas, and historical cancellations. These factors can change from year to year, so you need to know how next year may differ from last year in order to produce an accurate budget.

Lastly, determine what you want to achieve sales-wise in the coming year. My experience has shown that if you set a goal, you often will hit that goal.

When determining direct costs, the best method is to get a sense of direct costs as a percent of sales historically. Don’t forget to consider changes in compensation, materials and service delivery strategies. Also, make sure you accrue any bonus on incentive plans.

When you get into forecasting variable expenses, again, historical percentages and changes based on sales are important. When forecasting where expenses are concerned, use historical information for comparisons only and try to lock in your actual expenses in advance of the year.

The budgeting process can take up to six weeks and should involve all of your key managers. Question every line item in your budget. Don’t assume just because an expense was incurred in previous years that it needs to be incurred in the future. Ask these questions: Do you really need this expense? What can be done to improve or eliminate this expense?

Also, be sure to update your budget throughout the year. When managing by the budget, reviewing the company’s financial performance and comparing this to the original budget as soon as possible each month is important.

Exclusive Online Only Supplemental Content Not Appearing In Print

Ask these questions: Do you really need this expense? What can be done to improve or eliminate this expense?

There are other tips to keep in mind as you work through building the budget. Entrepreneurs often make the mistake of thinking they are flush with cash when in reality they have a 30 to 40 percent tax bill that has not been recognized.

Also, be sure to update your budget throughout the year. When managing by the budget, review the company's financial performance and compare this to the original budget each month.

Delegate a budget account watchdog to analyze and report variances each month. Do this by account and use your budget as the tool to monitor progress.

For those of you who have never built a budget, getting started is difficult, but you must do it. And you must shoot for improvement each year.

The first year the budget may not prove to be as accurate as you would hope.

In fact, if you are within 10 percent of the goal you set sales-wise, that's a pretty good start. Remember that your budgeting skills will get better each year.

There are a few absolutes that you must understand to be successful in business. Creating a budget, monitoring that budget in a timely fashion and using it as a tool to motivate and create employee accountability will help take your business to the next level.