If you are below budget in sales this month, you can’t make it up next month regardless of how good sales are then. A football coach can’t “lose these four quarters but make it up next game.” A loss is a loss. You can never make it up. Ever.
That is because expenses happen in months. You pay this month’s rent, this month’s utilities, this month’s wages, this month’s equipment payments, and this month’s paper bill. You can’t dip into next month to get cash to pay this month’s expenses.
While year-to-date is the best guide to budgeting expenses, it isn’t for sales. Why? You lose cash faster in a down month than you earn in an up month.
Assume a box score of 25 percent direct materials, 25 percent labor and 25 percent overhead, leaving 25 percent Income before Owner, from which the owner takes a salary of 10 percent resulting in 15 percent net income.
In an above budget sales month, the incremental sales over budget drops up to 75 percent to Income before Owner (100 percent incremental sales – direct materials of 25 percent = 75 percent) because wages and overhead are close to fixed expenses as most occur over time.
In a low sales month, every dollar of incremental sales below budget costs you the expenses you didn’t cover (up to 75 percent of the shortfall depending on owner’s salary). That’s because your wages, overhead, and owner salary is relatively fixed. So for every dollar you are below your monthly budget, you can lose up to 65 percent to 75 percent in cash (depending on owner salary again).
So, be under $10,000 in sales this month and you lose up to $7,500 cash. Be up $10,000 in sales next month and you can earn $7,500 in cash. Doesn’t the two offset each other? Yes, but the two also net out cash-wise to you making no money in these two months because you used next month’s sales to “make up” for what you didn’t do this month.
Worse yet, the lower the Income before Owner compensation; the more this hurts. In a situation where direct materials is 25%, wages 35% and overhead 35% leaving 5% Income before Owner Compensation; being $10,000 over in sales results in only $500 IB4 while being $10,000 under results in up to a $9,500 loss. So, be over $10,000 and earn $500. Be under $10,000 and lose up to $9,500.
In reality, we’re down usually more than we are up. An average is the best of the worst and the worst of the best. Line your monthly sales numbers up from smallest at the bottom to the largest at top. Now draw a line between three and four months and another line between six and seven.
Add up the bottom three and then double them. In a normal distribution where averages describe the data, doubling the bottom three will equal your top three. It usually doesn’t come close. So, you can’t rely on the average month for your sales don’t average.
So thinking you are “making it up” next month actually robs the real cash you earn in the high months to subsidize the cash you lose in the bottom three.
This is precisely why we use Sustainable Sales for financial budgets.
To calculate Sustainable Sales, take the last 12 months actual sales and then throw out the highest three months. Then take an average of the bottom nine and multiply that by 12 (months) and you will get your Sustainable Sales number for the year.
That’s a financial budget sales number where you have a shot at beating (winning) every month, even during your down months.
So, stop the stinking thinking. You either win this month’s game or lose or tie. You can never make it up next month.
If you lose this month, just admit it and move on. And yes, even the best coaches lose but they keep their jobs by winning. So figure out what you needed to do to win and make adjustments. Don’t let yourself off the hook by the stinking thinking that you’ll make it up. You never will. It’s gone.
Next month is a new game, so go out to win.
Something for you to think about….