1. The Gearwheels
of Your Budget
Designing a profit engine for your business
Budgeting Basics II

2. 2 | The Gearwheels of Your Budget – Budgeting Basics II
Introduction
To create an operating budget for the first year is one of the most frustrating
exercises for entrepreneurs. Fortunately it is because of the way they look at budgets,
not because of what budgets really are. "How can we know what our sales is going to
be?” or "How can we predict it?" are very typical questions from entrepreneurs that
illustrate my key points about startup budgets, so let me make it clear:
Budgets are NOT predictions.
Budgeting is NOT a math competition, where
there is a prize for the correct answers.
If you see operating budgets as predictions of revenues and expenses during the first
year, you put yourself in a situation where you are destined to fail. It is frustrating to
work on something that you know will
be wrong so why bother?
What would Christopher Columbus
have answered, if you had asked him
how long he thought it would take him
to sail to America. He had no idea that
he was going to America, and you
cannot imagine where your business
will take you even if like Columbus you
have a clear vision about it.
However, Columbus certainly has had an idea about his direction, how fast his ships
would be able to sail, how many men he needed and how much food etc. See yourself
as Columbus, when you make your budgets and focus on the things that can move
your project forward.
This ebook will outline a way to perceive the startup budget and give some practical
advice on how to go about it, so budgeting becomes a learning experience that you
do not want to miss rather than a frustrating task that your bank or investor has
decided to bother you with.

3. 3 | The Gearwheels of Your Budget – Budgeting Basics II
…then what is a budget?
If budgets are not predictions, then what are they? To me budgets are simulations
that show what a company looks like in numbers. It is your business plan put on
formula.
Your operating budget is an algorithm that
can simulate your annual profit under
different circumstances.
The formula is based on so your assumptions about how the world and the market
works and the assumptions are more interesting than the numbers as such. Put in the
most likely assumptions and see the result.
Another way of looking at your budget is to see it as the goals want to achieve. It is in
fact the most entrepreneur-like way of looking at it. That you are not trying to predict
or analyze, but instead you decide what revenue should be. The rest is then to set up
a company and a system that can generate that revenue.
The operating budget is your goal for the
next season – the trophys you want to win
and the number of training hours you want
to put into it.

4. 4 | The Gearwheels of Your Budget – Budgeting Basics II
What is the formula for your
sales?
Forecasting sales is probably what causes
the most distress for entrepreneurs when
they make their first operating budget.
However, I recommend that you make
sales budget as fast as possible and then
be critical later.
But how do I get started? My best advice is
to think from the bottom up rather than
top down. Some try to make an estimate of
the total market and then say that it
probably ought to be realistic with a
market share of fx 10 percent. But this is
pure guessing and basically a wrong way of
thinking as an entrepreneur.
Build your budget around what you can do
and not what the world happens to bring
you.
Well, let's get down to practice before I get too philosophical. I will show you some
examples:

5. 5 | The Gearwheels of Your Budget – Budgeting Basics II
Example 1 – Webshop
To illustrate my point about building a formula I just love webshops as an example
because the webbusiness is so full of easily accessable statistics about customer
behavior.
The following assumptions could define a budget model for a webshop:
• Effect of marketing – number of visitors to the website. Should be made for
each marketing initiative.
• Total number of visitor – made on a monthly basis.
• Conversion rate – how many percent of visitors will actually buy.
• Average order per customer – how much do they actually buy?
• Percentage of customers who buy more than once.
• Average number of orders per customer per year.
• Seasonal variations.
If you make assumptions about these numbers you will be able to make a
salesbudget.
And if you know your average
contribution margin ratio, you will be
able to calculate your contribution
margin.
Some of your assumptions will
probably be wrong, but after the first
month you will be able to see fx if
the average order is as expected. If
not you may adjust your budget
accordingly or think of a way to raise
the average order.
If the conversion rate is lower than expected, you may adjust the budget and see the
result or you may think of a way to improve your website, so people will actually buy.
Or you may change your advertising to get more relevant customers to your site.
You see, suddenly your budget is not just a wild guess in a drawer or file folder
somewhere on your computer. It is a strong management tool!

6. 6 | The Gearwheels of Your Budget – Budgeting Basics II
Example 2 – Selling hours
A simpler example is if you as a consultant or service provider primarily sell yourself
by the hour. Let's try to look at the budget as something that consists of a series of
gearwheels that pull each other around and where the speed of the last gearwheel
depends on the size and speed of the others. What are the gearwheels in your
budget?
• Hourly rate - the first gear is the hourly rate. What is the normal hourly rate
for the type of services you sell? Are there other categories of hourly rates in
your industry? - Eg. there's significantly differences types of accountants and
lawyers. Are there good arguments that you must be above or below the
normal rate?
• Billable hours per week - the next gear is billable hours per week (or per day
or month). How many hours is it realistic to bill per week? You also have to
spend time on administration, marketing, sales, etc. And what about
transportation from company to customer? How long time does it take and
can it be billed at the same rate?
In principle, we now have our approximate formula for revenue per month if we put
one month to 4 weeks (And we take into account some weeks of vacation).
Hourly rate x Billable hours per week x 4

7. 7 | The Gearwheels of Your Budget – Budgeting Basics II
But of course it is not quite as simple as that. There are just a few more
assumptions we must make:
• Effect of sales and marketing - if we take as a starting point that you start
without customers, we must also take into account that you do not start to
charge the maximum number of hours. We must therefore look at how much
power we expect from our marketing and sales work. Now it gets a bit more
complicated, but it gives a good idea about the necessary marketing and sales
effort. Let us take a few examples of sales and marketing:
o Direct mail and personal sales - how many prospects will you mail to
each week/month? How many will you follow up on by phone? (All of
them of course). How many customer visits you expect to be able to
deal? How many visits are for orders? If you must sell through personal
sales, which typically requires a sales visit before you get the order, so
there are inherently limits on how quickly you can build your sales up.
o Web marketing - how many visitors do you expect to be able to draw
to your website per. day / week? How many percent actually become
buying customers?
• Decision-making - one thing is that you can turn a certain percentage of sales
visits into customers, but maybe it's not here and now. Sometimes the
decision proceess is long. Partly because fx public institutions and large
companies can have quite cumbersome decision making processes. First, the
time may not be exactly right, and you have to wait some months before the
customer is ready. How long do you in general use at a customer before you
get a sale? Sometimes it takes years.
• Order Size - next cog in the system is order size. How many billable hours go
into a typical order. Here, many argue that it is very different, and that there is
a typical order. Well, split it up in fx small, medium and large jobs. It is usually
easier. It triples the course your work when you consider how many small,
medium and large jobs you can get in the house - but it gives some very
practical thoughts about how it is actually going to work.
• Season - and let's just get one more cog in the machinery. What does the year
look like by months? Is the market stable, or is it fx quiet in January and July.
Set fx percentages of each month, so the busy months are 100 percent while
the less busy months may be, for example. 75 per cent., 50 per cent. or
whatever is normal in your industry.

8. 8 | The Gearwheels of Your Budget – Budgeting Basics II
And now we are almost finished, so we can build a formula that consists of:
• Hourly rate
• Max. billable hours a week
• Number of new clients each week / month - based on fx number of customer
visits per months and the average decision time.
• Average sales per customer
• Seasonality
Did I call it a simpler example? OK, maybe not completely, but you could start out
with the first formula and then gradually incorporate other elements as you feel
comfortable with them.
The point is that you should only incorporate the elements that you want to monitor
along the way.
But my point is that it used to be wild guesswork in a blind, so it is now divided into
several parts, which you alone can have an informed opinion about - or at least some
goals.

9. 9 | The Gearwheels of Your Budget – Budgeting Basics II
Example 2 - Innovative product
Now it seems perhaps a little easy to
take an example of billable hours,
but the same mechanisms apply if
you have an innovative product that
you have to launch a new market.
You just need to be prepared for
slightly larger fluctuation margins -
but remember now, we're not trying
to predict. It's something
meteorologists do.
How much can you sell a completely new and different product in a market that may
barely exist yet? That one cannot answer. But maybe you can answer how much YOU
can sell, because again it's not a question of how much the market could absorb, but
how fast you can get customers and how quickly you can deliver.
Let us again try to take it one thing at a time:
• The price - again, the price of your product is naturally the focal point. The
factor that everything should be multiplied with.
• Customers annual purchase
• Effect of sales and marketing – fx number of sales visits per new customer
• Capacity – how much can you actually produce.
Example 4 – Car Wash
On the next page you see an example of a budget formula for a manual car wash
service. Assumptions are made about:
• How many employees do we hire per service unit?
• How many 60 minutes services can each employee manage per month (max)?
• How many percent of our working time can we actually bill to customers?
(How busy are we?)
• What will be the average price for a 60 minutes service?

10. Example 4 – Car Wash (continued)
Jan Feb Mar Apr May Jun Jul Aug Sep Okt Nov Dec
Number of employees 4 4 4 4 4 4 4 4 4 4 4 4
Max number of 60 min.
customers 480 480 480 480 480 480 480 480 480 480 480 480
Billable time (%) 50 70 80 90 80 80 60 80 80 80 70 60
Washes per month 240 336 384 432 384 384 288 384 384 384 336 288
Avg. price per wash 360 360 360 360 360 360 360 360 360 360 360 360
Turnover 86.400 120.960 138.240 155.520 138.240 138.240 103.680 138.240 138.240 138.240 120.960 103.680