- Charlie & Liz –
“Charlie, I think I’m ready to write my first business budget.”
“Of course you are Liz, remember Mr. Paterson’s story?”
“Charlie, Let’s do it now!”
I hope after you read my last blog about the importance of writing a budget, you’ve already taken out your favorite yellow legal pad, tablet, or even a white napkin and started to write down some of your own ideas about your budget.
In this post I want to tell you what can go wrong when writing a budget and in the next one I will introduce my fabulous 6 steps I take when constructing my monthly and yearly budget.
I know some of you may stop here and say “Liz, come on what’s the big deal? I will just write down my expenses and review them from time to time and I’m done. Liz, come on, you can write about so many other things. I know budgeting is important, but budgeting is so easy, once you write it down you cannot make any mistakes, the trick is just writing it down”.
For those of you (I know it’s not you) who believe a budget is just writing down some numbers on a paper, let me share the story of Mr. Paterson.
Mr. Paterson is a smart person, he went to the right school, he got the right degree, he went on to work for the right company. He became a director and then a managing director. He had many people working for him, but one day he decided he wanted to start his own business. Mr. Paterson thought to himself, “Why should I work for other people if I can work for myself, I run a 500 people group. Of course I can run a small business. Enough with flying around the world for the dreams of others, it is time to walk to the customers around the corner to fulfill my dream”.
Mr. Paterson started his own landscaping company; he called it “Your Grass is Greener, LLC”. Mr. Paterson is a unique person, although he worked in technology all his life, he still believes he is a great marketer, and who am I to judge?
Mr. Paterson knew he needed to have a budget. At his previous job, he used to run the annual budget meetings (and even the 3 year strategic planning sessions). However, once his group budget was finalized Mr. Paterson handed it over to his firm’s finance group, which in turn gave him a yearly report on his group’s performance against their budget. They were usually ok. Mr. Paterson was happy. Mr. Paterson sat and wrote his landscaping business yearly budget.
Mr. Paterson assumed he will have about 100 clients over the first year. Each client will pay his company about $40 a week for maintenance. Mr. Paterson also believed he will have 10 big landscaping projects. Each project will cost his client about $30,000 per project. Mr. Paterson is a smart person, summing up his revenue he figured out his business will make about $208,000 from his 100 maintenance clients and $300,000 from his company’s big landscaping projects, for a total of $508,000 yearly.
Mr. Paterson then went on and wrote his expense assumptions; first he looked at his main fixed costs:
- Business insurance will cost him $3,000 a year (he felt very clever to negotiate paying his entire yearly payment at a reduced rate upfront)
- Marketing expenses will be $20,000 for the year (mainly for the first several months as he needs to pay for his company’s website and marketing materials)
- His office rent will be $12,000 a year ($1,000 a month)
- Utilities and phones will be an extra $500 a month or $6,000 a year
- He also wanted to buy a pickup truck but decided on leasing one, the lease will cost his company $300 a month, car insurance was $150 a month and he estimated gas will be $100 a month so total car expenses were $550 a month or $6,600 a year
- Buying all his landscaping equipment will cost him $25,000 for the first year
Mr. Paterson summed up all his fixed expenses and got to a total of $72,600 a year.
Now for the variable costs, Mr. Paterson estimated he will need one worker to do the maintenance “package” work. He knew it will take about 2 hours for each weekly maintenance work and decided to pay his worker $10 an hour. Mr. Paterson calculated his business will make $20 of profit on any weekly maintenance work ($40 client payment for 2 hours of work a week minus the $20 payment to his worker).
Mr. Paterson then calculated the worker’s cost for servicing maintenance “package” for 100 clients, 52 weeks a year times $20 payment to his worker times 100 clients equals to $104,000.
Lastly, Mr. Paterson calculated his cost for the 10 big landscaping projects, he estimated each project will cost him about $15,000 for labor cost and $5,000 for material cost for a total of $20,000. Using his assumption of 10 big landscaping projects a year, Mr. Paterson wrote down his total cost for these projects will be $200,000 a year.
Mr. Paterson then wrote it all down:
“Your Grass is Greener, LLC” – year 1 budget
Maintenance package revenue $208,000
Large projects revenue $300,000
Total revenue $508,000
Business Insurance $3,000
Office Rent $12,000
Truck rental, insurance and gas $6,600
Landscape equipment $25,000
Total fixed expenses $72,600
Labor for maintenance projects $104,000
Labor of landscaping projects $150,000
Material for landscaping projects $50,000
Total variable expenses $304,000
TOTAL EXPENSES $376,600
BUSINESS PROFIT (Revenue-expenses) $131,400
Mr. Paterson was happy. Mr. Paterson was smart. Mr. Paterson wrote down his yearly budget, Mr. Paterson’s business bankrupt within 3 months.
I remember talking with Charlie about Mr. Paterson, Charlie knew him, he called him “a nice lad”, he always looks sad when talking about Mr. Paterson. Both of us talked with Mr. Paterson a few months ago, I asked him why he bankrupted? Based on his budget, it looked like he was going to have a very profitable business.
I remember asking him, “What happened? Did you have fewer clients than you assumed?”. Mr. Paterson nodded his head, “were your expenses higher than you estimated?”. “No” said Mr. Paterson, “but I did not budget for repairs of my equipment, for spoilage of seeds, or for legal fees when I had one unhappy client”. Mr. Paterson also said, “I did not think I will need to pay my workers before I got paid by my clients”.
Mr. Paterson added, “On a yearly basis my budget looked good but my bank account and my paycheck do not work on a yearly basis”. Charlie then sadly added, “I also assume you did not think of the fact you will incur many upfront costs like equipment, marketing and even insurance before you collected any money from your clients”. Mr. Paterson with tears in his eyes nodded again.
OK, I got to go back to review my own budget, I promise to write my own process of constructing my business budget soon. Until next week, I would love to know your insights from Mr. Paterson’s story.