There’s no one-size-fits-all solution to managing expenses and cash flow.
It sounds like a simple question.
If you’re running a small business, what’s the best way to spend your money? What percentage of your annual revenue should go to salaries, training, marketing, investing in new equipment, retirement savings?
The answer, though, turns out to be unexpectedly complicated.
Wouldn’t it be so convenient if there were handy rules of thumb? After all, we try to use them when we make choices about our household expenses — like the one that says your housing expenses shouldn’t be more than about 25 percent of your income.
Yet looking closely at even that longstanding principle suggests why this may be more difficult than it would seem. Does someone making $1,000 a week ($4,000 a month) and living where there’s a severe shortage of housing have any choice if the cheapest rents are $1,800 a month? Perhaps over the very long term (move or seek a higher-paying job). But the specific conditions of where you are — geographically and otherwise — defy such airy pronouncements.
THE MARKET IS KING
Larry Rush of Reading, Pennsylvania, spent 45 years in banking. In retirement, he now mentors small business owners through SCORE, which was previously an acronym for the Service Corps of Retired Executives.
“There is no one way to allocate percentages from revenues” to specific categories of expense, Rush says. Market differences along with individual business and industry circumstances all play a part in dictating those decisions, and you ignore that at your peril.
“When we at SCORE counsel new or present businesses, we ask the owners to do a business plan,” Rush explains. Using data from various sources, Rush and his fellow business mentors then offer examples of successful businesses within the particular industry to project cash flows from revenues to various expenses.
Even within an industry, though, there’s too much variability to come up with a one-size-fits-all set of rules. The first and most obvious: Is the operation a startup or long established?
Existing businesses “have historical numbers, which we review to see if they seem out of balance to their profitability,” he says.
CRUNCHING THE NUMBERS
“With startups, we ask each owner to tell us what equipment they need to perform their daily work,” he continues. And embedded in the answer to that question is another question — do you buy that equipment or lease it? “Leasing or even renting may be an option, so it doesn’t cost the full purchase price” when allocating revenues to that line item.
Employee costs are another variable. As the owner, you’ll start by doing everything, but the number of employees — and therefore the share of employment costs against your revenues — will change with the volume of work, increasing along with your revenue.
With a larger operation, you’ll need to consider how you as the owner manage your time most efficiently and parcel the work out effectively. As the business and number of employees grow, ensuring you have seasoned supervisors who can mentor new employees is key.
The time also comes when you must hire administrative personnel “to be sure that costing, billing, and payroll can be done without having the owner do that,” Rush points out. Your time as the owner is more important than those tasks — but your office personnel “need to represent the owner 100 percent to reflect the company’s face to the community.”
WHERE THE BUDGET FITS IN
So does all that mean budgets don’t matter? Of course not.
Rush advises starting by tracking your profit loss and cash flow month to month against the jobs you do and the revenue they produce. “We suggest that each job be priced with its projected overhead — costs of equipment, fuel, labor time, insurance and other overhead expenses — and then at the end of the job, price it to see if your beginning quote was correct or was at a loss,” he says. “Then learn from that.”
Overhead costs especially need to be spread out month to month, not just treated as lump expenses when they occurred. You’re paying $2,400 a year for insurance? That means you budget it at $200 a month. If your work has seasonal ups and downs, you need to account for that as well.
When setting wages, your benchmark is what other people with the same skills and experience in your market are making — and don’t forget benefits or the cost of vacation time. And you need to review those questions regularly.
YOUR OWN SPECIAL INTEREST
All of this doesn’t mean the starting question is pointless. It does mean that the answer is going to be so specific — to your business, where you’re located, and a host of other factors — that the only reliable answer is to consult with your local trade association and data providers that collect and aggregate information from a large number of companies in discrete industries.
And there’s another important thing to remember, which as a seasoned business owner you almost certainly already know far too well: Day to day, month to month, year to year, your business is not going to just tick on like some perpetual motion machine.
A seasonal boom might require you to call in part-time employees or hire a subcontractor. A sudden glut could force you to find makework for your people, or even, unthinkably, lay some of them off.
The only way you can prepare for those unexpected jerks in your bottom line is to relentlessly monitor your month-to-month profitability so you can maximize your cash flow and know you’ll be able to cover downturns when they occur.
And that, Rush concludes, is where budgeting comes in. You look at how you’ve performed in the past, and what you need to do differently to perform better next year.
Because the real answer to how much you should spend and what you should spend it on comes down to where you are now, where you want to be, and how you plan to get there.
And that’s a formula that will be as unique to you as your fingerprints.