Case Study: How to Budget for Sustainable Sales

Budgeting is foolish because how do you know what your sales are going to be next year? That’s what many think, so they either don’t do it or they pick a number and spend hours grinding out a budget that is useless because of the faulty assumption. So, what should we do? Yes, we should budget. But we should use an effective method to predict sales. Here’s how.

Let’s start with what not to do. In the old prosperous days many argued that since sales were up 10 percent the prior year we should budget for the same increase this year. Problem is this method allows us to increase expenses without growing sales. Many who did this remained behind the cash curve even when they hit their income projection. So we developed a rule: Budget based on where you are today and then, should sales continue to increase, you can take the money to the bank.

 

Why Two Budgets?

A financial budget is based on how much is going to be sold minus the costs, which equals income and, hopefully, how much money goes in the bank. A sales budget, on the other hand, is a goal—something to shoot for. Understand there is a difference between a sales budget and a financial budget. A sales budget is what we hope to do, and a financial budget is what we have to do.

A sales budget should be created by looking at individual customers and realistically estimating the sales for each during the next period. You could use this process in estimating the sales budget, but since we’re printers with printing salespeople who often don’t sell, I’ll give you an easier way: use 20 percent.

If your financial budget is $100,000 per month, then establish your sales goal as $120,000.

Why bother? It’s a measurement of management. If sales are $100,000 for the month, then ho-hum managers get to keep their job another month. If they turn in less than $100,000 they might want to polish their resume. If, however, sales are more than $120,000, then give them a high-five. That’s the way it happens in the real world.

 

Shift in Perspective

Then I measured a number of companies in the $1.2 million sales range with a cash flow budget of 10 percent, or $120,000, that barely broke even.

Why? We were using average sales. We took the $1.2 million, divided by 12, and got $100,000 per month. What this method didn’t allow for were the monthly swings in sales from a low of $80,000 to a high of $150,000.

No, this isn’t seasonality. Seasonality is like one company in the tourist north that I worked with that had only three real months of above average sales for the year, meaning that eight months were below average, with one month being barely average. We can see this by reviewing monthly totals for three years and then defining the percentage of sales yielded in any one month. However, seasonality applies to less than five percent of the companies I’ve seen over the years. Most often, there isn’t a seasonal pattern, yet the sales still swing significantly from one month to another.

 

Put It in the Box

What we were failing to do with these normal companies is understand that the few up months were subsidizing the down months. That’s because costs don’t materially change from month to month. Direct materials change, but not as a percentage of sales. Wage dollars are very similar, even in months when we work overtime. Overhead is more or less the same. And, most importantly, owner’s compensation is the same month to month, with additional withdrawals made from time to time. It is noteworthy that owner’s compensation rarely goes down with sales.

We must plan to win more than six out of 12 games. That’s what we’re doing when we budget on averages. Imagine a football coach who starts the season saying, “We have a real shot at winning half of our games.” Let’s plan on winning at least three-fourths of our games.

How do you do that? Take the last 12 months of sales by month and stack them up lowest to highest. Remove the top three sales months. Now take an average of the bottom nine months. Multiply that average by 12 and use this “sustainable sales” number for your financial budget.

Why is it called sustainable? Because it is the sales level you will most likely achieve without the heroic months. And it’s a simple and effective method that prevents us from spending money we don’t yet have. That way, we can put the money we make in the big months in the bank and not use it to subsidize the down months.

Oh yes, two other rules. If we have decreasing sales, plan for the same decrease in sales this year, even if your sustainable sales level is higher. Additionally, if your average sales level this year projects to less than your sustainable number, then use that for your finance budget. By following this procedure, you will bring realism into your budgeting process.

 

Tom Crouser is chairman of CPrint International and principal of Crouser & Associates, Inc., 235 Dutch Road, Charleston, WV 25302, (MyPRINTResource.com/10004688), 304-965-7100. Contact him at 304-541-3714 or tom@crouser.com.

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