7 Ways to Take Your Accounting to the Next Level in 2021: Tip #3

UPDATE: After an illness delay, this series continues!

The new year is a golden moment to make a fresh financial start. Between Thanksgiving and Christmas I'm planning to post seven practical tips for improving your company's finances in 2021. This is Post #3. Stay tuned for the other four!

Tip 1: If you have to enter more than 5 numbers by hand, find a better way

Tip 2: Lead with your balance sheet, not your profit and loss

Tip 3: Craft a detailed 2021 projection

I've never been a fan of budgets. When I hear "budget" I picture:

• The finance department squashing a manager's spending request like a tomato under a monster truck.
• The US Secretary of the Treasury standing beside a giant stack of paper no one could ever possibly read.
• Glazed-over eyes at a board meeting as the CFO delivers a monotone about proposed budget revisions.

Budgets make me wince with pain and boredom.

I am, however, a fan of flexible projections. Budgets restrict, projections predict. Often, the process of creating a projection is as helpful as the projection itself.

You can make a thoughtful 2021 projection for your company. I'll show how - in 7 steps - using a fictitious company that sells globes and wall maps.

7 Steps to a Great Projection

Step 1: Crack open a new pack of chocolate Double Stuf Oreo cookies and pour yourself a tall glass of milk.

This is very important. If you skip this and your projection fails, do not blame me!

Step 2: Set up a skeleton spreadsheet with a Summary page and four other tabs

On the Summary tab, make a column for each month of 2021, and a total column. NOTE: I'm omitting May to October on these examples to enhance image size.

This Summary tab is the end goal, but you won't enter any data directly here. The other four tabs will provide the numbers, which will feed automatically into this tab.

Step 3: Fill out the Revenue tab with the most granular level of detail possible

Spend the most time on this tab. If possible, make Revenue a formula as shown above.

The projected January globe revenue of $4,500 (highlighted) is simply a formula that multiplies 250 units sold x $18 per globe. Blue cells are where you enter data. Black cells are simply formulas.

The 250 units and $18 price are "levers" that can be changed to tweak the projection later as needed, without redoing a bunch of calculations.

Not every business has units. A project-based business could use Number of Projects x Average Project Size. A service business could use Billable Hours x Hourly Rate. A small consulting company could simply list out all their customers. The goal is to make this page as detailed and flexible as possible.

If you can't come up with levers like units and price, as a last resort just enter the projected revenue from each stream as a monthly lump sum dollar amount. At a minimum, each revenue stream with a unique gross profit expectation should be broken out separately.

Give careful thought to seasonal volume swings (e.g. school in session, Christmas) as well as pricing changes (e.g. mid-winter sales, Black Friday discounts).

Step 4: Fill out the Cost of Sales (COS) tab based on the Revenue tab

The Units Sold on the Revenue tab will generally drive the Cost of Sales projection. In the example below, the Units Sold are pulling in from the Revenue tab in the previous step.

The only new data that needs to be entered is the Cost per Unit. Everything else is simply a formula.

The Jan-21 Cost of Sales for globes is calculated as 250 units sold x $9 unit cost per globe = $2,250 (highlighted in yellow).

In a wholesale business like this, unit costs are straightforward. The unit cost of a globe is basically the globe itself, plus some packing supplies and shipping costs.

More complex industries like manufacturing and construction will need more complex calculations to arrive at accurate unit costs. If your business is in one of those more complicated fields, this tab will be substantially more complicated.

Two pointers:

• This is a great time to carefully consider unit costs. Have product costs gone up? If unit costs include labor, have labor rates or benefits increased? Are freight costs adequately captured in unit costs?
• Unit costs on a projection should only include costs that are directly driven by sales. For example, warehouse rent typically would not be baked into a unit cost calculation. Warehouse rent is the same whether you sell 10 globes or 1,000. In my opinion, a fixed expense like that belongs in the Fixed Expense section.

Step 5: Fill out the Fixed Payroll tab by employee

The first step here is to carve out any employees whose labor cost is already included in the Cost of Sales section above. For example, labor costs for production workers at a manufacturing plant typically would be in Cost of Sales. However, plant supervisors and purchasing agents (whose pay is generally fixed regardless of revenue) would logically be in this section.

Either way, after you have the list of Fixed Payroll employees, the next step is to add all fringe benefits and payroll taxes to each person's base compensation. This will get you to their "Total Pay." Divide that by 12 to get the Fixed Payroll per month per employee.

In the example below, Phil Smith's "all-in" monthly cost of $5,958 is his Total Pay (which includes all payroll taxes and benefits) of $71,500 divided by 12 months = $5,958.

It is truly amazing how much total pay varies by employee, depending on the benefits utilized. This detailed analysis strips away any delusion and gets to highly accurate labor projections.

Step 6: Prepare a detailed list of fixed expenses

This step will vary widely by company and is perhaps the easiest tab to fill out. As always, the more detail, the better.

Any costs or income that have not been included earlier in the projection must end up here. Don't forget odd items like interest expense or rebate income.

Step 7: Link the appropriate rows on the Summary tab to the total rows on the other tabs

If you glance back to the bottom row of the Fixed Expenses graphic in Step 6, you'll see it reflected on this Summary sheet in the Fixed Expenses row. The same is true for Revenue, Cost of Sales, and Fixed Payroll.

Gross Profit is simply Revenue minus Cost of Sales. Net Income is Gross Profit minus Fixed Payroll minus Fixed Expenses.

This page is a powerful tool for making decisions about 2021 operations. The projection is showing a net profit of only $8,402 for the entire year. Likely the management team will want to look at options to increase sales volume or margin, or decrease fixed expenses or payroll. The effect of each option on net profit can be seen with a few simple clicks.

Closing Points

1. Get someone to review your projection. It doesn't have to be a finance person, just someone who knows a little about business. A second set of eyes is invaluable.
2. Numbers sketched on a sticky napkin after a jolly dinner do not constitute a projection. Seat-of-the-pants projections are often more harm than good! They gloss over significant flaws and are often based on impossible assumptions.
3. The goal of a projection is to test the validity of your current business model. If you can't get the model to be reasonably profitable even on paper, your business plan likely needs a serious reboot.
4. As actual results come in for 2021, test your projection. Enter the number of globes and maps actually sold in January 2021 and see if your projection yields the same projected net income as your January financials actually show. If not, tweak the projection, to make it more accurate for the future months.

Now, grab those Oreos and get started!

This is Tip 3 of 7. Stay tuned for the next post!

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