Header image for Planning for Expenses or Profit including three business women discussing business financial objectives

Are you planning for expenses or are you planning for profit?

A Profit and Loss Statement or an Income Statement is Income – Expenses = Profit.  I’m sure everybody recognizes that equation.  We use it all the time.  It is logical.  It conforms to GAAP (Generally Accepted Accounting Practices).  It is the way we have always seen it.  When we translate this into budgeting, most people use a variation on this.  We figure out the Expenses, then we figure the Income and see what is left over for Profit.  We see what is left over for the Owner.  Have you ever thought about flipping that equation on its head?  What if we figured out the Income THEN FIGURED OUT THE PROFIT?

Just imagine if you planned for profit, for taxes, for savings, and for bigger Owner Distributions?  Would you be happier?  What about your family?  What would the impact be on your business?  All of those are easy answers.  You would most definitely be happier – no more worrying about whether or not you will be able to afford to pay your taxes, you wouldn’t worry so much about losing a customer if you knew you had some savings in the bank, and your family would be happier if they could take a vacation every now and then.  And your business?  It would be much more disciplined.

Here is what happens in a normal company.  The company gets started on a shoestring.  You are working off the kitchen table, reusing file folders to avoid a trip to Office Depot, and making do with your two year old laptop.  Then you get some clients.  Money starts to come in.  You grow.  You hire somebody because you are too busy to do everything.  More clients come in.   You get some office space because your family would like the kitchen table back.  More customers roll in, which means you have more money.  This means you are finally able to upgrade your computer.  And while you are at it, you add some great CRM software.  And you hire somebody to run it.  Now that you can track both current and potential clients, more money rolls in.  At which point you realize you need a new website so you can reach more people.  That is fine, you signed that great client last week, which will basically pay for the new website.  Website goes up and so does the number of new customers.  Awesome.  This business is really rolling along.  Your web guys calls and says if we can do this much with just a website, what if we add a little SEO?  Sure thing!  No problem!  You have new clients rolling in every month: “We have money – making more than I ever thought we would.”  You have to hire another couple of people to take care of all these new clients.  All of a sudden you have outgrown your space and need a new office.  A bright shiny Class A building that will really impress all of your clients (who never come in to see you) and that your employees will love.  State of the art.  And as long as all of this money is coming in, you start taking some for yourself.  Of course.  You earned it.  Look at this awesome company you have created from scratch.  Look how far you have come.

But there is generally another side to this.  The cash crunch.  You have all this money coming in and new clients signing with you all the time, but every time you get a new client it seems that the money is spoken for by some new expense almost before the ink is dry on the new contract.  You are covering all of your expense, but you still have to hold your breath on the 12th and the 28th – worried that you won’t have enough cash for payroll.  You get through those dates and take some for yourself and boom – another couple of days when you are worrying that the checks may not come in as fast as they need to go out.  But look at how much you are making.  Everybody is looking at the top line and you aren’t really admitting the truth about the bottom line.  Even to yourself.  You know that you are spending EVRYTHING you are bringing in.  And you wake up at night in a cold sweat because you remember that you missed a deadline for Mr. Jones, and if he gets upset about it he might fire you and you will be short.  How will you pay the rent?  And payroll is coming up.  And you have no savings.  And then the year ends and you accountant calls and says you have a huge tax bill.  How can you possibly owe that much in taxes – you only have $2,384.56 in your bank account.  Can’t he see you didn’t make any money?  You did make money – and took out all those distributions to fund your lifestyle at home and now Uncle Sam wants his share.

Most business owners can readily identify with this scenario.  Almost all have lived through it and some learn the hard lessons and change their ways.  Others pay off the IRS and keep doing what they have been doing while waiting for a different outcome.  The different outcome (profit) doesn’t have to be elusive.  You simply have to plan for it.  What portion of your income should go straight to profit?  Don’t know?  Do some research.  Go online and pull up public companies in your industry and see what percentage of their income remains in profit.  Profit Divided by Gross Revenue = %.  Ask people you know what their percentages are.  Ask your accountant what he thinks they should be.  Then apply this percent to your revenues.  We generally believe that in service based businesses, about 30% should go to profit.  Once you know your projected revenue, and you have figured out your projected profit, the leftover is what you have to spend to run your company.  Do you really need that Class A space?  Are you spending $3,000 a month on Google AdWords and SEO and still haven’t gotten a client from the internet?  Where do you get the most bang for your buck?  Have you planned for some business savings to pay for computer upgrades or to give you a buffer in case you lose a client?  What percentage of your revenue is going to go towards investing in the company in the future and ensuring that you can survive hard times?  You have to make decisions that will move your business forward in the most efficient manner.  Can you see that this forces some discipline into the equation?

And no borrowing from Peter to pay Paul.  Profit is sacrosanct.  In fact, to help with this, as soon as the revenue comes into your account, move the amount for profit into another account.  Preferably one where you can’t see the balance when you log onto the bank’s website.  If you have cash sitting in your bank account the chances you will spend it are pretty high.  Same with your business savings.  Move that the day the income comes in too.  And again, that money is not so you can go buy the flashy new binders with your company logo on them.  That is for the new computers you know you will need in a year.  And the cash you like to have on hand for when you miss a deadline for Mr. Jones and he fires you.

Once you start doing this you will notice a few things.  The primary one is you start to have more fun.  Once a quarter you get to disburse money from that Profit account.  You can watch it grow each month.  You can plan for what you are going to do with the money.  Trip to Disney?  New kitchen table?  And you know that when you make the disbursement, part of it is automatically going to Uncle Sam, so you won’t have the tax problem next April that you had this year.  Next, you start sleeping better at night.  Why?  Because you know the balance is growing in that savings account too.  You know that Mr. Jones might fire you, but that is OK.  You have realized that he is not really a profitable client and that your staff would be happier without him.  You might take a hit for a month while you find a new client to replace him, but you have business savings that give you that luxury.  Cash crunches become a thing of the past because you are planning more wisely and working within a budget that actually gets you a better return on your investment.  And isn’t that what it is all about?