Budgeting Your Business to its Absolute Core

To avoid the pain of a tough economy, kitchen and bath owners must take action – or risk having their businesses fall so far in the hole that there is little chance of rescue. Professional crisis managers strongly recommend budgeting your firm to its core as the very first step in taking responsible remedial action.

This budgeting process is critical because it enables owners to make smart overhead-reduction decisions, establish correct pricing formulas and develop key management tools to successfully steer their operations through rough waters. I encourage owners to do it over a three-year period because it gets them to think strategically and provides them with a vision of what to do if business turns out better than expected.

When considering each expense account, the guiding principle should be whether that expense delivers direct value to the client. If there’s negligible value, the account should not be funded. Here are the 10 steps to follow in this budgeting process.

  1. Consider the Best Conceptual Business Model. It should suit the owner’s strengths and short-term income aspirations. For example, in the current economy, a number of owners who serve in a general manager’s role have expressed frustration at the inability of their salespeople to close sales. If the owner has strong selling skills, perhaps a downsizing shift to a “studio” business model for the next two to three years would be in the firm’s best interests. In this model, the owner serves as the chief sales designer, supported by one or more design assistants, a project manager and an office manager.
  2. Make Realistic Annual Income Projections. Since a budget is a spending document, it’s key that these projections are conservative. Overly optimistic numbers, especially in a recession, will get you in trouble. The graph below is a sample of a hypothetical owner downsizing his operation to a “studio” business model for the next two years:
  3. Skip Over Projecting Gross Profit %. This is the biggest mistake most owners make when budgeting. You don’t want to look at last year’s P&L Statement, showing a 36% gross profit for example, and decide you should achieve the same number in 2009. This approach will prevent you from reaching for a proper net profit and sharpening your marketing skills to achieve that figure.
  4. Detail Burden Accounts. “Burden” is defined as the indirect costs of producing a project that are not easily “job-costed,” such as a project manager’s salary, trucking expense, truck depreciation, warehouse expense, etc. A firm needs to project these annual burden costs if it plans to have salespeople within three years and have a commission system based on the salesperson earning a percentage of the gross profit. (For more details on this topic, see the April, 2006 column “Creating A Price Formula.”)
  5. Detail Sales Expense Accounts. If the owner produces the $1,000,000 in business projected in the sample operation, then his or her executive pay should be the same market-rate 10% – or $100,000 – that would be earned if that book of business was generated for another dealer. Unfortunately, I usually find most owners undervaluing their pay by 25-35% for the job they perform. Other sales expense accounts for this “studio” business model include such items as market-rate salaries for design assistant(s), owner’s car expenses (gas, maintenance, etc.), marketing tools (cabinet literature, door samples, etc.) and advertising. In good times, experts recommend that businesses invest 3-4% of expected income in advertising to keep their brand awareness high. In bad times, they recommend doubling that investment percentage to maintain a continual flow of leads, secure a positive cash flow and gain significant market share as competitors cut this expense.
  6. Detail Administrative Expense Accounts. These would be for accounts such as office manager salary, rent, utilities, office equipment depreciation, health insurance, owner’s key man and disability insurance, property and liability insurance, retirement, office supplies, dues/subscriptions, amortization of leasehold improvements, etc.
  7. Detail Other Income/Expense Accounts. “Other Income” would include cash discounts earned on material purchases, rent from subleased space, buying group rebates, etc. These items should be posted “below the line” because “top line income” should be reserved for project income. Otherwise, a dealer’s gross profit margin gets artificially inflated. “Other Expenses” would include interest from loans and warranty service.
  8. Determine the Desired Net Profit. American industry strives for an 8-10% pre-tax net profit, so why not you? It’s not enough for owners to just earn a market-rate salary and perks. That’s nothing more than “buying a job.” There has to be a good return on investment for the blood, sweat and tears in satisfactorily completing $1,000,000 worth of kitchen and bath projects, as with this sample “studio” operation. And capital will be needed to fund the 25% growth in 2010 and 20% in 2011. The capital left in the business, called retained earnings, can help to finance that growth.
  9. “Reverse Engineer” to Gross Profit Dollars. Add up the totals of Steps 4-8 and post the result on the Pro Forma (summary) page under Gross Profit. This figure represents the gross profit dollars needed to pay for the burden, sales, administrative and other expenses – plus the desired net profit. Many owners are shocked to find the required gross profit percent may necessitate a 15-20% price increase – or more.
  10. Reflect on the Results. If the scale of the price increase seems radical, focus on reducing overhead. After all, a “lean and mean” operation is not only what you need in tough times, it’s what you need to be profitable. The effective use of proven marketing strategies will help consumers see dealers as a superior value. As a result, some determined owners have achieved 20% price increases – even in this economy.

To learn more about budgeting, and the key derivative financial tools that are developed from this process, dealers are encouraged to attend a day-long business seminar, co-produced by KBDN and SEN Design Group, entitled “Managing for Success in Today’s Challenging Economy.” For more seminar details, visit www.senseminars.com. Interested parties can also send me an e-mail requesting a Pro Forma spreadsheet that summarizes the proper budgeting steps to follow.