A budget is more than just an estimate of total company revenue and expenses for the year. It is a tool for setting sales targets and for making adjustments as market conditions change. A budget is also essential for decisions about hiring additional employees, for determining raises and bonuses, and for planning a benefits package. And a budget ensures that you know before the year starts what you need to do to earn the salary you want and the profit you expect.
Next year’s budget typically builds on what happened last year; it’s essentially an exercise in year-over-year comparisons. But market volatility in recent years has many veteran remodeling company owners starting from scratch. And if you’ve never built a budget before, this kind of “zero-based” budgeting is a good place to begin. Either way, something is better than nothing. As financial and management consultant Leslie Shiner says, “Being close matters, but you don’t have to be exact. It’s the ‘Nike’ approach. You pick some numbers and you just do it. Then you adjust.”
Top Down or Bottom Up
You can build a budget from the top down, starting with estimated revenue and calculating how much in expenses you can afford, or from the bottom up, beginning with expenses and determining how much revenue you will need to meet them. The fact is, the process is circular and requires both a best guess at expenses and a “What If” approach to revenue and gross profit targets.
When starting at the top, says Judith Miller, a Seattle–based business consultant and trainer, “Begin by asking, ‘How much can I sell? What will it cost to build those projects? What’s left over?’” In the bottom-up method, Shiner says, “Start by asking, ‘How much do I need to take home?’” Then look at what it costs to pay employees. Even without reliable records, most owners can estimate these numbers. But company owners who have gone back to working at least part-time in the field need to keep this billable labor separate from time they spend in the office or selling.
“Gross profit grows as a company grows. Young companies can earn 20% to 25% ... After 10 or 15 years, it can jump to 35% or more.” —Judith Miller, Remodelservices.com
An annual budget is better than no budget, but a quarterly or monthly budget makes it easier to make changes as you go. “A yearly budget doesn’t have any implications of seasonality of income,” says Alan Hanbury, owner of House of Hanbury Builders, in Newington, Conn., and a veteran remodeler who wields both an MBA and a hammer. “Business comes in spurts. You can’t do the same kind of work each month all year long and you can’t have the same expenses each month all year long.” For example, some months have more pay days than others. “If you’re doing a monthly budget, your labor budget will be 25% higher … four times a year.”
If you are a beginner, follow these six steps to build a simple “outline” budget that will help you earn more than you spend. If you need a refresher, check out the “itemized” version. But this is not an accounting lesson — if you still have questions, consult an accountant or the other sources mentioned here.
Breakeven is the minimum revenue needed to meet your budget, what Hanbury calls the “make plan amount.” In other words, at breakeven revenue, you earn enough to cover all COGS and overhead, and you bank a net profit, too. If you can estimate overhead and profit for the coming year, and you know your historical gross margin, use this formula:
(overhead + profit) ÷ gross margin = breakeven
If you don’t know your historical gross margin, estimate breakeven using the industry standard 30% gross margin (e.g., $195,000 ÷ 0.30 = $650,000).
“It’s a good number to know,” Hanbury says, but it’s a moving target. He cautions that every expense, from staples to vehicles to a new hire, will push out your breakeven. That means breakeven can be misleading if you don’t keep an eye on it, but it’s also a great planning tool.
For example, say you wanted to know how much more revenue you would need to earn to cover additional overhead — say, the cost of buying a new $45,000 truck. Divide $45,000 by gross margin. At 30% gross margin, “You’d have to do $150,000 more in volume just to pay for that truck — or that new accounting system or that salesman you’re going to hire,” Hanbury says. “It’s a magic number, but when ... we spend money, it just pushes our breakeven out.”
This sample budget contains the bare essentials. It meets the needs of a craftsman or a small, two- or three-person company with simple overhead expenses. As a company grows, adding other sources of revenue, taking loans, expanding employee benefits, and so on, a more detailed budget becomes essential.
Step 1: Owner’s Salary Start with a realistic number — an amount that meets your personal needs but also reflects your responsibilities as company owner. As Hanbury says, “You’ve got to pay yourself better than your best lead carpenter and pay yourself for losing sleep at night as the owner.” A good salary benchmark is between 6% and 15% of total revenue.
If you’re working both in the field and in the office, separate those figures, even if you have to guess. Your pay for working in the office should show up in Variable Costs, and your pay for working in the field should go into Cost of Goods Sold.
If you don’t pay yourself a salary, now is the time to start, if only because it helps you calculate the true cost of running the business. But it also helps later on as you plan to replace yourself — in the field, in the office, and anywhere else you might show up on the org chart.
Key to Success: Allow for the difference between gross pay and what you actually take home after taxes.
Step 2: Cost of Goods Sold Everything that is consumed by a project — material, subcontractors, labor — goes here. (Labor gets special treatment in Step 3.) Use “invoice” costs, before your markup is applied.
History helps here, but if you have no records, there are rough benchmark percentages for these items. Hanbury suggests that COGS should be no more than 70%. “Otherwise you won’t get a 30% gross profit margin.”
Key to Success: Keep as much labor and supervision expense “above the line” in COGS. Keep total COGS at or under 70% of revenue.
Step 3: Labor All labor costs for employees must include “labor burden” — that’s everything you pay over and above wages. It includes payroll taxes, workers’ comp, cell phone and vehicle allowances, training, holiday and vacation pay — even company picnics and parties.
Key to Success: Separate field labor from office labor, and keep field labor burden out of overhead. “If you don’t,” Hanbury says, “your jobs will look profitable in your job cost system but not in your accounting system.”
Step 4: Fixed Costs Part of “overhead,” these are the costs just to keep your doors open, even if you haven’t got any work. Fixed costs don’t vary much year to year, regardless of revenue, but there may be monthly differences.
Budget something for callbacks and also for bad debt. “[This is] the guy who never intends to pay you your last payment,” Hanbury says. He suggests budgeting 3% and using anything left over for bonuses.
Key to Success: Keep only office or administrative labor in overhead; field labor belongs in COGS. Budget something for use of an in-home office.
Step 5: Variable Costs These costs change depending on revenue. For example, more work means more labor hours paid, which means higher liability insurance and workers’ comp payments.
Budget for marketing, but avoid using a percentage. “[In a tough economy] look back and see how much you spent in a good year,” Hanbury says. “Then spend a little more so people will understand what makes you different and better.”
Key to Success: Include owner labor (plus burden) for hours worked selling, estimating, talking with vendors — anything not directly billable to a specific job.
Step 6: Gross & Net Now it’s time to see if the budget works. In other words, will revenue cover all costs and leave any profit? To find out, subtract COGS from revenue. The amount left over has to at least cover overhead and should also leave something extra — that’s your net profit. If it doesn’t work out this way, you have to either increase revenue or cut expenses or both.
Key to Success: Use a spreadsheet to make these calculations automatically and play with “What If” scenarios. You can download sample worksheets from the online version of this article.
This budget example is better suited to larger companies that have more complex sources of revenue, that need to track several categories of labor costs, and that regularly generate a variety of accounting reports.
Design & Supervision
In addition to direct field labor, this budget itemizes design and supervision labor that can be billed to specific jobs, as well as all associated labor burden. This information needs to integrate with the estimating system so it is properly priced.
Time spent working with tools is always a direct cost, but design project development, and supervisory labor can be a direct cost or overhead. All employees should use a time card to track actual hours; otherwise, apply a percentage of total salary to account for how time is spent.
Many remodelers prepare several versions of their budget. The first version is a best-case scenario and includes everything they would like to be able to provide, including vacations and other benefits for employees, training, new tools, and vehicles — the works. But if the numbers don’t work out, or they anticipate a slow season, they cut the frills and focus on covering the basics — salaries, licenses, legal and accounting fees, rent, office supplies and computer equipment upkeep, plus phone and basic utilities. (Consult with an accountant to determine budget amounts for depreciation and amortization.)
—Stacey Freed, senior editor, REMODELING.