Why Creating a Profit & Loss Budget is Critical for Success
1. Why is creating a Profit & Loss Budget so critical? It’s critical because it shows that you have considered and understand the key areas of your business that make your P&L come to life. Lets’ look at the core components of your budget and how they relate to your business:
a) Sales Income, these numbers are a result of your business’ ability: - to generate the right number and type of leads, a function of Marketing - to keep existing customers, a function of Sales, Team, Delivery of your Product or Service and Strategy in terms of pricing and offerings - to create new customers from leads generated, a function of Sales - to have a clear Strategy for the number and type of Income Streams and what percentages each contributes, a function of Strategy
b) COGS and Gross Profit, these numbers are a result of your business’ ability: - to quote effectively, a function of Sales, specifically estimating - to complete jobs within budget and on time, a function of Delivery of your Jobs - to ensure proper pricing, a function of both Strategy and Sales - have visibility of true Gross Margins and Profits, a function of Finance - allocate labour and materials to the correct jobs and Income Categories within your P&L, a function of Finance
c) Fixed Expenses, these numbers are a result of your business’ ability: - to forecast the non-variable running costs, a function of both Finance and Admin - to forecast wages, a function of Finance, I suggest recording non-billable wages in expenses and billable labour (employed and subcontracted) in COGS - to create and effectively execute a Marketing Budget and Plan, a function of Marketing
d) Net Profit, these numbers are a result of your business’ ability: - to do all of the above items successfully, a function of Leadership, Team, Systems and Strategy - to estimate what your true capacity is, a function of Leadership, Strategy, Team and Finance
Your leaders needs to have the ability to understand which areas of your business affect the various areas of your P&L, which team members have responsibility for producing those results and outcomes within those areas and a solid tactical and strategic plan that your team as a whole can run and implement to bring those numbers to life.
2. How to create your Profit & Loss Budget and track results? There are too many detailed specifics to go into in this article, however, using the above areas as a guide, answer each of the questions and then populate a month by month forecasted P&L Budget (based on an Accrual format not Cash). Your financial software should have this feature, if not, contact us and we can help you with one of our P&L Budget vs Actual templates.
To track results, simply run Year to Date and Monthly P&L Budget vs Actual reports, spot the variances, then get to work on fixing the under-performing areas responsible for the lack of results.
The true value in creating a Profit & Loss budget is that it forces you to ask the tough questions that will lead you to profit::
- What are the total Sales we can generate with our current team? - What is our existing customer base worth to us? - How many new customers and sales do we need? - What is the average dollar sale in each Income Stream? - Are our margins realistic, can we win and deliver the work with those margins? - What are the fixed expenses we need (objectively) to function properly? - Do we have a sound Marketing Budget and Plan to generate the leads needed? - Which areas of the business could be classed as weaknesses? - Are there constraints in areas that will crack under the pressure? - Can our current team and plan achieve the results we need?
Finally, I have mentioned this in most of my finance blogs, it is imperative you have an excellent working relationship with your accountant. If your accountant is simply doing regular compliance work for you at the moment and offering nothing else, then it’s probably worth finding a firm that can provide real strategic solutions as you grow. As a business coach, one of the first items I discuss with clients is what their relationship with their accountant is like and if they need help, I have a wide range of accounting firms who are part of my affiliates network I can refer to if needed.
Eric J. Gregory is the Author of ‘Would you like Profits with that?’ and the founder of Gregory Business & Trades Coaching which specialises in working with SME Business Owners and Entrepreneurs to ‘Create Quality Lifestyles through Business Success’.