As a re-cap, the five steps to success are:
In this, the fourth installment of this 6 part series, we will discuss putting together your Pro-Forma Income Statement or Budget, the road map for your success.
The Budget will be prepared in the same format as your company's current Income Statement. It is to be completed for the entire year, by month. The information needed to complete the Income and Cost of Goods Sold sections are available on the Gross Margin Plan and Open-To-Buy. As you will recall, the Open-To-Buy gives us the planned sales, inventory and Open-To-Buy (receipts) by month. The inventory and monthly receipts from the Open-To-Buy are at retail and will have to be converted to cost by subtracting from 100 the IMU% shown on the Gross Margin plan (i.e. 100 – 55 IMU% = 45 percent cost). Once you know the planned cost percent just multiply the planned retail inventory and receipts by that percent to get the cost figures you need for the cost of goods sold section of the budget. The Gross Margin Plan gives us the overall company Initial Markup percent and the Gross Margin percent. The only other items needed for the Cost of Goods Sold section are: Purchase Discounts and Freight-In. Usually, these two items can be budgeted based on last year’s expense. This year, Freight-In should be lower than last year’s actual numbers since fuel prices have been significantly reduced.
All that is left now is to budget the company's expenses and other income items. Before starting this it is a good idea to review your expense structure to make sure it is adequate.
CLASSIFICATION OF EXPENSES
The National Retail Federation has a standard expense classification system for retailers called the Natural Divisions of Expense. All the normal expenses associated with the usual operation of a retail store will easily fit into one of the 16 categories included in the Natural Divisions of Expense. The 16 basic categories are:
You will note that these are not listed alphabetically. Payroll is first because, after Cost of Goods Sold, it is the largest expense item. Advertising is next. Real Property Rentals, although a significant expense, is listed last because the only time you have control over it is when you negotiate your lease.
Each of the above Natural Divisions of Expense can, and in most cases should, be expanded to give a more detailed accounting of expenses. For example, Advertising can be further sub-divided into:
Likewise, payroll can be divided into a number of specific line items. Small stores may need only 2 or 3 while larger stores may need all listed here.
EXPENSE CONTROL: PLANNING OPERATING EXPENSES
Another method is called zero-base budgeting. Zero-base budgeting requires that you start from zero and justify every expenditure. It examines the costs and benefits of all expenditures.
Whichever method you use, and it may be a combination of the two, this is a good time to thoroughly review all the company's expenses to find new and better ways of doing things or discover what things can be eliminated entirely. For example, would an outside alteration service work as well for your store and be less expensive than an in-house tailor? Are there housekeeping tasks you are doing yourself, such as cleaning windows and waxing floors that could be done cheaper by outside contracting services? Don't continue doing things just because that is the way things have always been done. Re-examine and re-evaluate your practices. Every expense dollar saved is added to the bottom line for increased profits.
We recommend a budgeting process that normally includes budgeting for a minimum of 55-65 General Ledger accounts that appear on the Income Statement. It must be detailed enough to give you an exact accounting of where all the dollars are being spent. It does not do you much good to know that supplies are too high. It is much better to know that Office Supplies are too high so you know where to start looking to reduce costs.
EXPENSE PLANNING WORKSHEET
OTHER INCOME AND OTHER EXPENSE
BUDGET CONTROL DEVICE
Then, every month you must review the budget variance. If sales or Gross Margin are below plan or if any expense item is above plan steps must be taken as soon as possible to correct the problem or revise the plan accordingly so it is realistic.
Keep in mind that profit does not equal Cash. You must have adequate CASH to stay in business. Next month we will discuss turning your Budgeted Income Statement into a monthly cash flow projection.
If you are interested in improving your success as a retailer, please see our other aricles in this series.