Dreams, catastrophes and reality

Budgets are built on the assumptions business owners make about the future.

“Budgeting is simply a plan with numbers,´ said Dana Klausmeyer, director of business development for Dohn Construction. “How far that plan and those numbers project depends on the nature of the industry. A company that creates high-tech production processes, for example, had better not budget too far out.”

Because assumptions can change in the twinkling of an eye – a pipeline in Alaska breaks down or a hurricane sends the price of plywood soaring – Klausmeyer counsels businesses to keep a weather eye on changing circumstances and to consider adjusting the budget as swiftly as possible.

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Businesses large and small use four specific numbers when they peer into the future: projected sales and revenue; projected total costs for achieving that level of sales and revenue; profit or loss based on the first two numbers; and cumulative profits and losses over time.

In an article posted on www.entrepreneur.com, financial advisor Brian Tracy suggested that the four numbers be reviewed each month. In his view, “The act of studying each number each month will improve performance in that area.”

Tracy also suggested that the projected revenue number should actually be three different numbers: high, medium and low projections.

Kermit Allard, CPA and partner in Ehrhardt Keefe Steiner & Hottman PC, echoed this advice when he said that as businesses look to the future, they should anticipate having to deal with the unexpected.

“One of the mistakes people make is to plan with one budget when they actually need three,” he said. “There is the dream budget, there is the catastrophe budget and then there is the budget that is tied to present realities.”

Start plan with review

It is with the reality budget that Allard suggests clients spend most of their time.

“One of the best ways to start creating a budget for the next year is by doing a good in-depth review of the past year,” Allard said.

He added that big gains and big losses – statistical outliers, in accounting terms – are not the best predictors of what a new year might look like if those gains and losses were one-time fruits of a boom or expenses associated with expansion. And, as part of the yearly review, it is also wise to analyze the assumptions that accompanied the budget to see if they still pertain.

“You have to be aware of what is going on both nationally and regionally,” Allard said. “Read the trade and local business journals. When you come across an article that has information on trends in your industry, clip it and keep it.”

Sandra Hanna, president of Hanna, Holdredge & Associates in Loveland, works with many clients who are small business owners. In her experience, the formality of the budgeting process depends on where the business is in terms of its growth.

“A lot of small business owners carry their financial information around in their heads,” she said. “They deposit the checks and they pay the bills. And so they have a pretty good idea of what the rent will cost and how much utilities will run. It’s when they start to grow and have to think about managing more money that creating a formal budget becomes necessary.”

Hanna pointed to the construction boom as an example of how growth pushes budget planning.

“Having more business might require hiring new people,” she said. “And Section 179 of the tax code made it very attractive to invest in new equipment.”

But what the generous tax code gave in incentives for businesses to acquire giant pickup trucks and SUVs, the rise in oil prices has taken away. No one really anticipated that the price of gas would rise to $3 a gallon, thereby punching holes in the hulls of many budgets.

Unlike Southwest Airlines, which has been able to keep its pricing profitable by making smart investments in oil futures, most businesses simply have to figure out how to work with an imbalance of projected costs against projected sales and revenue.

These days, the topic of how to keep rising fuel and energy costs from strangling profit margins for small businesses is taking up a lot of cyberspace. Typical is longtime market watcher Richard Russell’s assessment: The price of oil is unlikely to go down, given the demand in China and India. Moreover, costs of energy are vulnerable to unexpected breakdowns in pipelines and power grids.

Expect the unexpected

One way to mitigate the effects of an unanticipated spike in any expense is to use the habit of monthly budget reviews to speed decision-making. Klausmeyer pointed out that rises in fuel prices affect everything in the construction industry. As a result, companies making bids on projects are well advised to place time limits on their price quotes.

“People need to make decisions quickly because circumstances can change quickly,” she said. “If the quoted price is good, move on it.”

While the rise in oil prices has shaken budgets nationally, thereby creating a grudging understanding among consumers that the cost of everything is bound to go up, each business needs to build into its individual budget some buffers against unexpected interruptions. Among “projected total costs” belong business interruption insurance and an investment in a solid system for backing up and recovering data.

Possibly because the company is in the business of planning, Hanna, Holdredge was able to continue serving its clients even as it recovered from a serious fire at its office on June 20, 2006.

“We have learned an awful lot during this process about disaster preparedness, insurance and client relations,” Hanna said. “When the fire started – teenagers were smoking in the ravine south of our building – we took our backups out with us. We got our servers out.”

She described watching the fire blaze out the attic and wondering why the firefighters weren’t spraying on water.

“What they were doing was spreading heavy tarps over our computers and other equipment that would have been ruined by the water,” she said. “By that night, we had the open places boarded up and a guard posted.”

In the days that followed, Colorado Catastrophe Recovery from Evans and BDR Fire and Water Restorationfrom Loveland  created a clean room on the site to clean and remove the smoke smell from all the paper. Denver-based Rescue Tech took all the mechanical equipment to clean and test it to make sure it still worked correctly.

“Our insurance covered all the damage, but if the fire had been bigger, it would not have covered replacement costs of all the personal property in our offices,” she said. “People forget the kinds of upgrades they have made on equipment and furniture.”

The fire experience confirmed for Hanna that no budget should skimp on insurance costs. Nor should businesses fail to invest in a good data backup system.

“The backup system goes off site, and it should be tested regularly,” she said. “We have made a decision to go paperless, scanning everything as PDF files. Even if everything in the office were destroyed, with a good backup, we could be back up and running in no time.”