Social Business Plans

How to set a budget

So, you've worked out what you're going to do - now you need to work out how much it's going to cost.

The way to do this is to do a financial forecast, which might sometimes be called a profit and loss account, or a budget (they're all more or less the same thing).

There's no one way to do it, but the way I'm going to outline here has worked well for me. You start with estimating your sales and cost of sales - on the next blog entry.

I'm going to give the example of a fictitious start-up cafe to help to explain the steps you need to take to develop a strong financial plan.

The section on budgeting on the Business Link website may also be useful to you too.

Estimating sales and cost of sales

First of all, estimate what kind of sales you think you might achieve - just to give you an idea of what size of business you might be thinking about. So, if you were running a cafe with ten tables, you might estimate that you'll turn over £250 a day Monday to Friday, and £500 on a Saturday, so your yearly income will be in the region of £90,000.

Then, think about your direct costs - the costs that can be directly attributed to producing your product or service. They are sometimes called cost of sales. It's not always so clear-cut, but in the cafe example it's pretty easy to say what your direct costs are - the ingredients for your food. You could potentially include some staff costs, eg your extra person for the busy Saturdays - but it's unlikely that you'd include more regular staff.

How will you get a figure for direct costs? It depends on your business, but you could talk to someone else who's run a similar business, you could chat to suppliers, look at trade magazines, or read a relevant "How to..." book.

You can now work out what your gross profit will be - more details on the next blog.

Gross Profit and GPM

So you'll have a figure for sales, in this case £90,000. You'll now have a figure for cost of sales - let's say £40,000 in this case - which wouldn't be far off the mark for a cafe. So you're forecasting that £90,000 will come through the till, and £40,000 will go straight to suppliers - leaving you with £50,000 to play with. This £50,000 is called your gross profit.

So you'll make £50,000 if you sell £90,000 - how about if you sold £120,000 worth of food and drink? This is where a calculation called the Gross Profit Margin comes in handy.
To calculate your gross profit margin, take your Gross Profit (£50,000) and divide by your total sales (£90,000), then multiply it by 100 to get a percentage:

£50,000/£90,000 x 100 = 55% - your Gross Profit Margin

So that means that for every £100 of sales, you should make £55 of gross profit. So if you brought in £120,000, you could expect to make:

£120,000 x 55% = £66,000 - in gross profit.

Real life isn't quite that simple, but your GPM will give you a good guide as to how profitable your business could be.

The GPM is important because of it's one of the three main variables that you can control in order to make your business profitable - you can increase sales, increase GPM, or reduce your overheads - which we'll look at in the next blog.

Working out your overheads

Overheads are sometimes called fixed costs - they're the costs that are there whether (in our example) you sell 10 sandwiches a week or 100 sandwiches a week. Depending on the level of detail you need, you could split your overheads into fixed overheads (such as rent, rates broadband fixed fees) and variable overheads (telephone, electricity etc).

It's not always easy to estimate your overheads at start-up. But try as hard as you can to be realistic - maybe by talking to people who've run similar businesses - and by getting real quotes from suppliers.

The headings you choose for overheads will depend on your business, but are likely to include things like:

Salaries - including any Employers National Insurance Contributions - there's more information here, but remember that you will need to budget for at least 12% above the gross salary figure to allow for NI contributions.
Pension contributions - will you have a pension scheme, and will you as an employer contribute? You are obliged to offer a stakeholder pension scheme if you employ five or more people, but you are not obliged to contribute - although many businesses do.
Gas and Electricity - you could look for good deals - and green deals - here.
Repairs and Renewals - a budget-line for when things go wrong
Cleaning - just materials? - or will you employ a cleaner?
Refuse collection - it's not usually included in Business Rates these days - and depending on where you live your Local Authority may not do it - so you'll need to find a commercial refuse collection service. If you're in Leeds, 3b are a popular choice - and you can get a quote from their website.
Rent - don't forget to check if the quoted figure includes VAT.
Business Rates - the current occupier, the landlord or the Estate Agent should be able to tell you the rateable value of the property. To work out how much you'll pay, you multiply the rateable value by the multiplier, which is set by Government each year. For 2007/08, the multiplier if 44.4p.

So, if the rateable value is £10,000, you will pay £4,440 in business rates (unless you can get business rate relief) Remember the rateable value isn't the same thing as the rent that you're paying - in many cases (fortunately) the rateable value will be lower than the rent you're paying.

Telephone and Internet - for the ethical option you could try the Phone Co-op - we've found their line rental and call charges to be good value.
Travel expenses - including public transport, and mileage for car and bicycle use.
Marketing - what will you spend to promote your business - to perhaps include a website, flyers, headed paper, business cards and any other promotional activities and materials.
Insurance - if you're setting up in business, you'll need Employers Liability Insurance - and perhaps some other types of insurance. You can get an idea of what you might need at the Business Link website.
Stationery - paper, pens, printer cartridges and the like.
Legal and professional fees. For example, you might need pay a solicitor to look at your lease and an accountant to look at your books.
Finance charges - if you are taking out a loan, or will have an overdraft, you'll need to include the interest charges and any other costs here.

Now that you've listed all your overheads, add them all up. In our cafe example, let's say that our overheads are £45,000. Now that you've added up your overheads, you can work out what your projected net profit (or loss) will be - we'll look at that soon - once we've added in your start-up costs - the subject of our next blog.

Working out your start-up costs

Your start-up costs - often called capital costs - are the one-off amounts which you'll need to spend in order to get your business up and running.

They're accounted for separately in a budget because it's important to have a sense of the underlying profitability of your business. You can see how they're listed separately on the template.

All you need to do here is have a good think about all the things you'll need to spend in order to get up and running. Be realistic - start-up often costs more than you think. Wherever possible, get quotes for things - particularly if you're getting any building/refurbishment work done. Also, don't forget VAT, sometimes quotes are given with the amount before VAT in big letters - to make it look cheaper! Unless you're VAT registered, you won't be able to claim the VAT back.

Other things that often trip people up at start-up stage include legal fees for agreeing a lease - check with your landlord whether any costs will be passed on to you.

It's also worth thinking hard about how you can keep start-up costs to a minimum. Maybe you could buy some things second hand (good for the environment too) from small-ads, auctions, ebay, freecycle, car boot sales or charity shops such as Emmaus. Remember, many businesses fail so there is never a shortage of second hand business equipment. You may also be able to share equipment - for example we bought our digital projector with a local church - saving us money whilst doing our bit for the environment. It's a great partnership - mainly because we don't work on Sundays!

Once you've added up all your start-up costs, you can include them in your forecast, and then move on to the next stage - and the next blog topic - calculating your net profit.

Your net profit

You can now work out your net profit - in other words the money you've got left once you've paid all your direct costs and indirect costs (overheads). In the cafe example, the net profit is:

£50,000 (Gross Profit) - £45,000 (overheads) = £5,000 net profit.

Hurray - you made some money - or at least you will if you stick to your plan! You could also work out the net profit margin, if you're that way inclined - it's a similar calculation to the gross profit margin calculation earlier:

£5,000/£90,000 x 100 = 6% - your net profit margin

The next question - and the next blog - concerns how long you should forecast for.

How long should I forecast for?

How long should you do a forecast for? It depends - some businesses only forecast for one year at start-up, as anything else is complete guesswork. Others forecast for two or three years, particularly if they are going to make a loss in the first year. Any investor or funder who is serious about social enterprise, will be interested in your potential to make a profit - so you need to indicate this in your forecasts.

To help you with your forecast, we've produced a template - available in the next blog entry.

To remind you of why it's important to have a firm grasp of your figures, have a look at what the Dragons think about people who haven't done their sums properly. (click on the Who's Counting? link)

A template for your budget

You can download a template for a budget here. You'll need to play about with it a bit, but it's a good starting point. With a bit of luck, it should do some of the calculations for you. If you notice any mistakes in the formulas, please email us.

We've developed a template which allows you to get a good feel for your trading position - in other words what you're making before any grants or loans are taken into account. We've also separated start-up costs so that it's easier to compare years 2 and 3 to year 1.

Download newblankprofitandloss.xls
Here you can find a worked example - for a social enterprise which wants to run a cafe. It's an example I use in a budgeting exercise - and you'll notice that they need to work a bit more on becoming profitable, but it should give you an idea of what a budget looks like.

Download sampleprofitandlosscafe.xls

Next, we'll look at another key calculation - your break even point - and then we'll look at doing a cashflow forecast.

Your break-even point

Once you've done your first budget, you'll have an idea of whether your business appears viable or not. There's a good chance that your first draft will suggest that you may lose money. Clearly you're not going to be in business for long if you don't do something to sort that out! That's where something called break-even analysis can come in handy.

In a nutshell, you want to work out how much you need to sell, at your current Gross Profit Margin, to break even - ie so that you neither make a profit nor make a loss.

Another way to think about it is that your GPM is the contribution that each product or service that you sell makes to the viability of your business. So, if your GPM is 65%, that means that for each £1 that you get through the till, 65p is available to you to cover your overheads, and then, eventually, make a profit.

To work this out:

Add up all your overheads. Let's say they come to £50,000.

Look at your budget to see what your projected GPM is. Let's say youre running a cafe, and it's 60% (that's somewhere near standard in food businesses).

So to work out your break even point, you divide your overheads (£50,000) by your GPM (60%), which gives you £83,333.

In other words, with a profit margin of 60% you need to bring in just over £83,000 in order to generate a gross profit of £50,000 - and hence break even.

How does that compare with your original sales projections? If you've projected £85,000, then things are looking good. If you've projected £55,000, then something needs to be done. The question is - what can you do?

I know my break-even point - now what do I do?

If you need to take action to make your business profitable, there are a few things you can consider:

• Increase sales: can you sell more at the same profit margin?
• Increase GPM: you'd be amazed at how much of an impact a small increase in GPM can have. For example, if we increased the GPM in the example above to 70% (not impossible in a food business), the required turnover would be:

£50,000/0.70 = £71429 - £14000 less than at 60%.

In practice, that might mean £2.60 for a sandwich instead of £2.40. What you need to ask yourself is - is that possible?

• Decrease overheads: You may decide that you can't squeeze any more sales out, and you can't charge your customers any more. So your third option is to decrease overheads. In our example, if overheads were reduced to £40,000, the break even point would be:

£40,000/0.60 = £66,666 (which is a bit spooky)

and if you managed to reduce overheads, and increased your GPM, you'd be in clover:

£40,000/0.70 = £57143

So you can see why break even analysis can be a useful exercise. But remember, you're running a business, not sitting a maths exam - so don't just play about with the figures 'til they add up. Instead, think things through, and think realistically about your options:

• Can I increase sales?
• Can I increase GPM?
• Can I decrease overheads?

If you can get the right blend, you'll be in business.

Next, it's worth doing a cashflow forecast - to anticipate when money will really come in and go out of your business.

Developing a cashflow forecast

Your budget is very important - it will give you a sense of whether your business is viable or not. Once you've done your budget, you can do a cashflow forecast - which will give you an idea of how the cash will flow in and out of your social business.

Many businesses fail because they can't make enough money - in other words there's a problem either with their sales, their margins or their overheads. A lot of other businesses fail because they run out of money - which if you think about it, can be a bit different.

You might have a great GPM, and sales might be strong, but what happens if your customers pay you a month after you've delivered the goods? Or what happens if you need to buy a load of stock, three months before you'll sell it? If you haven't got cash in hand or money at the bank, it doesn't matter how good you look on paper, you'll be struggling. That's why a cashflow forecast is so important.

We've included a cashflow template below. You can also get one here at the Business Link site - click on the link on the right hand side of the page. You'll need to adapt it for your circumstances, but the basis format is there. The main things you want to know are:

• How much cash have I got at the start of each month?
• What's due to come in each month?
• What's due to go out each month?
• How much money have I got at the end of each month?
• When might I need to take action - eg get an overdraft, review payment terms, or hold a sale to get rid of some old stock?

It's frustrating to got out of business because you can't make it pay. It's even more frustrating if you're basically sound - but have got cashflow problems. So it's worth taking time to do a forecast - and to keep revisiting it.

Your Bank wants you to be in business - so if you go to them in December and say "In February I'm going to need a £2000 overdraft", they'll probably listen. If you go to them on February 2nd and say "I need an overdraft today", they'll probably give you a harder time. That's why cashflow matters.

Download blankcashflow.xls