This article is the second in a series addressing how you can manage your company using systems and reports.
The first key component of a system is to set goals and quantifiable benchmarks. In the financial management system this starts with a business plan and operating budget. Without these benchmarks you have nothing to compare your actual financial results against.
An operating budget provides a basis for determining your appropriate mark-up percentage as well as targeting the amount of gross profit needed in the upcoming year to cover overhead and provide for a reasonable profit. To really make the best of your operating budget it is important to not only look at your expenses for the year but to identify your estimated operating expenses on a month-by-month basis. This will make it easier for you to analyze your financial results compared to your budget.
Before developing your operating budget it is important to have an understanding of your current business and what it will look like in the year ahead. Here are some good places to start:
- Take a look at both the internal and external factors that have an effect on your business. Look at the jobs you sold and produced. What type of work provided the greatest gross profit? Were you more successful in a particular part of town or subdivision? Was there a particular customer profile that was easier to work with? Evaluate the economic outlook for your current market. Examine the effect of political, demographic, and social factors within your marketplace.
- Examine your internal resources and systems. Are you getting the most out of your systems and people? Review your successes and failures during the year and make sure you plan to capitalize on successes and take corrective action to avoid future problems.
- Set some basic goals on the number of houses and/or dollar volume you would like to produce in the year ahead. Establish a target net profit you would like to make for your company. Net profit should be after paying yourself a “reasonable” salary for the work you perform for the company. Strive for a net profit between 7.5% and 10% of anticipated sales volume.
- Review your current year’s activity on a month-by-month basis. Identify your fixed expenses (those that won’t change with volume) and plan for possible increases. Examine your variable expenses (expenses that will vary with changes in volume) and link these expenses to your targeted sales goals.
Projected Profits.
After you have taken a first cut through your operating budget, sit back and examine the overall numbers. Add your targeted net profit to your operating expenses to determine the amount of gross profit you need for the year. Once you know the dollars of gross profit needed you can determine the markup you need to reach your goals.
For example, suppose you expect to produce five houses this year with an average sales price of $600,000 for total anticipated sales of $3,000,000. If you are looking to achieve a 10% net return, your targeted net income is $300,000. If your overhead for the year totaled $400,000 you will need $700,000 of gross profit (sales less direct construction costs—all costs not accounted for in your operating budget) to hit your goal.
In order to determine the markup you need, first find your targeted cost of sales by subtracting your targeted gross profit ($700,000) from your anticipated sales ($3,000,000). In this example, cost of sales would be $2,300,000. To determine your markup, divide sales by cost of sales ($3,000,000/$2,300,000), which totals a markup of 1.30.
If you see that the markup you must achieve to meet your goals is unreasonably high, it is time to go back and challenge your operating expenses. Make the necessary changes in your budget so that you can realistically meet your net income goal.
