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Budgeting 101: Creating Successful Budgets

We often discuss budgeting in our firm, and I often write about budgeting because it is such an important topic in any company. As a consulting firm, we deal with this issue at almost every client. Let’s rehash some basics… Why is budgeting important? As properly stated by Ron Real (the author of 13 ½ Strategies for Winning the Budget Wars), “To achieve success in anything, you need two ingredients: a target to aim for, and a way to measure your progress towards it” (more from Ron Real below). Before we go into creating successful budgets, let’s address the common problems with budgets.

Successful budgets, budgeting rules, common problems with budgetsCommon Problems with Budgets

We deal with clients all the time that either do not have a budgeting system in place, or they have the wrong budget system. The following are some of the most common problems we see with budgets at some companies:

  • Lack of accountability
  • Employees ignore the budget, don’t follow it, or find ways around it
  • Only applies to some groups/managers and not to others
  • Results in fights or power plays, or managers play games
  • Budget process takes too long and consumes too much of people’s time
  • Budget is wrong from the beginning
  • Established goals are either easy to reach or unachievable
  • Filed away when completed – lack of follow up
  • Built on faulty or unrealistic assumptions or not everyone agrees on the assumptions or principles
  • Budget performance and financial feedback is slow or nonexistent
Ready to start creating successful budgets? Become a SCFO Lab member and start the Budgeting 101 Execution Plan where we go in depth into common problems with budgeting, budgeting rules, and budgeting principles. Learn more about the SCFO Lab here.

Successful Budgets

Successful budgets are possible, but the TONE STARTS AT THE TOP. If the leadership or Board does not take the budget process seriously and does not hold others accountable, then you will have a problem with the budgeting process. You can build a budget and a budget process that is well conceived, creates a visionary plan, and shares resources. The budget process is very much a team effort, but it often needs to be taught to others in the organization.

The tone starts at the top, and your CEO needs an advisor they can trust. Click here to download our free How to be a Wingman Guide to start setting that tone.

4 Budgeting Rules

Successful budgets are created by following rules and principles developed over my 28-year career. You can find all these rules and principles in the Budgeting 101 Execution Plan inside the SCFO Lab. Let’s look at 4 budgeting rules that help create successful budgets.

Rule #1: Decision Making Tool

The budget is a tool for decision making. It is not a disconnected document that has little to do with the company’s actual business. Start by reframing your and your CEO’s perspective on the purpose of a budget in a business.

RULE #2: Management Tool

Budgeting is a very important management tool for achieving lasting success. Just like the CFO is the wingman to the CEO, the budget is the wingman to all management.

RULE #3: The Plan

A budget is establishing the discipline to set up a plan and then adhering to the plan. In fact, 94% of all ineffective budgets are the direct result of weaknesses in the organization’s corporate structure. Some of these weaknesses include the following:

  • Inadequate leadership
  • Poor communication
  • Conflicting goals
  • LACK OF ACCOUNTABILITY

Hint: Be disciplined and follow the plan!

RULE #4: Problems Exist

Issues that lead to a poor quality budget process mean that these problems already exist within the organization ALL THE TIME! If your company is experiencing budget problems, then it’s time to look at what the problem really is. Issues that are probably already part of the corporate culture, but many times ignored, include the lack of:

  • Vision
  • Accountability
  • Communication

“Without a yardstick, there is no measurement.  And, without measurement, there is no control”
– Pravin Shah

There are many other rules to budgeting and basic principles, but we can not cover all of these in this one blog; however, we do cover this topic at length in our Financial Leadership Workshop (Day 4) and our SCFO Lab’s Budgeting 101 Execution Plan.

Understanding how budgets really should work is critical. I recently had an executive tell me that he did NOT believe in budgeting because it just meant that people now had the authority to spend everything allocated to them at the end of the year. Unfortunately, this executive was thinking of budgeting like the government thinks about a budget. You have $1,000 for the year, so you must spend it by year end. That is NOT a corporate business budget or budget process. That is a very flawed interpretation of budgeting.

If I could use just one word that describes why it is important to have a good budget process, it would be “accountability”.  A budget will force your team to be held accountable. But, if that theme of accountability does not start with the Tone at the Top, then you are guaranteed to have a flawed budget process.

If you are ready to take your financial leadership development to the next level, then look no further than the Financial Leadership Workshop. Registration for the Gamma Series of the Financial Leadership Workshop is now open. Learn more about the program and how you can get started in October 2018.

Suggestions to Create a Successful Budget

Other quick suggestions to create a successful budget include the following:

  1. Set goals and objectives that push for growth and efficiency, but keep those goals and objectives realistic. There is nothing more demoralizing than to have a unachievable goal.
  2. Start your budget planning process early. For a calendar with year end at December, start no later than August of the current year.
  3. Measure your actual results every month versus budget, and hold people accountable.

Adhering the these budgeting rules and reframing budgeting to your CEO and leadership team is just one example of how you as the financial leader can act as a wingman. If you want to step up and be the trusted advisor your CEO needs, click here to download the How to be a Wingman Guide.

Successful budgets, budgeting rules, common problems with budgets

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Good Budgeting Processes

Budgeting garners a variety of reactions. Some are annoyed that nobody ever wants to look at them or follow them. Others don’t know how to read them – so they just ignore them. Then there are some that just follow the mantra – everything is going to be alright. But we have seen some budgeting errors that resulted in over $1.5 Billion of deficit.

I recently had a conversation with a CEO that a budget was useless and he could manage his cash by using the bank. Needless to say, I was shocked. Over the course of my career, I’ve written hundreds – if not thousands of budgets, financial models, business plans. It’s been cumbersome, annoying, and I can’t tell you how many times someone has tried to ignore it. It’s a pain and I figured I could communicate it easier. Every company needs a budget, but it’s made to be so complicated AND no one follows it. So, I’ve created some good budgeting processes that you can apply immediately.


One of the budgets revolves around your cash flow. Remember, cash is king. If your cash is limited or you just want to improve it, then access our 25 Ways to Improve Cash Flow. 

Download The 25 Ways to Improve Cash Flow


What is a Budgeting Process?

A budgeting process is a plan for the greater plan that helps you make strategic decisions and steer your company is the right direction. A budgeting process (or plan) enables you to keep your company alive.

“During every minute of the flight, I was confident I can solve the next problem.  My first officer, Jeff Skiles, and I did what airline pilots do: we followed our training, and our philosophy of life.  We never gave up.  Having a plan enabled us to keep our hope alive. There’s always a way out of even the toughest spot. You can survive.” 

Capt. Chesley B. Sullenberger III

What A Good Budget Looks Like 

Often, I get asked what a good budget looks like. A good budget allows the manager or executive to have control over what is going on with the cash. It builds both accountability and ownership for the employee and the manager. A good budget also allows anyone to make quality decisions – rather than making decisions completely blind. In addition, a good budgeting process generates discipline – thus, creating empowerment and success.

“A well-constructed numerical estimate is worth a thousand words.”  

Charles Schultze, former Director of the US Bureau of Budget

What A Good Budget Does Not Look Like

Just as important, we also need to look at what a good budget does not look like. In my career, I’ve seen numerous budgeting problems or pitfalls when working in my own companies or with clients. There was a lack of accountability. Employees ignored the budget, didn’t follow it, and found ways around it. Additionally, the budget could only be applied to specific groups/managers as it was not a universal budget. Their budgets resulted in power plays and managers played games, instead of leading their company forward.

Budgets also take time. I’ve spent months, working everyday on just one budget. The current process for preparing a budget takes too long. I’ve also seen clients with budgets that were wrong from the beginning. They built their budget on faulty or unrealistic assumptions. Or they ignored their team members’ concerns. The team was fractured.

And they established goals that were too easy to reach or simply unachievable! Other clients spend all this time creating a budget only for it to be filed away when completed. The common budget process calls for a lack of follow up. Feedback on budget performance is either slow or nonexistent. CFOs, controllers, and budget directors can’t do their jobs effectively without that feedback.

Finally, executives and top management have hidden agendas or aren’t committed to having a budget. They’ve gotten this far without using a budget, so why need one?

Your budgeting process determines the success of your final budget. Simple mistakes on your process could result in a massive cash crunch. To improve your cash flow, click here to access our 25 Ways to Improve Cash Flow.

Good Budgeting Processes

There is also no right way to prepare a budget. Each organization must find its own process. But there is an easier way to prepare a budget with your own process. Everyone sees budgeting as the CFO’s or accounting department’s responsibility, but a good budgeting process involves the entire company. There are a couple key things that you need to look at as you evaluate good budgeting processes.

Have These Four Budgets

In fact, there are really four budgets you need to account for. These include the

You cannot get to the capital budget and balance sheet budget until the operating budget is complete. So that it your #1 priority! In addition, you cannot get to a balance sheet budget without a cash flow forecast, so add that to your to-do list.

Create a Micro-Budget

A great tool for measuring and controlling a specific or vulnerable area is the micro-budget. The micro-budget instills both focus and accountability into your company. Micro-budgets are single focus budgets that companies use to measure and control one specific area. Some examples include:

  • Accounts Receivable
  • Marketing Activities
  • Construction Projects
  • Cost Centers
  • Unique Product Lines
  • Any Area Where the Plan is Vulnerable

Simplify Your Focus

Additionally, many accountants make their firms budget more complex than it needs to be. In fact, measure the complexity of your budget by four factors:

  • Operational Complexity
  • Diversity of Products and Services
  • Size and Geography of the Organization
  • Accountability to Others
  • Hallmarks of a Good Budget

Have Clear AND Measurable Goals

Budgets require clear and measurable goals. Without budgets, it is very difficult to achieve the business goals because each budget defines targets and measures the progress towards them.

Connect Activities and Profits

What prevents people from controlling costs or conserving resources is that they cannot see the direct connection between their job activities and their company’s profits. Part of your job is to help your coworkers and peers see how the work they perform impacts the bottom line. You can accomplish this by involving every employee in the budget development process. Ask them what they need to better accomplish their goals, issues they are seeing, or ideas to pursue.

What Your Budget Needs To Be

You can build a prudent, predictable, and well-conceived budget that creates a visionary plan and shares resources equitably. The process has changed. It’s now a team effort! Your team needs to know the concepts and budget process because (rule #1) the budget is a tool for decision making. It should not be a disconnected document that has little to do with the company’s actual business.

A Fiscally Prudent Budget

When you produce a fiscally prudent budget, it is achievable and balanced. Also, measure it using multiple non-financial metrics. The budget should both stretch employees and the organization as a whole. While it may leave wiggle room for flexibility, the budget should establish proper reserves where needed.

Remember, a fiscally prudent budget makes an investment in the present, as well as the future. The budget does not borrow from the future to fund today! If any one of the strategic goals listed on the budget is not met, then it should not put the company in financial distress. Finally, all the decision makers, executives, owners, and employees need to believe the budget is realistic, or else it risks not being a fiscally prudent budget.

A Well-Conceived Budget

In comparison, one creates a well-conceived budget at a strategic level. It is developed in conjunction with the firm’s planning process. Furthermore, it utilizes the business acumen of an employee in the trenches. For example, an employee in the trenches is serving the customer or making the product. They are the first line of your company. They have continuous feedback built in that informs the leaders whether a strategy is realistic or not. The leadership has to be in tune with their front line. In addition, a well-conceived budget includes the interests of all the organization’s stakeholders. Then develop the budget by consensus.

Conclusion

In the end, a good budgeting process enables you to better manage your cash flow and adapt when needed. If you are seeking more ways to increase cash flow in your company, download the free 25 Ways To Improve Cash Flow whitepaper to find other ways to improve your cash flow within 24 hours.

Good Budgeting Processes

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Good Budgeting Processes

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Budgeting: It’s About Achieving Success

budgeting

Ron Rael, author of 13 ½ Strategic Ways of Winning the Budgeting Wars, once said that, “To achieve success in anything, you need two ingredients: a target to aim for and a way to measure your progress towards it.” Budgeting is all about achieving success in business. When you improve the budget process, you are able to foster both empowerment and accountability. Eventually, it will lead to a better company. Although initiating change in your budgeting process will be challenging, it will further demonstrate your financial leadership.

The Most Common Budgeting Problems

The reason why you may have not seen much success come from your budget is because of the following common budgeting problems. First, the goals that are established before the budget is created are either too easy to reach or are simply unachievable.

If you know your economics, then you can avoid potential unrealistic goals or assumptions. Click here to download the Know Your Economics Worksheet to shape your economics to result in profit.

Then the budget is built on faulty or unrealistic assumptions. If the assumptions are correct, then maybe not everyone agrees on the assumptions or principles. This disagreement of what to build the budget on results in a dysfunctional team.

After the budget is built, there is often little to no feedback from management about the budget. We have seen this time and time again in companies. Those not involved in the budgeting process simply don’t care about the budget. They think that because they are not the CFO or Controller, it’s not their job. But everyone in an organization should care about the budget.

Additionally, when the budget is completed (usually after weeks of non-stop focus), it is filed away. It is rarely taken out and use in the daily strategy of the company. There is a lack of follow up.

When leadership has to meet with shareholders, stakeholders, etc. regarding the budget, they realize that they haven’t used the budget at all. Then they go to any means to achieve their budget. This manipulation defeats the purpose of having a budget. We suggest to design a budget that cannot be manipulated.

If you are thinking that the most common budgeting problems are more like cultural issues, then you’re correct!

Top 2 Budgeting Problems

Everything we have already said concerns the entire company. But the majority of our audience consist of CFOs and Controllers. The two problems that impact CFOs, Controllers, and budget directors the most include hidden agendas executives may have, the lack of commitment from executives for having a budget, and executives seen budgets as the CFO’s job. The responsibility of the budget is not solely reliant on the accounting department or CFO.

How Businesses Can Prepare for Natural DisastersHow to Budget Successfully

Budgeting successfully requires you to transform how you think about budgeting overall.

Use It As Decision-Making Tool

If you want to budget successfully, then you need to use your budget as a tool for decision making. It is not some disconnected document that has little to do with the company’s actual business. Instead, it should be a living and breathing part of your decision making. Plus, it is more effective when you use it to make decisions. When people ignore it or play games with it, your budget becomes ineffective.

Additionally, understanding the need to improve the quality of decision making and making it happen are two different animals. What you get all depends on the leaders’ commitment and attitude.

Use It As Management Tool

Budgeting is a very important management tool for achieving lasting success. A budget should establish the discipline to set up a plan. But you must also adhere to the plan. Furthermore, this management tool always you to measure your progress, and ultimately, your success.

“Without a yardstick, there is no measurement.  And, without measurement, there is no control”
– Pravin Shah

Issues Are a Result of Culture

We said it earlier, and we’re saying it again because it’s that important. Most budgeting issues are a result of an organization’s culture. Issues that lead to a poor quality budget process mean that these problems already exist within the organization ALL THE TIME!

Cost Associated

Everything has its cost! The budget is no exception. Budgets take work! They are not easy to implement nor are they easy to manage. Some of these costs include the following:

In addition, there are other costs associated with budgeting that could impact the bottom line. If employees are not conserving costs and making the most of opportunities, the bottom line will suffer. If leaders are not investing in their tangible and intangible assets equally while employing them to their fullest potential, the future bottom line will suffer.

Require Specificity

The budget and the plan it drives from is only effective when it leads to specific actionable and measurable activities and generate stakeholder value. Therefore, a budget must require specificity.

Assumptions Drive Everything

Also, your assumptions drive everything. Therefore, it is crucial that everyone be on the same page regarding assumptions in relation to decisions on what is important in your budget.

Governance of Budgeting Process

When your leadership team establishes governance in your organization, they are deciding how to best use all their resources to accomplish the purpose or mission.

Governance Principles

Use the following governance principles in your budgeting process. A reality based budget and planning system that enhances accountability is necessary for the good governance because it increases transparency. Furthermore, the key factor in a realistic and honest budget is people and their accountability. A well conceived and thoughtful budget improves the governance demanded by all stakeholders. In addition, the budget is a reflection of the importance that your executives place on governance and ethical conduct. Every game played with the budget is actually a breach of the organizations Code of Ethics.

CFO’s Role in Making the Bottom Line Commitment

 The CFO is essentially the CEO’s cheerleader! The CFO inspires higher level of performance.  The greatest challenge is to ensure that the strategic objectives and operational plans are adequate and inspirational enough to achieve the leaders’ desired financial objectives. The leader’s three plans, when combined into a cohesive strategy, will generally lead to success; however you define it. Furthermore, the CFO and executive team are the guardians of all assets – physical, financial and human ones. Use these assets to implement the plan and achieve the goals!

 CFO’s Discipline

Having the discipline to build a healthy budget, and having the budget instill discipline across your firm has many benefits. Not only will your budget properly serve as a management tool, but the benefits of discipline will filter over to other areas of your operation which will lead to efficiency and profitability. The next step in achieving success through your budgeting is knowing your financials or economics. If you want to shape your economics to result in profit, then click here to download the Know Your Economics Worksheet.

budgeting

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Why Prepare Budgets?

Do you need to take an umbrella to work today?

Without a trusty weather app or friendly meteorologist, it would be difficult to know the answer. Fortunately, you probably have one of these tools to help you make an informed decision.

The CFO/Controller is the meteorologist for the business.  It’s your job to help the company decide when, and if, you’ll need an umbrella.  How do you do this?  By preparing a budget.

prepare a budgetWhat is a budget?

A budget is an estimate of income and expenses within a given amount of time. It contains economic goals, boundaries, and limits on expenditures of the organization.

By creating a budget, you’ll be able to hold the company accountable for its expenditures, reduce costs, and prepare for a worst case scenario. It serves as a measurement tool that can visually illustrate if you have enough cash to operate or to grow.

The steps in the budgeting process are:

  • Prepare the budget
  • Negotiate and agree on the budget
  • Monitor the budget

Prepare the Budget

First, you as the financial leader must choose what type of budgeting method you want to use. There are two main types of budgets: zero-based budgets and traditional budgets. While zero-based budgeting allows you to re-examine all of your costs, traditional budgeting is more user-friendly.

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Typically, prepare the annual budgets before the fiscal year begins. This window of preparation helps facilitate execution.  Early decision-making will provide boundaries within which the company must abide. Oftentimes, if you don’t prepare budget ahead of time and create it on the spot, then arguments and internal issues begin to arise. You can avoid disputes when executing a budget by preparing early.

During preparation, it’s important to focus on fiscal targets. Fiscal targets are are goals for specific financial categories. These could include profit, debt payback schedule, operating expenses, projected borrowing requirements, etc. By laying out these goals, you’ll be better equipped to prepare a budget that will allow negotiating and finalizing of the budget to go smoothly.

Optimistic Budgets

prepare a budget

As a reminder, an overoptimistic budget can result in late payments and disorderliness in regards to keeping in compliance with the bank. There are several ways you could be overoptimistic in your budget, the major one being you are not projecting your sales correctly. If you’re a couple cents off, it’s okay.  A budget should be seen as a “set of guidelines, not rules, based on the best forecasts at the time but always open to amendment as circumstances warrant” (Accounting at Your Fingertips, p. 332).

To reduce the chances of creating an overoptimistic budget, it’s important to go back to the basics. By focusing on the economics of your business, you’ll not only create a realistic budget, but you’ll be better able to project future growth.

(NOTE: Want an easy tool to analyze your company’s economics? Download the Know Your Economics Worksheet to make sure you’re pricing for profit!)

Negotiate and Agree on the Budget

As with most things in business, negotiation comes into play.  The purpose of negotiation is to allocate resources according to your targets and policies with everyone’s best interest in mind.  However, fiscal policies should provide the framework for budget formulation. Make sure that you consider your company’s economics when structuring the budget.

During this negotiation process, it is vital for you as the financial leader to maintain the meeting as a negotiation rather than let the meeting turn into a bargaining session. Bargaining results in a win-lose situation where the goal is to get as many of your points on paper over another person or department. It may drive the process, but it is not effective. Often, the outcome of bargaining is inefficient resource allocation.

By comparison, negotiation is all about a group of people working towards one goal. Part of this goal should be to comply with fiscal policies and targets.

Monitor the Budget

So much time and hard work goes into creating a budget, yet so many companies fail to utilize the budget. The purpose of a budget is to measure operational efficiency and performance issues.

The efforts of budgeting should be focused on improving revenue forecasting or projecting. A budget is useless unless utilized in a dynamic manner. While budgeting provides the short-term execution plan, forecasting allows you to take historical data to measure the reality of success in executing your budget. You’ll be better able to allocate resources to the right departments.

(Check out the 5 tools that you might not be using but should be implementing along side your budget.)

When you link the budget and the forecast, you’ll be more equipped to monitor the budget.  Contrast this with a static budget that is often useless after the first month. It all starts by knowing your unit economics and then assessing your economics to judge whether they are working for your company.

To ensure that your budget is built to achieve your business goals, make sure to start with the basics. Find out more about how you could utilize your unit economics to add more value to your organization by clicking the link below.

Know Your Economics (on blog)-2

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There are many methods you can use to improve productivity in your company. Click here to download a PDF of 10 Ways a CFO Can Improve Productivity.

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Zero-Based Budget (ZBB)

What is a Zero Based Budget?

A zero-based budget (ZBB) requires all expenses to be justified each period. Essentially, a zero based budget is when you create a budget from scratch each period. Each period, reevaluate and justify all expenses in terms of the company’s overall strategic objectives. Distinguish the zero-based budget from the traditional budget. Do not build a ZBB upon the previous period’s budget.

Traditional Budget

Often times, when creating a budget, the manager will simply start with the previous period’s budget and add to it. The previous period’s costs and expenses are considered inevitable for the current period. Based on proposed plans and projects the manager then adds costs to the budget for the upcoming period. Over time, when using this method, budgets can just grow period after period. By starting with the old budget and adding costs, the company does not justify or reexamine the previous period’s costs.

Zero-Based Budget

A zero-based budget basically requires starting from scratch each period. When preparing a ZBB, the previous period’s budget is all but ignored. At the beginning of the period, all cost-incurring activities must be examined and justified in terms of the company’s strategic objectives. Cut activities that aren’t necessary. Scrutinize necessary activities for opportunities to reduce expenses. Then continue essential activities as needed. Then build the budget around the remaining necessary activities.

Zero-Based Budget – Advantages

There are several advantages to using a zero-based budget. By severing the link with the previous period’s budget, you can avoid the gradual incremental increases that can accumulate period after period when budgets are prepared using the traditional method. You can also reevaluate and fund business activities according to merit and according to alignment with the organization’s strategic objectives. Preparing a budget with the zero-based budget method is an effective way to plan and an effective way to contain and control costs in an organization.

Zero-Based Budget – Disadvantages

Preparing a budget using the ZBB method can be costly. It requires a lot of time, effort, and commitment from employees. Preparing a zero-based budget requires much more time than preparing a traditional budget. Because of this, it may be optimal to prepare a ZBB every few fiscal periods as opposed to every fiscal period. Preparing a zero-based budget requires much more effort than preparing a traditional budget. It requires deeper analysis and scrutiny of all budget items.

zero-based budget, Zero Based Budget

See Also:
How to Estimate Expenses for and Annual Budget
Capital Budgeting Methods
LIFO vs FIFO
Chart of Accounts (COA)
Administration Expenses

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Percent-of-Sales Method

See Also:
ProForma Financial Statements
Cost Center
Weighted Average Cost of Capital (WACC)
Standard Costing System
Activity Based Costing vs Traditional Costing

Percent-of-Sales Method

The percent-of-sales method is a technique for forecasting financial data. When forecasting financial data for strategic planning, budgeting, or for developing pro forma financial statements, analysts can use the percent-of-sales method of forecasting to create reasonable projections for certain key data.

The idea is to see how a financial statement account item relates historically to sales figures. Then use that relationship to project the value of those financial statement account items based on future sales estimates. This method of forecasting requires the items to be estimated based on relations to sales figures, thus it is necessary that movements in the items to be forecast are highly correlated with fluctuations in the sales figures. Forecast that item using a different technique; especially if there is no clear correlation between the item to be forecast and sales figures.

For example, if, after examining and analyzing historical financial statement data, an analyst determines that inventory levels are typically at 30% of sales. Additionally, the sales forecast for the coming year is for $100,000 dollars in sales. Then according to the percent-of-sales method of forecasting, the analyst can estimate inventory of approximately $30,000, or 30% of the estimated sales figure.

If you’re still not sure how to accurately project your sales, click here to access your free Goldilocks Sales Method tool. This tool allows you to avoid underestimating or over-projecting sales.

Three Step Process

There are three steps in the percent-of-sales forecasting process. First, use the sales figures to identify the correlated items. Then separate the uncorrelated out. To do this, analyze historical financial statement data. Only the items which are correlated with sales figures can accurately be predicted or forecast using the percent-of-sales method. Estimate items that have no concrete relation to sales figures using a different technique.

Next, forecast sales for the fiscal period in question. Because all projections in the percent-of-sales method of forecasting depend on relationships between financial statement items and sales figures, it is very important to get an accurate sales forecast.

The third step in the percent-of-sales method of forecasting is to forecast the values of certain appropriate financial statement items. You can accomplish this by using the sales forecast from the previous step in combination with the historical relation between the financial statement item and the sales figure.

Percent-of-Sales Method

1. Analyze historic financial statement data
2. Forecast sales for the fiscal period
3. Forecast financial statement items using sales forecast

If you need help creating an accurate sales pipeline, download the Goldilocks Sales Method.

percent-of-sales method

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Margin vs Markup

See Also:
Gross Profit Margin Analysis
Retail Markup
Chart of Accounts (COA)
Margin Percentage Calculation
Markup Percentage Calculation

Margin vs Markup Differences

Is there a difference between margin vs markup? Absolutely. More and more in today’s environment, these two terms are being used interchangeably to mean gross margin, but that misunderstanding may be the menace of the bottom line. Markup and profit are not the same! Also, the accounting for margin vs markup are different! A clear understanding and application of the two within a pricing model can have a drastic impact on the bottom line. Terminology speaking, markup percentage is the percentage difference between the actual cost and the selling price, while gross margin percentage is the percentage difference between the selling price and the profit.

Effective Ways to Optimize Profitability

So, who rules when seeking effective ways to optimize profitability?. Many mistakenly believe that if a product or service is marked up, say 25%, the result will be a 25% gross margin on the income statement. However, a 25% markup rate produces a gross margin percentage of only 20%.


NOTE: Want the Pricing for Profit Inspection Guide? It walks you through a step-by-step process to maximizing your profits on each sale. Get it here!

Download The Pricing for Profit Inspection Guide


Markup vs Gross Margin: Which is Preferable?

Though markup is often used by operations or sales departments to set prices it often overstates the profitability of the transaction. Mathematically, markup is always a larger number when compared to the gross margin. Consequently, non-financial individuals think they are obtaining a larger profit than is often the case. By calculating sales prices in gross margin terms they can compare the profitability of that transaction to the economics of the financial statements.

(Try the calculators at the bottom of the page to discover for yourself which is better!)

Steps to Minimize Markup vs Margin Mistakes

Terminology and calculations aside, it is very important to remember that there are more factors that affect the selling price than merely cost. What the market will bear, or what the customer is willing to pay, will ultimately impact the selling price. The key is to find the price that optimizes profits while maintaining a competitive advantage. Below are steps you can take to avoid confusion when working with markup rates vs margin rates:

Establish a Price

Still deciding whether to use margin or markup to establish a price? Easily discover if your company has a pricing problem and fix it with either margin or markup. Download the free Pricing for Profit Inspection Guide to learn how to price profitably.

margin vs markup, Effective Ways to Optimize Profitability

Strategic CFO Lab Member Extra

Access your Strategic Pricing Model Execution Plan in SCFO Lab. The step-by-step plan to set your prices to maximize profits.

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margin vs markup, Effective Ways to Optimize Profitability

Margin vs Markup Chart

15% Markup = 13.0% Gross Profit
20% Markup = 16.7% Gross Profit
25% Markup = 20.0% Gross Profit
30% Markup = 23.0% Gross Profit
33.3% Markup = 25.0% Gross Profit
40% Markup = 28.6% Gross Profit
43% Markup = 30.0% Gross Profit
50% Markup = 33.0% Gross Profit
75% Markup = 42.9% Gross Profit
100% Markup = 50.0% Gross Profit

Margin Calculator

Markup Calculator

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