It’s an age old issue, most SME’s don’t do an operating budget and there is a very good reason for this, they don’t work. Why?
Because they are not prepared based on a set of defined strategies – just guesstimates.
When I prepared annual Profit and Cash Flow Plans (notice I didn’t say budgets) for clients the task was undertaken in way that most business owners and their team don’t know about.
Generally budgets (if done) are based on guess work which is then applied to the Total Revenue of the business in a prior year and hoping for an improvement in Net Operating Profit.
Here’s a couple of examples to consider.
Example A (Traditional)
This year we will increase revenue from $1,873,468 to $2,100,000 (a guess) and increase net profit from $101,337 to $150,000 (another guess).
A better way to do this is:
Example B (Strategic Budgeting)
Focusing on the 6 drivers of profitability, we will increase our Net Operating Profit to $150,000 by adopting the following strategies:
- Increase our active customer numbers by 10% by reducing customer loss rate by 5% and increasing customer gain rate by 5% through improving our customer service level and promotional activity
- Increase our gross profit margin by 2.0% points through revising our current pricing and directing our sales focus toward higher margin products
- Increase average items per purchase by 10% through improving our customer service level and product bundling
- Increase our customers transaction frequency on average by 5% through improving our customer service level and additional promotional activity
- Reduce our fixed cost : sales ratio by 5% through refining and/or re-designing our business processes
We have 438 active customers whose average purchase value is $483.
I think you’ll agree, there is a distinct difference between Example A and Example B in determining the budget parameters.
Each strategy in Example B requires specific tactics to achieve the resultant revenue and profit outcome which will incur additional costs.
Take a look at this video demonstration using ‘Profit Explorer’ to see what the results are using Example B as the basis for the Operating Budget.
I’ve never met a business owner who was not amazed by this process.
Once your clients see how simple it is to develop (with your help) a strategically focused budget for their business (it’s a learning experience) they will very likely want you to do this for them every year.
- I know this from personal experience.
- Once a business owner understands what drives profit they quickly embrace the required initiatives.
- There is a strategic focus to running the business.
- If outcomes are not being achieved they will be able to identify strategies that aren’t succeeding and shift focus to those that are.
Click here to go to our ‘Advisor Tools’ page should you wish to use the ‘Profit Explorer’ with your clients.