The following video prepared by our virtual cfo services division for digital agencies discusses the top level financials. We go over the key points you need to consider when looking at your profit and loss statement, or income statement, at the start of the year.
For your company to be profitable, you must budget at the top level (company level) and production level (employee level). Preparing budgets can be a daunting task that involves substantial resources to create.
However, you can create a more simplistic budget based off industry percentages. The simplistic budget will allow you to bring into your company’s analysis the financial metrics needed to obtain your year-end goal.
This budget can be analyzed quickly each month and used as a barometer to determine if you are on track. While detailed budgets and updated forecasts should always be considered, these financial metrics give you a starting point.
Hello everyone, in this video we’re going to go over budgeting for digital agencies. Now, even though this is geared more towards digital agencies, if you’re a service based organization you can utilize this video. Obviously take out the word digital agencies and you can use this information to help build your budgets. Now in this video I’m going to do a top level budget first.
Normally in budgeting you want to build your budget based off of the production employee first and build up to your top level budget or your overall company budget. But in this video I wanted to go through this video first so you have a concept of all the items that go through your respective company and how they flow. In the next video, I’ll show you how to build your budgets for your production employees.
Now when you’re looking at this particular item, or as we look through this budget, you’ll notice it’s all geared off of this item up here called production employees. Because you want to be able to budget how much net income you’re going to have, you really need to identify the employees that you know more or less produce and have chargeable hours versus the employees that do kind of the backroom admin accounting type stuff yet of the administration stuff. So once you’ve identified the production employees, then you need to identify how much revenue each one of those production employees is going to produce. And in this example I’ve oversimplified it just so that you can see kind of how the information flows. Each production employee is going to bring in 227,500 dollars. You then can multiply this out by 5 and 10. The reason why is I wanted you to kind of see how this gets bigger and bigger but percentage wise is you can still utilize this information if you only have 5 employees, 10 employees 25 you know what have you.
I’m going to show you how to build this up into this particular budget, and this is what I meant earlier when I said this is a top level budget and you’re going to build up into this. I’m going to show you how to build those budgets for each of the respective employees and bring that information in here and so that at the employee level will drive a lot of this information. So in this example, you know we’re assuming there’s 227 thousand budgeted revenue for the respective employee.
Now employee costs, salary, and this is just straight salary. This is what they signed their contract at for the respective year. Again this 85,000 is right now it’s just kind of an arbitrary number. This may go up or down, but it’s important that you build this into your budget because there’s other elements in here that will flow through down to the bottom line that helps you understand how that process goes. So for this particular situation we’re seeing one production employee, their salary, their gross salary is $85,000.
Now the next item, the burden rate. This is going to be your FICA that you have to pay. This is going to be any kind of other fringe benefits, such as PTO ,insurance, what have you. Traditionally burden rates kind of across most industries, not just digital agencies, but most industries is in the mid 20% range. And so instead of doing the brain damage of calculating the FICA rate and the insurance and so on and so forth, you just take a flat burden rate and you can calculate this every year.
To find out what your true burden rate is, as long as you track your gross salary and all the benefits and separate GL accounts, general Ledger accounts, you’ll be able to back into this number and find out where your true burden rate is. There’s also industry guidance out there for this particular industry and in all industries that you can kind of back into what the overall burden rate.
Traditionally this has been in the at 24 1/2%. So you add that as an additional cost to the employee. In this situation, total employee costs 105,000 for one employee, and so that takes into account their salary plus all the other benefits of hiring one production employee. This is not just going to be the 85,000 gross salary that you hire them at, it’s all the other ancillary things that come into play. As you hire that employee an employ them for their benefits, insurance and so forth you come down to other production expenses. These are the miscellaneous expenses that truly are related to the production of revenue, and as you’re looking at this, keep in mind this is no different than cost of sales for a manufacturing company. You know when you have a manufacturing company and you make a widget, you know the cost of the material, then the labor to assemble it and then so on and so forth. That’s the cost of sales. Same concept with service based organizations. Its your employee costs that do the production. That is your cost of sales and so that’s why it’s important that you understand. If I got all these other miscellaneous expenses, what are they related to? Are they related to the production revenue or are they related to the admin costs? Copy paper or cables or whatever miscellaneous small costs there may be.
Then you come down to your gross profit. Now the big thing on this particular slide where this particular line is over here, you’ll see gross profit of 49 1/2%. Now that is about where most digital agencies are sitting at for their gross profit percent and again, just real simplistically is that’s the amount of revenue you’re earning after all your costs. Based off of this situation we have one production employee and it goes across. For five employees, 10 employees, what have you based on how the formula is now. This is important because this gives you an idea as to “OK if I want to achieve a gross profit of 49 half percent that number of that percent right there” allows you to understand. OK, if I’m going to hire A new employee, but because of the labor market I’ve got to, instead of paying production person 85,000, I going to pay 100,000. OK, that allows you to then back in how much revenue you really need to be bringing in. You need to increase your fees, your billable rates that you charge for your services, what have you to keep that 49 half percent, and so that’s one of the great things about percentages is it allows you to understand very simplistic high level how much I need to adjust my revenue and my other respective items.
Then we get down into overhead costs. Now overhead costs are going to be all the costs that are not related to the production, and it’s important that you understand that your sales, marketing.
Then those costs that are outside of more or less the employee expenses are probably going to fall down into your overhead category. And of course administrative. That’ll be employees, Internet, what have you, and it’s going to be all your miscellaneous costs.
And then you get to your total overhead costs. As you can see over here we have a 30% for our overhead costs. That’s traditionally where digital agencies, an SAS type organizations fall in for their overhead costs. Now the break out between the admin and sales and marketing may fluctuate depending on what exactly you’re selling or what kind of service you are doing. These calculate to 21% and 9%. Those percentages may fluctuate in between one another. However, the total of those you want around the 30% range for your total overhead cost.
Then we get into your facility costs, which are traditionally going to be the rent cost and possibly interest on a mortgage. If you purchased the building depreciation. These are going to be more of those costs that don’t really fall into any of these other buckets which goes down to your total overhead, which you’re seeing at 35% now.
Why do we throw all these percentages out? The reason why we’re doing this is once we understand what we need our percentages to be, we can build the budgets even at a top level based on in this example, one employee, five employees or all production. And again, that’s production employees. An understand how it’s going to flow through, because when we get down to the very last number, the net income we want our net income, your net income has to be higher than 10% of total sales. If it’s not, if you’re 9% what we’re seeing today is 10% is the new break even. yes, you have net income, but you’re barely breaking even for your respective industry. This is why we want to build these budgets to say in this example, we’re saying we want to be at 14 1/2% of net income. Granted, obviously we always want to have that number higher, but if we understand, here is our budget. Here’s where we want to obtain for this year.
And again, a budget is the destination of a company. “Where do you want to go”? Your forecast is going to be “how are we going to get there?” And so we’ll go over forecasts in a later video, but in this one we’re saying we want our net income to be 14 half percent of total revenue.
Understanding how the expenses, how everything flows through first is going to allow you to build your budgets.
So like I said in the next video, we’re going to go over the individual production employee budgets and how to build those so you can understand those budgets, understand how much salary we need to bring in, and then how everything is going to flow through to your bottom line. And one of the beauties of when you start building this is if you have to all of a sudden hire somebody at a higher level expense wise than you normally would. You can see immediately how that’s going to impact your bottom line. Let’s say we’re not having to hire new people, but we’re going to adjust our revenue by let’s say, $10.
Normally you’d hear somebody say a dollar, but that’s just kind of odd for billing rate. So let’s say you adjust billing rates for maybe your higher end people by $10.
How does that impact your bottom line? how does that flow through? If you want to give a bonus to all your employees, how is that going to flow through? And you can budget that out. Also, this allows you when you build this budget and you start incorporating it into your monthly analysis of where you’re at and where you’re going. This allows you to fully understand hey, what level, what financial lever do I need to pull to get back into the 14 half percent?
So let’s say your expenses are way out of whack. This allows you to see it and say OK if I do X, how is that going to impact my overall net income now?
Again, this is a top level budget and when you develop your top level budget you want to have it kind of as simplistic as possible because otherwise you’re going to overwhelm yourself with too much data. And when you do this you want to start you know what we traditionally call an accounting. We want you want to assign your general Ledger accounts to each of the respective categories as best they fit into it. So overhead admin. So all these GL accounts these are all admin. These are all sales. This is other production expense. You know whatever your items are in there and so that allows you to break it down so you can keep the detailed general Ledger that you have right now and I’m sure some of you have quite a bit of detail in there and that’s totally fine. But when you bring it to this level, you need to be able to pull that into and assign it in there. Now there is software out there where you can export out of your respective accounting software into not necessarily Excel, but there are some software will take and they will do what’s called, assigned those accounts and drop EM already into theirs respective categories and then from there it’s just a matter of clicking and then automatically seeing. Again, you can just set up a macro export like in QuickBooks Online, you can export into Excel, set up a macro and it’ll combine these for you. So again, 14 half percent. This is pretty good. You want to be above 10% and like I said in the next video, we’re going to go over how the build up to the overall level of the revenue. When I get done you know showing you that I will have those Excel schedules available for download after that particular video. So you can go and start dropping in your respective information and playing around with it. If you have any questions, you have any feedback, please feel free to contact me again at my website hovlandforensic.com
Or you can email me at Steve@hovlandforensic.com.