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Hey, did you know that 75% of all small businesses in the U.S. operate without a budget? Yes, that is true, but no wonder that only 50% of all small businesses make it past their fifth year, and the culprit? Having an operating budget. Having an operating budget for your business like the big companies do, it’s critical to the success of your business. In today’s video, I’ll be showing you how to prepare an operating budget for your business in 20 minutes or less. Yes.
Hey, everybody. Welcome to 7 Figures & Beyond. I am your host, Leo Landaverde. I am an author, a business coach and CFO, and I’m on a mission to help small business owners quickly and efficiently scale their businesses to seven figures and beyond while maximizing profit and dramatically increasing the value of their businesses. Let’s do this. If you’re ready to scale your business to seven figures and beyond while creating the financial freedom and the lifestyle you want, then subscribe to this channel, and don’t forget to hit the bell so you’re notified every time a new video comes out. Thank you so much.
Hey, everybody. In today’s video, I’ll be showing you how to prepare an operating budget for your business. I’m going to try to do it in 20 minutes or less, so let’s do this. This is part of a workbook in Excel that I’m actually running on Excel online, so typically in my line of work, there’s an interaction between the owners and the management team and my team, this becomes a team effort, to create a budget, which is I cannot stress enough how important it is to be able for you to look into the future of your business. You got to have a plan, and you got to have a vision, and that vision needs to be translated into numbers. In our world, as a CFO, that is a budget. We’re going to live with the budget. Of course, we’re going to try to do better in the revenue side than expected, and we’re going to try to be lower on the expense side than expected, so we want more profit.
So, it has … This tool has multiple … It’s a pretty robust tool that I use, and it has multiple sheets. We’re not going to go over them today. Really, the video today is about the operating budget as he pertains to the profit and loss or the income statement, and in other videos, I’ll be diving deeper into the balance sheet and the cashflow statement, but it has multiple parts, so let me kind of give you a quick tour of it.
An internal rate of return. So, this is … Occasionally, businesses will come to me because they want to look for an outside investor to inject any amount of money into the business and what would the internal rate of return would be. This assumes zero. There is no investors for the sake of this budget, so this is that sheet that we’re not going to be really using today. The summary, everything that you see in this color right here are input sections. So, even when you download the template, which I really suggest you do … I spent a lot of time over really many years, really fine-tuning and honing a lot of the tools that I use to run accounting departments for lower middle market companies and even startups. These are tools that you can use. I’ll be happy to give it away for free to use, so you could just sort of have to follow the directions at the end of the video, but the input sections are colored, so you really don’t want to play too much outside of that.
Raw materials, for the sake of this budget, we’re going to have raw materials. We’re going to have a seven product lines, and each product line will have a cost right here. This is our cost of goods. So, you got your revenue piece, you got your cost of good piece that is going to give us a gross profit percentage. In this scenario, we have a 75% gross profit. It’s a pretty, pretty generous gross profit. I don’t know about your industry specific. Different industry verticals will have different types of gross profits. If you’re in manufacturing, we want to be between 30 and 35. If you’re in construction, you’re probably going to be between 15 and 20%, so it really depends on your industry.
The next section is your operating expenses. These are not variable expenses for the most part. These are fixed expenses. While this expenses right here are variable, which means they go up with revenue and come down with revenue. The ones down here are more what we call OPEX, operating expense. To do a budget right, you got to start with the prior year. So, we are in 2020. We’re going to be looking at the variance in 2019 as we prepare for the year. We don’t want to be too far off. We’re going to make some assumptions as to what areas were increasing, which areas were decreasing on the expense line, and we enter the numbers here that get populated in the next sheet, so there are no capital expenditures that we’re going to do for this exercise. Now, let me take you to the income statement.
So, the income statement is really, it feeds up the summary sheet and income statement would begin with the revenue. You’re going to notice that we have the seven product lines, related sales and the seven product lines, related cost of goods. It’s going to give us a gross profit of 75%, which matches to the one prior. This is really built on … You notice that there’s no color here. There’s not to be entered. There’s no information to be entered. It just starts to process and create an income statement. What it tells us here that our operating expense of $824,489.88 equals to 59.5% of the revenue that is generated for this calendar year.
This is our EBITDA, which is our earnings before interest tax depreciation and amortization, which is 15.5%. Pretty robust. Depreciation and amortization is a separate line because earnings before … so then, we added back earnings before interest and tax. Let me check. There’s really no interest expense to speak off for this. This company, there are no loans. We’re not paying any principle. Hence, we’re not paying any interest, so that’s not an expense line. Okay, so now, there is the balance sheet. The balance sheet is all of these formulas are all of the sheets kind of talk to each other. They have formulas embedded. It borrows, it takes information from the other sheets, and now, the balance sheet, it needs to be a build up, but I already take some information on the cash and cash equivalents from other sheets.
The cashflow statement begins with the EBITDA, and here’s an interesting about the other cashflow statement. The cashflow statement is this stop gap between the balance sheet and the income statement. The cash flow statement begins where the income statement ends. These are our payroll inputs. I have some scenarios here. These are fictitious. They don’t exist, but I wanted to show you for an illustrative purposes. This is the loan amortization. Pretty cool tool because it tells you if you were to get a loan what you would do, the length of the loan, how many months. It could be a 60-month loan. It could be a 72-month loan, and then it’ll populate the other areas.
So, let’s go back to the summary. So, when I am building budgets, the first thing I ask is, I look back into, how did we do last year? What are the assumptions, and what are we projecting from the sales team, from the CEO, the VP of Sales, and how are we going to do in each line? So, I assume that I got all the data, and I crunched it. We’re going to move a hundred units of product one. Notice that the selling price, this product is $10,000. So, our raw materials or the cost to generate to prepare or to sell this product one is 2,500 for every 10,000 units. So, 2,500 or the 10,000 really is our cost to generate that product, so it gives us a contribution per unit or a gross profit of $7,500 per unit sold. To keep it simple, it’s 75% across the line.
Now, if you’re a product based business, you may have different gross profits for different products. You may have a wholesale division, and you may have a retail division. So, your wholesale division, the gross profit would be lower than the retail. Product one, we have 100 units. Product two, we have 100 units. So, then you can figure what would that be per month. Well, just to keep it simple, if you take 100, divide it into 12, I’m assuming that we’re going to move somewhere between eight and nine units per month of this product that we can sell for 1,000. It kind of helps me kind of … Because I’m not able to see the income statement right now, what it allows me to do is, how are we doing with the revenue without having to go back and forth here because this is where it kind of crunches the numbers? It gives us the output. This is a summary, so what I do is I kind of look at it from left to right and see what I’m doing.
Now, say if I was to sell lesser units and we did 80 units, notice that our revenue for product one would go from $1 million to 8$00,000, but we’re going to go back to the hundred units, and then we have $1 million for product one, 100 for product two, 75, 50, 25, 10 and 125 for product seven. So, it is important, you as a business owner, your business begins at gross profit. Every time I speak, I say this, and I need it to make sure that it resonates with you. When you’re building a budget, gross profit is everything. So, if you have a $5 million business but your gross profit is 20%, so really, you have $1 million worth of gross profit and then you take your expenses and that’s your net profit. I cannot stress how important it is to understand, you need to know your numbers, you need to know your metrics, you need to know your gross profit because the gross profit is what you live off.
Okay, so with that said, we have gross profit. I mean, I’m sorry. Cost of goods. This is the cost of doing business. It’s 346,000, which is added up here, which is the sum of all the cost of all the products for this year. If you take our sales at 1.38, 1,385,000 minus $346,000 worth of cost to incur in those sales, we have $1,038,750 in gross profit. Now, we really began to build up our expense line. It’s pretty standard. There’s going to be some additions on different industries but for the most part, there’s going to be automobile expense, bank service charges, charitable contributions. That is a bonafide tax deductible expense for your business if you are actually giving money from the business to a 501(c)(3), a non-profit.
So, you got your computer and internet expenses. You got your consulting. You got your contract labor, your health benefits. For the sake of this, we have no, zero for health benefits. This is a fairly new startup. We have insurance expense. I always want to make sure that a business is adequately protected in case something happens. It’s much like you wouldn’t drive a car without insurance. First of all, it would be illegal, but then it would be very foolish not to have it. I recommend that business owners are very souped up on non-onwed auto policies if you have drivers in your business, but the expense is commensurate with the revenue. So, the higher the revenue, the higher the insurance expense. You got your internet expense, interest expense, your marketing dollars. This is different from sales.
Marketing really is what creates the environment in which people want to buy. That’s the branding, meals and entertainment, miscellaneous, office supplies, payroll expense, postage and delivery, professional fees. The professional fees are going to be those, the experts in their fields. So, you’re going to have your accountants. I am a CFO, so I would be a line item in an operating expense of an income statement. You got your attorneys. You got your legal fees that we’re budgeting for. You got your rent expense, your repairs and maintenance, taxes and licenses, telephone expense, travel and etcetera.
So, now that we have that , this number did not come in a vacuum. This number comes from prior historical expenses incurred for automobile expense. So, for this fictitious company in 2019, we spent $20,000 worth of automobile expense. We think we’re going to need to invest a little more. So, we’re budgeted for $25,000 for the year. What this does, this Y cell, which is not an input sale, calculates what that would be per month. So, at $25,000 a year, we’re incurring $2,083.33 average expenditure per month, which is 25% higher than it was last year. So, we’re budgeting an increase. We expect more driving to happen, more gas.
Side note, there is two ways that you can go and deduct the automobile expense in your business according to IRS guidelines in the U.S.. It’s either the federal rate, which it changes, but I think from 53 to 58 cents per dollar, which takes into account the amortization or the depreciation of the car, or you can go actuals. Now, if you have a very expensive car like a truck, like a work truck and the repairs and maintenance and then the gas, then you have a decision to make. That’s the conversation for another day, but you’ve got to be wise, and you’ve got to have good people advising you in what is the best way to optimize the expenses of your business you could get the best bang for your buck.
So, $25,000 bank service charges. You can’t get away. This is going to be anywhere from 10 to $12 a month is what I usually see. So, we just put it in here. We spent $179 last year, so we’re expecting a little less. It’s a line item. It’s marginal. Say we’re going to donate some money to a cost throughout the year, so it’s going to average $50, so we will enter $600. There’s a 20% increase over the prior year. We go down the line. You got your computer and internet expenses, so you can see now that we’re 40% increase in internet expense that we are projecting, so we’re probably going to have more hires, more bandwidth. We’re uploading more things. We need more power. There’s no change in your consulting. We’re really decreasing for the sake of this exercise, our contract labor.
In another video, I spent quite a bit of time talking about the difference between independent contractors and W2 employees when I talked about cashflow statement. The laws are changing particularly in California as far as what the new definition in the ABC test that makes somebody independent contractor versus an employee. It is a pretty robust definition. I wouldn’t play with it. Get a labor lawyer to help you if you’re understanding. Anyway, you got your insurance expense. Marginal increase. We spent $36,000 last year. Expect there is going to be more sales so we’re going to pay more insurance, 20%. There was a loan last year that we paid off, so there’s no interest expense this year. Marketing expense is a 6.2% increase year over a year from prior year, meals, and you get the picture, right?
What’s interesting to note is that your biggest expense in your business will always be payroll, will always be your wages and salaries. So, don’t just hire people for the sake of hiring people. Hire people with a purpose. When I did the video for the top 10 KPIs to motivate employees, I mean you really … They can become your greatest asset or your worst liability. So, you got to be fair, but you got to be wise as you add employees. Last year, we spent $350,000. This year, we’re projecting a growth.
Now, there’s one other sheet that I want to discuss in this video that supports the summary sheet, and that is the payroll input. Given the fact that your payroll is your largest expense, you should go out, usually go into it with eyes wide open. For this video, we have nine employees with different wages. Let’s just say this is a professional services. I’m sorry. This is a high end company that has … the labors is, it can be very expensive, so $40,000. We’d factor in 12% of the wages are employee-related payroll taxes, which is up here. That’s a business expense. Those are separate from the taxes that the employee pays, so it gives us … When you calculate your budget, you’ve got to look at their whole cost of payroll, wages plus the payroll taxes, and that, with the nine employees is $139,000.
Now, this particular company pays commissions to the degree of 5% if you notice here. Right here, 5% of the sales are paid out to sales reps. These are awesome. That’d be two sales reps that actually are in commission. We’re expected to pay $69,250 this year, which we’re going to paying payroll taxes on. It’s $77,000, so our total payroll for 2020 is $516k. Now, there’s a couple of more additions that we didn’t have from the prior year, but just to kind of say how this … Say we were to delete this, our payroll goes down and so, but this is for the scenario. So, the payroll goes down, the employee related taxes go down. This line will go down as you noticed, is by $516,000 on nine employees, but if we didn’t have nine and we had seven, our payroll is $434,000. For the sake of this example, we have nine, $516k. Notice this number. This number comes back here because it borrows from the other sheet and now divided by 12 gives us $43,000 a month.
So, at the end of it, there are fixed expenses. Last year was $672,000, and we are projecting $824,000 worth of expenses with a 22.6% increase. Keep in mind, this is where we’re budgeting. Is it budget fluid? Yes. Will they change strategy a year? Perhaps. Most likely it does. This is a living document. You got to be looking at it. Here’s the important thing in about an operating budget. An operating budget, it’s only helpful if it is … if you look at actuals versus budget. One of the exercises that I do every month with my clients is that either me or my staff will go over a budget variance, so this budget will get approved by the management uploaded into their accounting software whether that is QuickBooks, Xero, NetSuite, et cetera, and co-construct whatever industry you’re in. Then, you run what it’s called a budget versus variance report. That’ll tell you whether you upload that on all different categories, which is really cool thing to do. The goal is to be a little ahead of budget in the revenue and a little under the budget on the expense side.
So, here’s the cool part. So, now that we have a budget and we’re assuming that everybody is on board and we think we’re going to generate $1.3m just shy of $1.4 million and we’re going to have $1,038,000 profit, we have $824,000 worth of expense of 59 and a half percent of revenue. That gives us $214,000 or 15.5% so you’re making 15.5 cents for every dollar that you sell. The cost of service in that revenue on the operating expenses, 59%, and then if you take away the 25% that you’re spending the cost of goods, it leaves you the 15.5%.
Please feel free to comment below, and let me know if you have any questions. I’d be happy to answer all the questions that you have regarding the budgeting process. I’m giving away this budget, this template, because I think you can definitely benefit from it. I think it’s a free tool. Use it. I spent a lot of time building it, so that helps. So, I hope this exercise was helpful to you. Again, we’re not talking about the balance sheet. We’re not talking about the cash flow statement. We did cover payroll and just remember that the areas in color are the areas you can’t change everything in white. Everything in white, it’s already is based on a formula.
So, you’ll notice here, C33 divided into 12, which is your input for 14,000 gives you the 1,166. So, now you know how to prepare an operating budget, and I think we did it in 20 minutes or less. The truth is that 75% of small businesses in the U.S. operated without a budget. How do they do that? Well, and as I said, no wonder how many businesses go out because for lack of planning, and without a vision for your business, your business will perish.
Hey, please comment below, and let me know what type of experience, if any, have you had with creating an operating budgets for your business and what that experience and process has been for you. I would love to know. Please comment below and like the video. As my gift to you, I would like to give you this budget template. We went over on this video today. It took me many hours to get it to the way it looks today. Click on the link below, so you can get it. Also, if you want to join a community of like-minded, successful entrepreneurs just like you, then join our community on Facebook at the link below where I share tips, tactics, and strategies on how my clients are growing their businesses to seven figures and beyond.
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