Budgeting Debate: Gross Profit vs. Gross Sales

A budget or a business plan forecasts how many large, medium, and small additions; how many kitchen and bath jobs we are going to do. I wasn't smart enough to forecast how many of each type of job we would get, or whether we would build a custom house, so I didn't try. We did something else.

We are all good at estimating. We know how long it will take and how much it will cost to put together 14,280 loose pieces of "stuff" like 2x4s, shingles, pipe elbows and door knobs; to match a set of drawings. We'll even guarantee it will happen for a fixed price that we budget; so what makes doing the operating budget such a pain? Maybe it is we go about it. We take the different types of jobs that come our way, at the right price. Does it make any difference from whence commeth the gross profit? NO, just as long as it commeth.

Other than construction costs, we pay for everything out of gross profit (GP). Why not create your operating budget from the gross profit rather than gross sales? It works the same way: start with a reasonable net profit; add operating expenses of GA & O; sales and marketing expense; and you have your operating budget. It is the amount of gross dollars you need to generate in order to put a smile on your face, and a trip to Grand Cayman on your calendar. Your company history (or industry benchmarks) shows what gross margin you have or should have. Dividing the GP by the margin percentage tells you how many sales dollars you need to create.

We can make a good estimate of how many jobs each supervisor or project manager can produce in a year, depending upon the type and size of the job (houses, large or small additions, kitchens, baths, even handyman). Each experienced supervisor should be able to produce roughly the same amount of gross profit dollars. At our company that was about $150,000 per year. And it should not make a difference what the job mix is. Let's see an example: three project managers, each creates an average gross profit of $150,000/year or a total of $450,000; if your average gross margin is 33 percent, your sales will be $1.36 million.

You track your progress against budget at the gross profit level. I like it because it gets to the real meat of the issue, "How much must I make to pay my bills, ME and have something left?" You should still prepare reports with percentages to sales because that is how the industry compares companies. You are not pulling anything funny by doing this; it just seems to me to be a little more straightforward in projecting how much business we can or want to do.

It is great for planning growth. We can't hire part of a person, so if we add a project manager, we should expect him or her, when trained, to produce another $150,000 of gross profit or (at 33 percent margin) $450,000 of gross sales. It's the same budget from a different direction . . . sorta like from the bottom line up.