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Copyright January 1, 1996
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Transmitted from Jacksonville, Florida
Dear Friends. . .
It s that time of year again. New Year s resolutions; compile payroll tax
information; and finalize the budget. Budget? Budget! Yes, budget. And, not
one budget but two: the operating budget and the capital budget. Here s the
We all generally are familiar with an operating budget, although most of us
rarely prepare one. An operating budget essentially projects your income and
cash flow for the year. Most of us strive valiantly to just get this far. The
capital budget is where you decide what you are going to do with the cash
that you do build up such as build working capital; buy equipment; increase
the amount you take out of the business; or put some away for retirement.
Why Not To Budget
I use to work at the Westinghouse plant and we budgeted each year, but it
was just a farce. We just told them what they wanted to hear. Okay. But
that s the fault of the budgeteers, not the budget process.
How in the world can you predict what is going to happen in the future. It s
a waste of time. It is tough. I was a Logistical Programs and Plans Staff
Officer in the reserves at the time of the Persian Gulf war. A doomsdayist of
the first degree. We spent a lot of time creating scenarios and preparing for
war. The most popular was the European scenario. Well, the war which came
along was with Iraq. Now, were we better prepared because we planned,
prepared and predicted a scenario which didn t happened? Or, should we have
just waited to see what was going to happen, then prepare? Obviously, planned
things happen best, even though they aren t planned exactly that way.
Budgeting is predicting what is going to happen in the future, that is true.
Many of us don t.
The Operating Budget
We begin with the Operating Budget which follows the income statement:
- Projected Sales
- minus Direct Materials (%)
- minus Labor
- minus Overhead
- equals Net Income
- add Depreciation/Amortization
- from Overhead, above
- deduct Payments on notes not
- reflected in Overhead, above.
- equals Projected Cash Increase/Decrease
Within this process, there are two areas where many get into trouble:
projecting sales and not considering payments on debt.
How do I know what sales are going to be? Or, worse than
that, I predict sales will increase 20% next year. (The following does not
completely apply to a start-up shop.) My advice is don t project sales. Look
at your sales over the last three years. If you have an average positive
increase in sales without a significant downward trend, then project your
sales to be equal to what they actually were in the last year. In short,
project your sales where they are now. If you can t make money where you are,
increasing sales by 20% rarely will do anything for you. I can give you many
horror stories on this and many folks guff galled at this advice while times
were good. Then we hit the recession wall and lost many of our fellow
printers because they could not count on next year s sales increase to cover
what was being spent this year. If your sales are decreasing, then budget for
Projecting for sales increases is the first mistake most people make in
budgeting. This is not to say one can not have a sales budget. You should
have. You just shouldn t confuse sales goals with the sales you use in an
operating budget. One is a desire, the other is life and death.
What is a direct material? Paper, inks, copier meter clicks
and shop supplies. I always say if you printed nothing, then you would have
no direct material cost. If your item still costs you even if you do not
print or copy anything, then you have an overhead or labor expense. I also
add, Of course, I know printers who could print nothing but still have waste
and spoilage. Usually, printing management students don t get the meaning of
that. Industry audiences always do.
Direct materials are best budgeted as a percentage of sales. If you have
historically spent 27% of sales on direct materials, then I predict you will
in the future. If you institute a price increase to decrease your cost of
direct materials, do not consider the decreased direct material percentage in
your budget until it shows up in your year-to-date income statement.
Manufacturing accounting theory holds that direct labor (such as press
operators working directly on the product) is a variable expense and should
be considered outside of indirect labor (such as the bookkeeper who labor is
indirectly related to the product). For budgeting purposes (not budget hour
rate purposes), it really doesn t matter. Your press operator is going to be
in the shop 40 hours a week. If you start sending them home when you don t
have work, then you will find the press operator working for someone who
So, multiply the hourly rate by the hours per week. Do not calculate overtime
hours which are not planned (such as overtime to get out all of the work).
Regular overtime, such as being open on Saturday or other such self inflicted
silly punishment, should be counted. If you pay any kind of bonus or anyone
has a great deal of overtime, calculate their effective hourly rate by taking
their year-to-date total pay divided by a normal 40 hour work week to obtain
an effective amount of pay per hour and use that for your budget. Allow
yourself room for periodic raises by budgeting workers at a higher rate than
they are earning now. Estimate future payroll taxes and benefits as a
percentage of payroll. If payroll taxes and employee benefits amounted to 20%
of total pay in the previous period, projected 20% of future pay to cover the
expense. Do not budget just for the absolute historic dollar amount of health
insurance, for instance.
Owner s Pay
Yes, budget a salary for the owner assuming the owner is
actually doing work (no free lunches, bucko). Assume a salary which would
allow one to hire someone to do what the owner is doing if desired. Any owner
income above this should comes from net income earned and the capital budget.
Rent, utilities, professional fees, advertising, professional fees.
Ooops. Did I have professional fees in there twice? Well, whatever. These are
period expenses and are pretty well known to you. Equipment expenses such as
the base cost of the Kodarox 9999 are overhead expenses because if you made
no copies then you would still be paying this base amount. Project what these
costs will be.
Projected sales - direct materials - labor - overhead = projected
net income. Second biggest problem with budgeting is that many stop here.
Don t stop. Go to the next step.
Add your budget cost of depreciation, and any
amortization, to net income for these are non-cash expenditures.
Deduct your projected payments for items which are not
included in your overhead budget above. For instance, deduct the cost of the
Porsche Delivery Truck if it is not leased and accounted for above. Deduct
the press payments and any other note payments which have been capitalized
(put on the balance sheet as an asset). And, yes, I know these payments
include interest. Well, if it is really material, you can back out the
interest. But, for 90% of us, just deduct the payments which do not show up
on the income statement as expenses. (Kodarox 9999 s are sometimes on the
balance sheet and sometimes not depending upon the specific contract.)
Projected Cash Increase/Decrease
From Net Income, add Depreciation/Amortization and deduct Payments. This estimates a cash increase
or decrease. If it estimates a cash decrease, then go back to the budget and
fix it without increasing your sales. If it estimates a cash increase, then
you may proceed to the Capital Budgeting process.
It is from the increase of cash flung off of the operating budget, that we
find money to do with what we want. However, there are still some basic
considerations here. First consideration is all stakeholders should decide on
the following including the founder, spouse, and other stakeholders whether
or not they work in the business on a day by day basis.
Income taxes will have to be considered on the earrings if they were
not considered in the capital budget. Sometimes we have to consider special
tax situations with some sub S corporations, for instance. So, from the cash
which is being spun off, calculate how much to set aside for taxes.
If you don t have a 2 to 1 current ratio (current assets /
current liabilities), then calculate how much money it will take to give you
that ratio. (Example: company has $75,000 of current assets and $100,000 of
current liabilities therefore it has a .75 current ratio. What does it need?
A 2 to 1 current ratio would be $100,000 x 2 or $200,000 of current assets.
Well, we have $75,000 now, so we need an additional $200,000 - $75,000 or
$125,000.) If you do not have a 2 to 1 current ratio, stop here and put all
of your money into your current ratio until you do. How? Pay down your
accounts payable, taxes payable, etc. and/or accumulate cash in the bank,
accounts receivable, etc. Do not take current assets and withdraw them for
your personal use nor take current assets and convert them to non-current
assets by buying equipment. Let it happen.
How much money will you need and when will you need it to put
junior through college? Most of us entrepreneurs count on the lotto
scholarship typified by the Who, me worry? attitude. Maybe we ll have it
maybe we won t. We usually end up taking heavy money out of the business at a
time the business can least afford it and possibly bringing down the house of
Calculate how much money you would need to have in the bank
earning 6% interest to create the same gross pay you receive now. Now,
calculate how much you would have to put in the bank every month in order to
have that retirement amount waiting for you. Then do it. Those relying on the
pot of gold at the end of the printing rainbow are disappointed.
Do you need or want to take more money out of the business
than the wages considered in the overhead section of the operating budget?
Notttt sooo fast. Get the family to agree.
Yes, equipment is put into play with retirement, current living,
education and all the rest. Is the equipment more important than something
else? Many times it is. The capital budget has to allow for the replacement
of equipment, for instance. When the one press in the shop dies, someone had
better planned to have the cash to buy another one.
Or, the stakeholders can decide to expand the business by buying equipment
not now possessed in exchange for later having more income to divide. Either
way, we can decide how much money we can spend on equipment purchases in the
future based on our current operating budget. Now, we can choose among
equipment investments in a planned manner. And that s budgeting.
Will be presenting Power Pricing in Dallas on February 3rd
sponsored by the Printing Industries Association of Texas. We ll also present
the session for the NAQP chapter in New Orleans on March 23rd. We ll be doing
on-site visitations in Florida and Texas in January and February as well as
having Performance Group meetings in Pittsburgh. Hope to see you there. And,
Happy New Year to everyone.
Happy Trails... Tom Crouser
P.S... Planned things happen best. Old time management bromide.
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Crouser & Associates Performance Group program includes two on-site evaluations
by Tom Crouser each year along with two group meetings. Management training is held during the group
meetings along with participation in a meeting with non-competing printers. Join others who have decided
to run their business instead of the business running them. Reply to by Email to
Tom Crouser for more detailed information or call Clark Workman
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Date inserted: Wednesday, January 31, 1996 7:34:55 PM
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