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are recognized for their achievements by their peers, you can almost be
certain that they will meet the objectives that they themselves set.

Once action items are set, negotiate deadlines for completion. Before
they are finally written, deadlines should be agreed on between the
manager and the employee, and interim deadlines should be set if there
are long or complex projects.


Reality Check

Ask each person who is responsible for the action items to help you and
others determine if the action items are appropriate for them. Have them
answer these questions:

• Do these action items work toward meeting the objective set?

• If all the action items under a single objective are met, will the ob-
jective be met?

• Are these action items clear enough to give employees adequate
direction?

• Is there any ambiguity about what successful accomplishment
means?

• Is the employee/group committed to getting these things done?

• Does the employee/group think these plans are realistic consid-
ering the current workload?

• Are there adequate resources available to make these action plans
possible?


VISUALLY REPRESENTING YOUR PLAN

Frontline workers often complain that they™re not told where and how
their efforts fit into the company as a whole. That feeling can be a major
disincentive to effective work and innovation. Take every chance you can
to help your coworkers understand that their contributions make a dif-
ference to the company.
26 Create Your Vision



It is vital to take the vision/mission, corporate objectives, and action
plans out of your head and develop them visually as a communications
tool. You must translate into graphic form the concepts, objectives, and
goals you™ve set out in other exercises.

Pulling together all of the elements from this chapter, we can visually
show how each section draws from the previous to make up our game
plan. It compares different exercises in relation to one another and their
overall importance in the management process. This is a powerful tool
for communicating all of the pieces of the planning cycle to your people
and for letting them see where their work fits into the whole.



Making It Happen

Colorful eye-catching visual communication is inspiring and exciting.
When I was CEO of a publishing company, we tried to be as creative as
we could when we used graphics to represent important business con-
cepts. We tried a number of different methods, from using glass jars and
beads to toy horses on a track to stacks of books.

A graphic can compare statistics or trends that don™t always leap to mind
as relevant but, together, shed insight and understanding on a key busi-
ness function. This kind of graphic tells everyone where he or she fits in
the planning process”usually something companies, especially big
ones, keep trapped in the boardroom.

One of the methods we liked best was to create a wall-size circle and post
it in a common area. In the center, we put the company vision. In the next
concentric circle out, we placed the mission. This was followed by the
corporate objectives. Ultimately, each department and then each individ-
ual was named with his or her own action items. This showed a direct
link between the company™s vision and the individual™s course of action.
Keeping several years of these circles in a conference room reminded us
of how much we had accomplished.

Use your imagination to add color and graphics as appropriate to commu-
nicate your direction to everyone, every day. Encourage people to study
the visual representation”and even have employees and managers cross
off items that have been completed, and date them at companywide meet-
ings. Celebrate each of these significant events. If you can develop a
27
Moving from Vision to Action



graphic that lives on the computer, it can be changed in real time and
made available to all employees when they wish to see it.



Reality Check

Looking at your visual representation of your vision, mission, objectives,
and action items, consider these questions:

• Do you have a sense of a team pulling in one direction? Do any of
the items you see contradict each other?

• Does this look like a year™s worth of work? Are all of the items
significant and meaningful?

• Are you excited by the work this represents? Does this visual
help you imagine how you will feel when projects are completed?

• Is this document posted in a place where people will find them-
selves and mentally review their progress (and that of their
peers) every day?



W H AT ™ S N E X T

In this chapter, we™ve started our work on a vision for the company
and translating that vision into action. We are still in the planning
stage. We take that planning stage closer to reality in the next chap-
ter on budgeting. Budgeting is planning with dollars and it is
through the budgeting process that we begin to know whether our
vision can be translated into a profitable company.
PART II
SET HIGH STANDARDS
2
CREATING A BUDGET
EVERYONE CAN
USE AND UNDERSTAND
If you can™t pay for a thing, don™t buy it. If you can™t get
paid for it, don™t sell it.
”Benjamin Franklin




O ne of the most grueling parts of running a small business is budget-
ing. Many people hate budgets; some to the point that they run their
businesses using their daily bank balances as their only financial tool.

You, too, might resist the notion that you can benefit from good budget-
ing”until you try it. You would learn that budgeting takes some of the
hazard out of business by minimizing the guesswork. Budgeting gives
you a blueprint for action. It tells you what to expect and alerts you to
trouble when the unexpected happens. Indeed, it is crucial to know how
your business will accomplish the goals you set for it, and your budget
measures your success; when your business outperforms your projec-
tions, you know you™re doing well.

To benchmark your success, you can calculate certain financial and oper-
ating ratios that look at both your income statement and balance sheet,
giving you an indication of your financial health over time. You will also
want to compare your numbers against your competitors™ and the indus-
try standard. For most industries, it is possible to compare your ratios to
the industry standard to get a sense of how financially competitive you
are as a business. You will certainly want to strive to be in the top half, or
better yet, the top quarter.


31
32 Set High Standards



In this chapter, I take you through the basics of budgeting, showing how
to put together a bottom-up budget”that is, an overall budget that re-
flects the real needs of your business. I present case studies that show
the value of budgeting to a young business and to the business facing a
crisis. I also include a number of worksheets at the end of this chapter to
show you how to analyze your average selling prices, month-to-month
unit sales, sales projections, payroll, expenses, and overall performance.
First, I explain in more detail why the budget is so crucial and how to
keep your budget under control in even the most volatile industries.



THE BUDGET SETS PRIORITIES

You send a direct message about the priorities of the company with what
you spend your money on, as opposed to what you say with your vision
or mission statement. You might say your company is committed to cus-
tomer service, but if you spend little money training or staffing your cus-
tomer hotlines and a great deal on your corporate facility, employees will
know what your real commitment is.




PA RT IC I PAT I V E B U D GE T I NG

It™s an oddity of traditional businesses that budgets come down
from on high, from senior management, particularly from the fi-
nance department. The best budgets show the input of the people
making the expenditures and focus on each business function in
the company from the bottom up and starting with zero in each col-
umn of numbers. The best budgets reflect the thinking of the people
who know best where the company really spends its money. Get the
input of these people when you put your budgets and projections
together.

Senior managers must also understand and have input into the num-
bers in the budget. Good budgeting is a highly interactive process.
Whereas people may not argue for changes to the mission statement,
they will almost certainly argue for changes in allowable spending.
Budgets should be drafted, compared to the previous year™s actual
expenditures, debated for the best use of resources, and redrafted as
necessary.
33
Creating a Budget Everyone Can Use and Understand



You should prepare budgets after you set direction with your vision and
mission statements and corporate objectives. The budget is the next step
in taking you from the generalities of your business plan to the specifics
of day-to-day operations.

By setting priorities, the budget makes clear what your finances permit
you to do to reach your goals. It translates the vision and mission state-
ments and corporate objectives into action.

Above all, the budget is a tool for all people who have responsibility for
spending money and making money, not just CEOs. The financial state-
ments you show your directors, investors, and lenders don™t tell man-
agers what you expect from them and which of their efforts you value
most; your budget does.


KNOW WHEN TO STOP

It is important to spend time creating your budget, but when you finish it,
get back to daily business. The most important point is to have something
to measure reality against, not to make the budget perfect. Budgeting be-
comes more realistic as time goes on. Budget 12 months in advance, and,
if possible, update quarter by quarter to create a rolling 12-month budget.
This enables you to make changes frequently enough to do reasonably ac-
curate budgeting. Don™t think too much about the budgeting process in
the meantime.

In addition, build some tolerance for variance into your numbers. Your
budget stops being accurate the moment you finish it, and when vari-
ances occur”and they will”make sure the numbers allow opportunity
for your managers to act creatively. Although budgets should be de-
signed to create accountability, accountability should be related to the
real issues behind the numbers, not the numbers alone.

Remember that finance plays both operational and analytic roles. Some
business owners become excessively enamored of quantitative analysis”
to the detriment of qualitative analysis, which can lead to problems. When
an overzealous finance department detects a companywide difficulty, it
can make matters worse by forcing its priorities on other units rather than
looking at the underlying problem.

One Illinois-based consultant offers a good example. When an internal
audit finds too many assets tied up in inventory, he says, “out goes a
34 Set High Standards



memo telling all unit managers to cut inventory 25 percent in six months.
Only the hot items move out fast. The rest sit there. When it™s all over, in-
ventories are down 10 percent, the CFO declares victory”and the only
items left are the ones nobody wants.”



PLAN FOR DEBT

Knowing where you stand can yield big benefits, as Andrea Totten dis-
covered in running her California-based quilt-making company, Rags to
Riches. She founded the company in 1971, selling quilts and comforters
at flea markets and art fairs, then used a small catalog to generate orders
from stores and designers. “[Business] started getting really busy and
that™s when I decided that I needed to find a direction,” she says. “I
guess then I didn™t think of the word business plan, but I guess now in
retrospect that™s what it was.”

Totten wrote proposals and went to a variety of lenders, only to find
most reluctant to lend to small businesses and some, it seemed, reluctant
to lend to women. “Even though I had a house and a car, they wouldn™t
take them [as collateral],” she says. “Each year they™d say, ˜Come back in
a year.™ Meanwhile, four or five years passed.”

Totten resorted to “asset based lending””high-interest loans made
against accounts receivable by fashion industry lenders called factors.
“You sell your receivables,” Totten says. “[The loans] were good at the
time because they were needed. But they turned out to be too expensive
to maintain.”

The factors charged 4.5 percent interest per month. “The only way to
beat it is to keep the money going. So once the business slows down, it™s
a killer,” she says.

She persuaded a bank to lend her working capital when her billings
passed half a million dollars. Still, Totten found herself devoting 20 per-
cent of her cash flow to servicing debt. In addition, she didn™t think her
bankers valued small-company business; among other things, they fre-
quently changed the terms of her credit line. She paid her loans down as
quickly as she could and eventually got out of debt.

“By the time I took classes on how to write [business plans, the instruc-
tors assumed that] you sell $20,000 and the next month you have $20,000
35
Creating a Budget Everyone Can Use and Understand



in because the people always pay on time. Not true. Receivables don™t
come in that smoothly, and vendors want money. Your labor, of course, is
COD,” she says. “I brought in $80,000 in cash, where was it? The business
plan was hard to keep to because of the fluctuations of our industry.”

In the late 1980s, a number of Totten™s competitors went out of business.
Trouble plagued the retail industry, too. Stores that had always paid
their bills on time now stalled her, stretching her receivables to $10,000
or $15,000 per store. Then suddenly they™d be gone, leaving her with lots
of bad debt.

All this led Totten to manage her receivables strictly. “I never let any-
body get high enough to ruin me if I lose,” she says. “It™s kind of like
gambling. Don™t ever gamble more than you can afford to lose. I look at
my receivables and [decide which] people I™ll put on COD. If they don™t
want to buy from me anymore, that™s okay because I™m losing money
[with them] anyway.”



FOLLOW THE MONEY

Totten developed a number of strategies for staying on budget in a tu-
multuous industry. First, she downsized by attrition”that is, she opted
not to replace employees who left. Once she had little or no short-term
debt to preoccupy her, she could reassess her market, too. “I said: ˜What
do I want to do? Do I want to go and look for new business or do I want
to better serve the business I have?™ And I chose to stay with the stores
that were loyal to me and not advertise.”

In addition, Totten was selling to almost 1,000 retailers throughout the
country. Whereas many entrepreneurs would look to add even more re-
tailers, Totten felt that she was stretching herself too thin. She looked at
the big customers who paid most reliably and cut back on doing business
with the rest. In the end, she trimmed her customer list by two-thirds but
maintained almost the same revenue. As she explains, “To me, there are
two ways to go out of business. One is to have too many orders and the
other is to have too few. I used to look at gross sales, but my accountant
showed me if I sell $900,000 a year and my profits are higher, that™s a suc-
cess, not if I sell a million a year and my profits are down.”

Totten also released her outside sales reps. They took 10 percent commis-
sions and often didn™t service the customer well, giving out the wrong
36 Set High Standards



information or not knowing the answers to key questions. “I [used to
pay] two people to do the same job. Now we have our [in-house] reps call
and customers fax the orders in. We call back and go over the order with
them,” she says.

Throughout this restructuring, she kept prices steady, protecting her
margins. Her strategy translated into stiff terms with her customers. Rags
to Riches doesn™t give retailers discounts beyond those in its price list”
and those only to retailers who display the company™s wares prominently.
“It™s one thing to get into a new store, but its another thing to get re-
orders,” she says. In fact, she uses reorder trends as her main diagnostic
test for how the company is doing. “If we don™t get reorders, then we
know that something™s wrong. Either the salespeople don™t know how to
sell [the product] or it™s not displayed correctly or it™s in the wrong store.”

Her final observation about taking control of her company™s finances was
that “Small business people have to keep up with what is happening just
as much as a CEO at a huge corporation. If you™re not on top of your fi-
nances on a real-time basis you™re not going to make it.” Thirty plus
years later, Rags to Riches produces bedding and upholstered furniture
along with hand-painted furniture in a 13,000-square foot facility and
employs a staff of 50.



CONTROL EXPENSES

Andrea Totten grew her business by remaining flexible and by keeping
an attentive eye on her market. She controlled expenses and reshaped her
finances to fit her needs. She learned the value of understanding the im-
pact of finances on her business.

Totten™s example holds some valuable lessons, including these:

• Evaluate your projections regularly, particularly when adding capi-
tal to your business (whether yours or somebody else™s).

• If you have a hunch about the future, follow it”but look for similar
surprises in the past and find out what impact they had. Don™t
simply adjust your financial projections on instinct. Instead, base
your new thinking on as much hard evidence as you can gather.
Your hunch may tell you that an upturn lies around the corner”
but that new market you pursue may trail the overall economy by
a year.
37
Creating a Budget Everyone Can Use and Understand



The owners of new businesses often review every expense, but as things
progress, they back off. They control expenses with budgets and paper
trails”that is, invoices and purchase orders”and make sure that only a
few, accountable people handle cash.

Once your business is established, you should spend most of your budg-
eting time on the big numbers, where most of your money is spent. The
major categories are revenue, payroll, inventory costs, marketing and
sales, facility, insurance, computers, and others that may be related to
your particular business. Here are some simple reminders about holding
down expenses:

• Purchasing. In a small business, put one person”not five or six”in
charge of ordering merchandise and using overnight mail services.

• Supplies. Make your employees aware of the costs of office supplies;
some managers mark the individual cost of each item, such as
pens, on the box. Hold your managers responsible for expenses in
their departments. Keep an eye out for hard-to-budget costs such
as delivery fees. You may spend less to send an hourly worker to
pick up supplies.

• Travel and entertainment. Scrutinize expenses such as travel and
entertainment. Trips should be planned in advance when possible
to take advantage of travel discounts, especially some of those
now found on the Internet. Make sure that travel and entertain-
ment expenses pay off with increased business.

• Professional fees. Negotiate fees paid to lawyers, accountants, and
consultants by the project or the period of time, or even their
hourly rate. Set caps on what can be spent without specific
approval.

• Computers and related costs. A great deal of money has been spent
in the past few years on personal computers and software, most
of it necessary. Set a budget for computer hardware and a sepa-
rate budget for software and technical support.


PLAN FOR CASH

Unfortunately, in most businesses, cash coming in lags behind cash
going out. For instance, you may have to pay for inventory or raw mate-
rials months before you receive money on the products they produced.
This requires cash flow planning. Your budget may be right, but it may
38 Set High Standards



not take into consideration when the cash has to go out and when it will
come in. Many businesses use a line of credit to plan for this lag time.

Get a line of credit when your business is doing well”when you don™t
need it. When you do need it, you probably won™t qualify to get it.

Knowing how to slow down spending and collect what others owe you
are skills essential in any business. These skills give you access to the
cash you need to grow or to stay in the game.

Accounts payable are the bills from vendors. It is often possible to negoti-
ate terms that will allow you to hold on to your money longer. For in-
stance, you may be able to pay bills in 45 days instead of the customary
30 (this varies by industry) if you make arrangements beforehand.

When a company is facing a financial downturn, one of the first things
it does is slow down the paying of its bills. It may be unable to borrow
from a bank at that point, so it borrows from its vendors. It is important
to know how to do this well, as well as to know when it is being done to
you. If you find you need to pay bills late, the most important thing is
to maintain communications with your vendors. It would be expensive
for them to have to forcibly collect these monies from you, so they will
likely be willing to hang in there for some time, as long as you provide
them with a plan for repayment. This is particularly important if you
need to keep purchasing from them during your financial crisis.

Do not get in the habit of paying your vendors late unless necessary.
When it becomes necessary, you will need the track record of a good
payment history to convince them to give you extra time. Especially
in tight industry niches, word travels about who pays on time and
who doesn™t. The day may come when you need a favor from a vendor
who feels ill-used or when a credit agency downgrades your payment
rating.

Accounts receivable are monies that your customers owe you for product
already delivered. The object is to collect this money as quickly as
possible. Coming from the opposite perspective, it is important to
know the top (at least) 10 customers who owe you money and to track
their payment habits. You are more likely to be paid if you keep in reg-
ular communication with them and they need your services on an on-
going basis. You should specify a maximum amount of credit you are
willing to extend to each customer, and watch carefully any customers
39
Creating a Budget Everyone Can Use and Understand



at the upper end of that limit. Don™t loan more than you can afford
to lose.


BUDGET FOR THE BIG ITEMS

Another kind of budgeting that companies must do is budgeting for the
big-ticket items that can be depreciated over time. Depreciation allows you
to take the expense of the big item into your records over time so that you
have a more even profit picture year to year. Real estate, a building, a
computer system, or other large equipment are examples of these big-
ticket items, called capital expenditures. You should budget for these ex-
penditures separately because they don™t go into your income statement.
Income statements are intended to represent your revenue and expenses
from regular operations, not extraordinary one-time purchases.


PLAN FOR PROFITS

Even if cash lags behind, always plan to make a profit. You may be able to
get through short periods where your expenses are higher than your rev-
enue, especially when you first start in business, but it will catch up with
you. However, in spite of your careful budgeting, the truth is that rev-
enue is often less than expected, and expenses are usually more than ex-
pected. Knowing this, budget enough of an excess to allow for a margin
of error to ensure a reasonable profit.

What makes for a reasonable profit varies by business, industry, and is
usually affected by the economy as well. Some years, survival itself is a
victory. In other years, building up a cash reserve to protect yourself in
the down years (and expect that there will be some if you are in business
long enough) is essential.

For the long run, it is essential to develop a business that prospers in
both an up and down economy”preferably with some products or ser-
vices that sell well when the economy is great and others that people
need when times are tough.


SET FINANCIAL CONTROLS

Budgeting and sharing financial information with employees doesn™t
mean loosening the reins on financial controls and checks and balances
40 Set High Standards



to prevent errors and theft. It is estimated that employee theft may cause
U.S. businesses as much as $100 billion each year. Discuss with your CPA
the best methods you can use to prevent fraud and embezzlement. I
found the following essential both for my own peace of mind and the
protection of my employees:




S I X T H I NG S YOU CA N D O TO
P R E V E N T E M P LOY E E F R AU D

1. Mail should be opened immediately, and checks received
should be individually recorded by someone other than the
bookkeeper.

2. Checks should be stamped “For Deposit Only” and deposited
the same day received.

3. Purchase orders or other documentation must be required for
every check written. Approval requirements should be set de-
pending on the size of the check.

4. Bank statements must be reconciled monthly by someone out-
side the accounting department. At one time, I had statements
sent to my home instead of to the office.

5. The same person should not be buying inventory and receiv-
ing inventory.

6. It is always a red flag if accounting or purchasing employees
never take vacations. They can™t afford to have someone else
examine their files for a week or two because it might be dis-
covered that they have been stealing from the company.




In summary, budgets serve as defensive mechanisms against risk, alert-
ing the organization to problems lying ahead by building on the past. The
important thing is to stay in the game. If you have losses and let those
losses continue, you will eventually run out of cash. It usually happens
slowly”you have a line of credit that you have maxed out or can™t pay
back. You take longer and longer to pay your bills. You spend a greater
percentage of your time stalling creditors and looking for any source of
cash. Eventually, if this continues, you come up to a payday with too lit-
tle cash to meet payroll. That may be your last day in business. However,
41
Creating a Budget Everyone Can Use and Understand



budgeting lets you know in advance that you may have a shortfall. If you
budget, you will have plenty of opportunity to make changes in your op-
erations to avoid that situation altogether.

In addition, successful companies use their budgeting to identify spe-
cific, realistic, and quantifiable goals. Budgets bring order to the task of
pursuing those goals. First, you identify a revenue or sales objective for
the year. Then, identify the tasks necessary to reach that objective. That
done, explore the costs and budget for them, outlining the time and re-
sources you must commit to reach the goal. The budget quantifies your
plan in dollars. It also tells your managers and employees what you value
as an owner or manager.

Remember that you don™t win when bankers or customers allow you to
use their money. You win when you pay them off. For new businesses,
the first order of business is to pay off lenders. Particularly when you
consider that owners of new businesses generally sign personal guaran-
tees for bank loans, leases, and company credit cards, and in some cases
with their biggest suppliers in order to get the best credit terms. The
quickest way to get to financial stability is to identify basic financial fac-
tors and measure them, so that you can make midcourse corrections.
Here are some final tips for successful budgeting:

• Don™t keep your budgets and financial projections in a drawer.
Use them to chart the implementation of your strategies. There™s
no guarantee that careful budgeting and financial analysis will
bring the success you want, but without them, failure becomes
more likely.

• Scrutinize every potential risk that your business faces. That
means looking at”and sometimes looking beyond”the bottom
line.



REVENUE FORECASTS

Now that we™ve covered the importance of a realistic budget and how to
control your budget, we turn to calculating your budget. The two compo-
nents to the budget, which are done separately and then put together, are
revenue (sales) and expenses (costs). Generally, you will do the revenue
budget first, using the sales unit quantity numbers as a base for both the
sales dollars and expenses.
42 Set High Standards



Revenue forecasts are much more difficult to determine with accuracy
than expense budgets. You might be successful forecasting an increase
in revenue as 20 percent from the prior year, but you lose the importance
of the process. Instead, look at trends in your business and outside your
business and take a hard look at what will be different this year. Do you
forecast a 20 percent increase in sales this year just because you think it
will look better if you do or because of a new product, an increasing
market, or an upswing in the economy? In addition, if possible, you
should base your revenue dollars forecast on expected units to be sold”
number of customers, transactions, renewal sales, products produced,
and type of product.

The easiest way to begin a projection is to map out at least one year”but
no more than three years”based on your performance over the same pe-
riod in the past. If you don™t have that much history, start with the pro-
jections you made in your business plan, adjusted to actual performance
since you opened for business.

Put expenses into categories (examples follow later in the chapter) that
make sense in your business. The most important thing is to define what
expenses you want in each of these categories so that you have some con-
sistency for comparing actual with budget and can accurately trend the
numbers over time.

Budget according to what actual expenses have been in the past, but be
proactive as well. Determine a reasonable amount to spend on office sup-
plies and budget accordingly. You can establish other benchmarks by
comparing your expenses with other companies in your industry. If you
belong to a trade group, find out how other members have done relative
to their projections. Have they come in over or under their projections?
Did they miss or exceed the mark by less than 5 percent”or by more
than 10? Try to find out how specific competitors have done. If all else
fails, find out how businesses in your region do in general.



PROFITS DETERMINE SURVIVAL

Profits aren™t everything in business; in fact, your vision statement
probably says nothing about profits. However, without profits and their
conversion to cash, no business survives long enough to reach its goals.
Fittingly, therefore, almost everything in budgeting stems from the
43
Creating a Budget Everyone Can Use and Understand



simple formula for determining profit: revenue minus expenses. This
formula drives business. Profit ultimately defines performance, in other
words. Everything else is elaboration.




TOOLS FOR CREATING A BUDGET EVERYONE CAN USE

The following exercises will help you to create a bottom-up budget:


• Revenue budgeting.

• Expense budgeting.

• Budget notebook.

• Payroll projections.

• Income statement projections.

• Balance sheet projections.

• Break-even analysis.



REVENUE BUDGET

Revenue budgeting is a series of steps to determine how much you are sell-
ing, in terms of units; how much each unit is bringing in, in terms of dol-
lars; and when to expect the dollars, in terms of time.


The four worksheets in this section are:


1. Average selling price per product.

2. Unit sales by product.

3. Dollar sales projections by product.

4. Dollar sales projections by month.


Even if your business is a service business rather than a product busi-
ness, you can do a modified form of this analysis. You can count by num-
ber of customers instead of units of products.
44 Set High Standards



AVERAGE SELLING PRICE PER PRODUCT

To begin to project your sales for the year, it is essential to know how
much you are selling of each unit of product now. Worksheet 2.1 consid-
ers pricing issues across all product lines in detail. This is critical if you
discount your prices for volume or other criteria. You may think your
prices are close to retail, but the average price may be at a deeper dis-
count than you think.

This worksheet is useful in making pricing decisions. Some industries
have standard discounts and pricing schedules required by retailers
from wholesalers.

If you know you must make at least $10 per unit to be profitable and the
discount required by retailers is 50 percent, you must set your retail price
at $20 minimum.

The trend in average price per product may also give some important
signs about your business and your industry. If the average selling price
drops consistently from year to year (as, for example, with computer
software), you will have to become much more efficient in production to
remain profitable.

Worksheet 2.1 also gives you valuable information about what your cus-
tomers are willing to pay for your products. After calculating the average
selling price per product, compare this to what your largest customers
are paying. Are they buying far below this number? Are some of your
larger customers willing to buy at a number higher than this?

This approach to determining price per unit may be too basic for com-
panies with complex product lines (though the theory behind price per
unit measurement remains useful). It will work in many cases.



Making It Happen

To calculate average price per product, list your products in column A
and their total sales volume in column B of Worksheet 2.1. In column C,
list how many units were sold of each. In column D, list the selling price
for each unit of the product. To compute the average price per unit in col-
umn E, divide column B by column C. For F, the average discount from
45
Creating a Budget Everyone Can Use and Understand



Worksheet 2.1
This past year
Average Selling Price per Product
Two years ago

A B C D E F
Total # of Selling Price Average Price % of Selling
Product $ Sales Units Sold $ per Unit $ per Unit (B/C) Price (E/D)
46 Set High Standards



the selling price, divide column E by column D. Complete this exercise
for at least two years™ worth of information.



Reality Check

Consider these questions about your completed worksheet:

• Has your average price per unit decreased or increased over the
past two years?

• How have your selling prices increased or decreased over the
same period of time?

• Are discounts”as a percentage”about the same over the past
two years or have they stayed the same? Do you have to give up a
larger percentage of total revenues over time?

• Is one customer large enough to be responsible for a sizable drop
in average price per product? Can your discounting policy be
changed to encourage purchase of higher margin?
47
Creating a Budget Everyone Can Use and Understand



UNIT SALES BY PRODUCT

It is important to begin any series of sales projections with what your ac-
tual unit sales were the previous year. Sales dollars may be increasing
year to year because of price increases, while unit volume may actually
be decreasing.

The number of things that you sell”regardless of price or terms”
reflects the underlying strength of your business. If unit sales aren™t in-
creasing, you aren™t growing in real terms.

Keep the actual numbers that come from these worksheets over time. All
products have life cycles. You will see which products have consistent
sales and which have increasing or decreasing sales. Generally, a hand-
ful of products have unit sales much greater than expected (although
dollar sales might be right on target or even below expectations). Most
have sales slightly below our usually optimistic projections.

Unit sales are a much better method of measuring real growth than
are dollar sales. Dollar sales can be impacted by price changes, additional
charges, and so on. Decreasing unit sales provide an early warning sig-
nal that can be addressed now rather than later”when dollar volume
sales begin to drop as well.



Making It Happen

List all the types of products you sold last year in the far left column of
Worksheet 2.2. Then tabulate the actual number of units you sold for
each type of product by month. Add the total units by product in the first
shaded column. In the last column, divide this number by 12 to get the
average unit sales by month.

Now do this worksheet a second time to project the number of units you
expect to sell this year. Project as conservatively as possible. If you do not
have a specific reason to expect an increase, use last year™s average num-
bers as a projection. In some products, you probably expect a decrease.
There may also be new products to add that you did not have last year.
Factor these differences into your projections.

You can also apply a percentage increase to the number of units sold
last year to get a projection for this year, although this tends to be less
48
Actuals Last Year
Worksheet 2.2
Projections for This Year
Unit Sales by Product
Actuals for This Year
Month Unit Sales Average Unit
Product 1 2 3 4 5 6 7 8 9 10 11 12 Year-to-Date Sales by Month*




*Divide total year-to-date unit sales by current month number.
49
Creating a Budget Everyone Can Use and Understand



accurate than estimating what you will sell month to month based on
marketing efforts. Finally, Worksheet 2.2 can be used to monitor how
close your actual unit sales are to your projections by adding the actual
numbers to a third blank worksheet.



Reality Check

Consider these questions about your completed worksheet:

• Are unit sales cyclical as evidenced by sharp increases in certain
months or seasons?

• Are unit increases due to particular marketing efforts?

• Are unit sales obviously affected by particular accounts™ buying
patterns?

• Are new products doing as well as expected as soon as expected?

• Have any product sales dwindled during the year or from the past
year?
50 Set High Standards



DOLLAR SALES PROJECTIONS BY PRODUCT

Worksheet 2.3 helps you project, conservatively, the dollar sales using unit
projections by product with an average selling price from the prior year.

It is important for the morale of the company to be aggressive in market-
ing and to have high expectations of the sales growth you want to
achieve. Save these high hopes for your sales meetings. The budgeting
process considers both sales and expenses. If you project a 20 percent in-
crease in sales for the purpose of determining your profit picture, you
may allow yourself to increase your expenses by more than you should.

While the company is busy looking at what it is spending, the sales and
marketing people must be busy looking also at what the expected sales
are. Take a very conservative approach to sales projections. Base them as
much as possible on what actually happened the prior year, both in
terms of real unit sales and your actual average selling prices. Factor in
any price increases and expected unit increases very carefully.

Remember, in virtually all but the most disciplined companies, if sales
are up, people ease up on the expense reins and the horse runs free. Al-
most all employees can find something they would like to have to im-
prove their lot. If money appears to be no object, people will ask for more
than they really need”including everything from office furniture to
computer software.



Making It Happen

Because the most realistic sales projections are done by looking not at
dollars, but at units sold, we begin with the unit sales number from the
previous worksheet (2.2). The number of units projected to be sold is
then multiplied by the average price received for the product last year to
get an idea of what sales dollars the product would be expected to bring
in this year.

It is also important to factor in any price increases, but be very conserva-
tive in doing so. If you increase your selling price by 10 percent, often
you don™t increase your discounted price to high volume purchasers by
an equal amount. In this case, you might want to factor in only a 5 per-
cent increase in the average price.
51
Creating a Budget Everyone Can Use and Understand



Worksheet 2.3
Dollar Sales Projections by Product
A B* C** D
Unit Sales Average Price Projected Price Projected $ Sales
Product by Product per Product Increases (%) (B/C/D)




*From Unit Sales by Product Worksheet.
**From Average Price per Product Worksheet.
52 Set High Standards



To get a total, multiply columns B, C, and D of Worksheet 2.3. The
shaded box at the bottom should be your total expected dollar sales for
the entire year.



Reality Check

Consider these questions about completed Worksheet 2.3:

• Have you reviewed profitability and market factors to consider
price increases?

• Are projected sales substantially greater or less than actual sales
from last year?

• Are sales projections particularly aggressive for some products
and not for others? Do these differences accurately reflect the po-
sitions of various products in their sales cycles?

• Are there other significant sources of income not taken into ac-
count by product sales (i.e., shipping and handling)?

• Is there any other information, such as the possible loss of a major
customer, that needs to be factored into sales projections?
53
Creating a Budget Everyone Can Use and Understand



DOLLAR SALES PROJECTIONS BY MONTH

Worksheet 2.4 takes the dollar sales projections developed on the prior
worksheet and allocates them by month by looking at sales by month
during the prior year. It is important to know when we expect the sales
to be booked. For most companies, sales are recorded on shipment of the
company™s product.

Filling in Worksheet 2.4 with your actual sales figures from the previous
year will allow you to see if any of your products are seasonal. Even if
sales of your products generally don™t appear to have any dramatic fluc-
tuations from month to month, certain products will. This may signal a
particular buying segment that orders at a particular time of year. Know-
ing this may help you spend your marketing dollars for this buying
group at the right time.



Making It Happen

For the purpose of accurate projections, it is important to do Worksheet 2.4
twice.

First, use actual numbers from the last full year to get the percentages that
are calculated at the bottom of the page. These numbers show what per-
centage of the total sales was made each month of the previous 12 months.
The total in the box at the bottom right should be 100 percent.

List your products in the left-hand column. List actual dollar sales by
product for each of the past 12 months. Total the numbers, month by
month, at the bottom of the page. Using these total dollar figures, divide
the total dollars by month by the total dollars in the shaded box at the bot-
tom right corner. Enter these percentages by month at the bottom of each
column.

For your second calculation, use the totals and percentages you just calcu-
lated at the bottom of the first Dollar Sales Projections by Product Work-
sheet (2.3) to make sales projections. This time, enter the total dollars by
product that you calculated in the previous worksheet (from Dollar Sales
Projections by Product [2.3]) in the far right column, and total at the bot-
tom. Next, enter the percentages by month at the bottom of the page from
the percentages done on the worksheet showing the actual numbers from
last year. Multiply the number in the total column by the percentage at the
54
Actuals Last Year
Worksheet 2.4
Projections This Year
Dollar Sales Projections by Month
Month
Product 1 2 3 4 5 6 7 8 9 10 11 12 Total*




Product $ $ $ $ $ $ $ $ $ $ $ $ $
% by Month % % % % % % % % % % % % 100%
* From Dollar Sales Projections by Product worksheet for this year only.
55
Creating a Budget Everyone Can Use and Understand



bottom to get a number to fill in each box. This will give you an expected
dollar sales volume by month.

Illustrating this data graphically (a simple bar chart works well) will in-
crease its impact.



Reality Check

Consider these questions about your completed worksheet:

• What effect does seasonality have on sales and cash flow?

• How do debt service and other major financial commitments co-
incide with or run counter to the annual sales cycle? How will
this affect your cash flow?

• Will profit margin decrease substantially because of variable
costs coming into play during certain times of the year?

• Can marketing efforts be adjusted to smooth out erratic cyclical
and seasonal sales patterns?

• Will you require a line of credit or some other borrowing mecha-
nism if cash flow isn™t adequate to meet expenses during certain
times of the year? Is that borrowing mechanism ready?



EXPENSE BUDGETING

I™m convinced that there is only one way to start to review your ex-
penses and project your sales: from the bottom up and in writing. Many
companies project expenses by increasing each expense item by a regu-
lar annual percentage or budget as a percentage of sales. In contrast, a
bottom-up method forces you essentially to start over each year.

This allows more flexibility to do things such as reducing expenses.
When you carefully analyze the checks you write, you may find you™re
paying for things you aren™t using, especially for ongoing commitments
such as maintenance agreements. An annual review is essential.

In preparing for your annual review, it goes without saying that the
number-crunching part of the budgeting process can and should be done
by computer, but spreadsheets are only a part of a budget. The “whys” for
56 Set High Standards



the numbers are often contained in peripheral documents such as leases
or supplier purchase agreements. To understand the budget completely,
you should house the spreadsheets and copies of relevant documents to-
gether. Putting the interim and final product in a notebook allows for
easy access and discussion at meetings and for reference during the year,
and it makes a much more accessible and complete document for em-
ployees. It also allows an obvious place for note taking to prepare for the
next year™s budget process.

Spreadsheets can be set up by department on a computer network, giving
each manager a password for access to his or her department™s section
only. These sections can automatically be added to the total company
worksheet so that changes will total immediately.


THE BUDGET NOTEBOOK

Our company created a budget notebook each year that documented
every expense item, including which suppliers we had used and gen-
eral ledger numbers to correctly categorize each expense. The impor-
tance of complete documentation in your budgeting process cannot be
overemphasized:

• First, the budgeting exercise in this book makes you really analyze
your sales projections and expenses in detail. It doesn™t allow you
to pass over any item.

• Second, it tells your accounting department how you want items
categorized for reporting purposes. You may wonder why rents are
so high on your reports. It may be because accounting thinks you
want equipment rents expense reported here, while you think ac-
counting allocates this expense to repairs and maintenance. With
documentation, everyone is clear on which expense goes where.

• Third, it will convince your employees, like nothing else, that you
mean business about really scrutinizing what is being spent.

Done well, the budget notebook can be the one place to find all the an-
swers. You can keep copies of contracts in this notebook to show expense
commitments you have made for periods beyond the current year. Last,
this kind of notebook helps employees understand how the company™s
money is being spent. Employees sometimes overestimate”signifi-
cantly”how much the owner or manager takes out of a business. They
assume that if you take in $3 million in revenue, the owner is taking
57
Creating a Budget Everyone Can Use and Understand



home $2 million. The notebook shows them how much money it takes
to make payroll, pay insurance premiums, pay rent, and so on.

Set up your notebook in a three-ring binder. Prepare the dividers and
have one blank sheet of paper for each item with its title on the top. To
begin writing, start with the easiest items first, usually some recurring,
consistent expenses. For example, how much do you pay in rent each
month? Add to this any information you need about your lease, such as
the starting and ending dates, and when increases occur. This is a good
time to review your lease and look for any hidden costs that will need to
be a part of your budget.

Each line item has several general ledger account numbers associated
with it. These general ledger numbers are used by your accounting staff
to allocate every item for which the company writes checks. By looking
at each of the expenditures in each general ledger account number, you
can do budgeting from the bottom up. Ask your accounting department
to add your general ledger numbers to the right side of this sheet.

Try to use the “miscellaneous” line item as little as possible. I never
budget for anything other than petty cash in this category so it will not
become a catchall for items accounting cannot otherwise categorize.

The budget notebook starts with sales projections, which we focused on
in the last few worksheets. Your sales divider should be followed by the
completed Average Selling Price Per Product Worksheet (2.1), the Unit
Sales by Product Worksheet (2.2), the Dollar Sales Projections by Product
(2.3), and by Month worksheets (2.4). These will give you a system to cal-
culate conservative expectations of sales by which you can realistically
budget expenses.

We had four other sections that called for dividers in our notebook:

1. Cost of goods sold. The expenses incurred in making your product.

2. Sales and marketing expenses. What it costs you to sell your
product.

3. Overhead expenses. Most of the other expenses incurred in oper-
ating an office.

4. Income taxes. We don™t discuss estimating taxes in this book, but
you should have a section in your notebook for tax planning and
discuss this with your CPA.
58 Set High Standards



In addition, we had a section for the balance sheet budget, which in-
cludes major capital expenditures. In the following index from our
budget notebook, the categories in bold type are section topics and have
their own sections, and each line item listed has its own page. Every
company will have its own additional items, but what follows are the
main categories that are almost universal:


Sales projections.

Cost of goods sold.
Materials purchased.
Salaries and wages.
Production supplies.
Temporary help.
Shipping supplies.
Mailing and shipping.

Sales and marketing expenses.
Salaries.
Sales commissions.
Direct mail.
Advertising.
Publicity.
Consulting.
Other sales and marketing expenses.

Overhead expenses.
Personnel.
Salaries.
Bonuses.
Payroll taxes.
Group life and health insurance.
Workers compensation insurance.
Employee benefit plans.
Officers™ salaries.
Employment expense.
Training.
Temporary help.

Facilities.
Rents.
Property tax.
Repairs and maintenance.
59
Creating a Budget Everyone Can Use and Understand



Utilities.
Property and liability insurance.

Administration.
Accounting services.
Automobiles.
Bank charges.
Computer supplies.
Charitable contributions.
Depreciation and amortization.
Dues and subscriptions.
Legal services.
Licenses.
Miscellaneous.
Office supplies.
Other professional services.
Telephone.
Travel.

Income taxes.



Making It Happen

This process gives you a format for writing down and tracking expected
expense items, as well as a way to compare last year™s expected and actual
numbers for the same group of expenses. Worksheet 2.5 is an example of
what a budget notebook page might look like. I™ve provided a sample of a
page titled “Rents,” which might include office building leases, parking,
warehousing, and equipment rentals. Start by listing, at the bottom of the
page, what the budget and actual numbers were for the previous year. This
will give you an idea of what the expense figure for this year might be and
whether there is a tendency to over- or underbudget for this item.

The Rents category may include several general ledger accounts”office
space rental, equipment rental, or warehouse rentals. For each of these
general ledger account numbers, your accounting department should
have a standard list of vendors to whom they often write checks. Ask to
see this standard list on a regular basis.

Again, budgeting should be a participative process. Doing it alone defeats
the purpose. Teams should be given the responsibility to analyze last
year™s bills and project expenditures by category and vendor this year.
60 Set High Standards



Worksheet 2.5
Sample Expense Budget Page

2004
Rents
Main Building ABC Properties $196,806
($16,198/month, increases 3% on 8/1)
Parking Parking Lots, Inc. 480
(12 spaces at $40/month)
Warehouse SuperStorage 2,400
($200/month)

Equipment Rentals
Postage Meter Rental Pitney Bowes 835
($412.50 twice a year, due 1/1 and 7/1)
Copy Machines Xerox 4,272
($356/month, expires 4/4/07)
Telephone Bell Communications 14,628
($1,219/month, expires 7/1/08)
TOTAL: $219,421
Budget Last Year: $195,008
Actual Last Year: $201,962




Especially once you have been through the process a year or two, teams
should report to you annually on ways to reduce these expenses, and
management™s role during the process should be limited to making final
decisions on approving expenditures and to putting it all together to get
the desired profit picture.

On each blank sheet, first list the type of item. Next to each, list the ven-
dor of that item. Last, make an estimate of how much you think you will
spend on that item this year. This estimate can be made by looking at
how much you spent last year and making an educated guess as to
whether this will go up or down. You can also often get a close to actual
number if the item is based on a contractual agreement and doesn™t often
vary. Be sure to consider automatic price increase clauses and other hid-
den costs often overlooked. Wherever possible in this budget, list the im-
portant financial points of the lease to make this process easier next year
and to let the accounting department know if these payments are ex-
pected to increase, stop, or decrease at any point during the year.
61
Creating a Budget Everyone Can Use and Understand



Reality Check

Consider these questions about your budget notebook:

• Have all important expense items been captured in the worksheet?
Does your budgeting process include most, if not all, employees?
Do you feel certain you have captured all your real expenses?

• Have you reviewed supplier contracts or other agreements to cap-
ture all costs and look for cost reduction possibilities?

• Are your preliminary estimates significantly over or under the
actual numbers for last year?

• Are explanatory notes understandable to everyone?

• Are there any items you are no longer using?

• Are there any numbers that seem out of proportion to the value of
the service you are paying for?

• Look at total amounts paid to various vendors during the previ-
ous full year. Will this year be about the same as last? Is there an
automatic increase to any of these expenses?

• Do you plan to use less of a given product or service next year?

• Do you always pay a specific amount for a given product or ser-
vice each month, or does it vary by the quantity used?

• Are there new vendors you™re negotiating with now that you plan
to begin using in the near future? How will they compare with
existing expense items?

• Are your expense categories all encompassing? Would all of your
suppliers™ services fit into some category?

• Will the categories you have chosen be meaningful in decision
making?

• Do some of these categories house too many different types of
items so it won™t be clear to all what the category means?
62 Set High Standards



PAYROLL PROJECTIONS

Worksheet 2.6 will accurately project and document payroll, the largest
area of expense for most companies. It is important to project payroll ac-
curately, not only because it is a significant expense in and of itself, but
also because of its direct impact on many other expense categories. Pay-
roll taxes, workers™ compensation insurance, life and disability insur-
ance, and retirement plan expenses generally all fluctuate with changes
in payroll.

This worksheet will help you to look at how payroll is spread out over
time. Most entrepreneurs know exactly which weeks they need to cover
their payrolls. It™s hard for most employees to understand, but if your pay-
roll is $1 million a year (and a company of 35 people can easily have that),
every two weeks the company sends out about $40,000 worth of paychecks.

My company paid employees every other Friday, which came to 26 pay-
checks a year. Employees got three paychecks in June and December, and
two in every other month. Accordingly, our payroll on a cash basis was
higher in June and December than in every other month. This becomes
important to know if June is your lowest sales month.

Finally, if there is one piece of most budgets to which not everyone has
access, that piece is the payroll. This makes it difficult to study for cost
reduction as openly as you might any other budget item.



Making It Happen

To calculate payroll, ask each manager to determine the department™s
head count and payroll costs. Worksheet 2.6 gives columns for each em-
ployee™s current salary (times a number of months) plus a column for
a salary increase (times the number of months the higher salary will be
in effect).

Adding the numbers in the last column gives you the total compensation
of each department™s employees for the year. Add below the actual payroll
for that department last year. Totaling the shaded box at the bottom right
of each department worksheet will give you the total company payroll.

Payroll is rarely, if ever, reduced, except in crises. Employees never ex-
pect their salaries to be static. They generally expect their compensation
Worksheet 2.6
Payroll Projections
Current Next Salary TOTAL
= Total at = Total
Employee Monthly Current Increase x% Future at New COMPENSATION
— # of — # of
# Employee Name Salary* Months Salary (Date) Increase Salary* Months Salary (Total Shaded Columns)




Total
Actual Total for Last Year $

*If hourly wage, convert to monthly. Formula to convert hourly rate to monthly rate is: Hourly rate — 173.3 (example $10 hr — 173.3 = $1733/month).
64 Set High Standards



to increase once a year. These increases rarely respond to real productiv-
ity increases. They™re part of an entitlement employees feel about their
jobs, which most assume include a higher salary and greater benefits
with each passing year.

Because of the always-growing nature of payrolls, many companies are
experimenting with progressive compensation plans, including perfor-
mance-based pay. Regardless of how you determine what you pay your
employees, payroll must be projected to get an accurate profit picture.



Reality Check

Consider these questions about your payroll projections:

• Are some departments™ payrolls increasing more quickly than
others? Is this because of additions to staff or pay increases? Is
this in line with your overall growth plans?

• Are your payroll dollars going to the areas you wish to emphasize?

• Are managers realistic about the increases they want to give?

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