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Finance Expert: Process for Forecasting Operating Expenses with Scott Geller · Budget Your Business

0:00
Scott: Hello and welcome to budget your business, the podcast for small business owners who want to learn how to financially plan for every aspect of their business.
0:11
Scott: I'm your host, Scott Geller.
0:14
Scott: Today is a little different.
0:15
Scott: I'm recording a quick take on budgeting, or as I prefer to say, forecasting.
0:22
Scott: No guests today, just me talking about how to forecast your operating expenses.
0:29
Scott: A standard episode or show dives deep into a single area or topic within your business, such as hiring a tech leader or offering a 401k, maybe building out an employee compensation plan.
0:44
Scott: Whereas today we're taking a little different approach by taking a step back and talking about a forecasting topic that I think is helpful for businesses.
0:56
Scott: And today that's forecasting a company's operating expenses at a roll-up level, meaning you're aggregating all your operating expenses together and forecasting them out.
1:13
Scott: So it's just me, and let's dig into our forecasting topic.
1:18
Scott: As part of any financial planning, the operating expenses should be a significant portion of that effort.
1:26
Scott: And when you're talking about operating expenses, sometimes the easier, easiest way to talk about what what is to discuss what were what are not operating expenses.
1:38
Scott: And the biggest the biggest expense or category that is not an operating expense are the costs of goods sold.
1:46
Scott: Alright, Scott, so you're throwing out another term here.
1:49
Scott: Well, what are costs of goods sold?
1:52
Scott: According to the Harvard Business Review, I like their definitions.
1:55
Scott: Of course, look according to the Harvard Business Review, the cost of goods sold are the cost of component parts of what it takes to make whatever it is a business sells.
2:07
Scott: That means those expenses that are required to provide the service or goods that you are selling.
2:16
Scott: For example, if you're a service-based business, let's say it's a software development company or a um a therapy business where therapists meet one-on-one with your clients, or maybe even HVAC business, and you have these technicians that go out on um uh jobs.
2:41
Scott: Those people providing the services are the cost of goods sold.
2:46
Scott: They are providing what your customers are looking for or they're buying.
2:50
Scott: Maybe based by the hour spent on the client, uh, and maybe it's not all the persons, so maybe it's just the time spent on the client.
2:58
Scott: Maybe sometimes there's some admin that don't fall into cost of goods soul.
3:02
Scott: But in a service business, typically it's the people, the people that are providing those services.
3:07
Scott: Another example would be staffing.
3:10
Scott: Let's think of a staffing company that places long-term employees.
3:15
Scott: Well, what are those expenses?
3:18
Scott: Well, it's payroll, it's reimbursements to the employees or the contractors, it's the benefits that you're placing those long-term employees at the client facility or location.
3:31
Scott: Um, and it can be the fees that you're having to pay for for placing those people.
3:35
Scott: Maybe you go through a VMS and or you're paying those VMS or MSP fees, and those are those are all considered cost of goods sold in for a staffing company.
3:49
Scott: On the other side, let's talk about manufacturing or inventory.
3:54
Scott: Sure, there's people as part of those, but a big piece for manufacturing and inventory business are the parts, those those parts that you're buying, that you purchase to make something else.
4:07
Scott: That's those are examples of cost of goods sold.
4:11
Scott: Of course, the delta between revenue and cost of goods sold is the gross profit.
4:17
Scott: We're not getting into that today.
4:20
Scott: So, what is not operating expenses?
4:22
Scott: One big category are the cost of goods sold.
4:26
Scott: Other categories that are not operating expenses are usually those that fall below the EBITDA line.
4:33
Scott: And the EBITDA line is the profitability line in your income statement.
4:38
Scott: That's calculating the earnings before interest, taxes, depreciation, amortization.
4:46
Scott: So, what are not operating expenses?
4:49
Scott: That's it.
4:50
Scott: Well I just mentioned the interest, the taxes, depreciation, and amortization.
4:56
Scott: If you think of your income statement, you've got your revenue, you have a cost of goods sold, you should then have your gross profit.
5:03
Scott: You then list out all your operating expenses.
5:06
Scott: Then you get to your EBITDA.
5:07
Scott: So it's everything it should be everything between the gross profit and the EBITDA on your income statement.
5:14
Scott: Assuming, of course, that your income statement is set up correctly.
5:19
Scott: But if it is, that's where the operating expenses are.
5:23
Scott: That's what's left, the operating expenses.
5:27
Scott: What I like to refer to operating expenses are are those expenses that are needed to keep the lights on.
5:35
Scott: Examples.
5:36
Scott: Let's see.
5:37
Scott: Let's talk about some examples of what since we talked through examples of cost of goods sold.
5:42
Scott: Uh let's talk through some examples of operating expenses.
5:46
Scott: Even though we talked about payroll being a cost of goods sold, every business also has payroll as part of their operating expense.
5:56
Scott: You have payroll for running the business.
5:59
Scott: These are paying the founder, paying the management team, admin rules, think of HR, accounting, marketing, sales, all those are at considered admin roles that should be rolling underneath the operating expenses.
6:16
Scott: I touched on before, when we talked about cost of goods sold, the people in the cost of goods sold.
6:23
Scott: There are times where the payroll for some people in your organization can be split between cost of goods sold and operating expenses.
6:36
Scott: So part of someone's time might be spent on providing the goods and service, and part of their time might be considered admin time.
6:44
Scott: So the admin hours or the admin time could be classified as operating expenses.
6:49
Scott: If you really want to start digging down and really breaking out the into finite pieces, uh, you could start breaking some of your payroll between cost of goods.
7:01
Scott: So for in for each for individual people, like for the same person, you could think about splitting one person's time between cost of goods sold and operating expenses.
7:13
Scott: That gets a little more complicated.
7:15
Scott: You need a system, you need a process, and you need to be make sure you're on top of that.
7:19
Scott: Other payroll expenses that fall underneath operating expenses are typically benefits and payroll taxes.
7:26
Scott: Other examples of operating expenses are really your SGNA.
7:32
Scott: Or another way to think about that or say that is your sales general administrative expenses.
7:39
Scott: Think your marketing expenses, your print ads.
7:42
Scott: The general administration side would be expenses that support the business in order to operate.
7:49
Scott: Sure, you can sell, but you have to have supporting functions behind and expenses sitting behind that sales function or the uh you know whatever you're selling in order to provide those.
8:02
Scott: Think of rent, legal, consulting, travel expenses, office supplies and equipment, gifts, bank or other financial fees, company insurance, payroll fees, software and hardware, dues, on and on.
8:20
Scott: We could go on and on.
8:22
Scott: Before I do, I do want to make one point.
8:24
Scott: When I threw out there software and hardware.
8:28
Scott: If you're a technology company or say a SaaS company, some of that software and hardware, you're gonna need to split that out as well.
8:36
Scott: Similar to some individuals, some people we talked about, where the payroll can be split between cost goods sold and operating expenses.
8:43
Scott: The software and the hardware can also be split between cost goods sold and operating expenses.
8:50
Scott: So think about that tech or the tech spin, so the software and hardware that is required in order to provide your service or good.
8:59
Scott: And if it is, guess what?
9:01
Scott: That goes in cost of goods sold.
9:03
Scott: If not, then absolutely should go into your operating expenses.
9:09
Scott: So before moving on, I'd like for you to think about how you structure or group all of these expenses.
9:18
Scott: I just rolled through several expenses and several examples of expenses, and that's just the tip of the iceberg.
9:25
Scott: You're gonna have so many expenses.
9:29
Scott: In your accounting system, you're gonna have what's called a chart of accounts, and that's just a fancy way of saying a list, a list of every single GL or general electronical account, so every account that you post expenses to.
9:44
Scott: And think about those accounts, think about the expenses you have, and then think about how you want to structure group those expenses.
9:55
Scott: For example, let's group all the payroll expenses together.
10:00
Scott: You can take your SGA or the sales administration, sales general administration bucket, you can use it as one bucket, or you could break that into a few different buckets.
10:13
Scott: You want you say you have a couple of accounts or enough spend in your sales and marketing, so that should be a separate bucket or category.
10:22
Scott: Let's say you have buildings or or an office, you could use that as a separate uh category.
10:30
Scott: If you pay, let's say taxes or you pay taxes across several states, uh, maybe that might be that those taxes specifically are a bucket.
10:40
Scott: Technology might be a bucket.
10:42
Scott: So your software, your hardware, your data expenses, those could all be technology bucket.
10:49
Scott: Now, don't go overboard.
10:51
Scott: I I do believe in the KISS method, you know, keep it simple, stupid, and limit it to say two to five categories.
10:58
Scott: So take that laundry list of operating expenses or operating um expense accounts and try to group them into two to five categories.
11:12
Scott: I highly recommend having a payroll.
11:15
Scott: That's the one that that's unless you only no matter what, I really just recommend having a payroll category for your operating expenses.
11:24
Scott: And then think about your SGA and whether or not it makes sense to break it up into two to three other categories.
11:32
Scott: And that goes back to the sales and marketing, the building, the technology.
11:36
Scott: Those are just a couple of examples.
11:40
Scott: But how do we project our budget for them?
11:42
Scott: Well, let's talk about payroll first.
11:45
Scott: Payroll, I'm gonna go into a slightly a little bit more, a little bit more um detailed level with payroll because I do think that building out payroll by the person is important and can add value.
12:02
Scott: And that means you take all of your people that are considered operating expenses and you list them out each person, individual lines.
12:10
Scott: You think about an Excel file, you have your tab, the first column is a person's name.
12:17
Scott: The second column might be the ID, unique ID number.
12:21
Scott: But uh I highly recommend having employee ID number so you can distinguish between people.
12:27
Scott: So that might be the second column.
12:29
Scott: The third column would be their title.
12:31
Scott: Their fourth, the fourth column, if you want to, you can put in their start date.
12:35
Scott: I think that's important by you're having the start date in there.
12:38
Scott: The fifth column would be the department if that's applicable.
12:41
Scott: And then the sixth column would be their monthly compensation.
12:44
Scott: So let's say if they make$120,000 a year, because I want to make my math easy, then their monthly compensation would be$10,000 a month.
12:53
Scott: You then take that monthly compensation and and think about what that monthly comp could be, because it could be a couple of different ways of calculating it.
13:01
Scott: The easy way is by salary, right?
13:03
Scott: You take their salary divided by 12.
13:06
Scott: Another way would be if they're hourly, think about what their rate times the average hours per month.
13:14
Scott: So if somebody works, say an average of 30 hours a week, and there are 4.3 weeks in a month, so 4.3 times 30 hours a week equals 129 hours, or let's say 130 hours a month.
13:34
Scott: So take that 130 hours, and let's say they they um work uh or they they are at$30 an hour.
13:45
Scott: Well, that would be$3,870 per month.
13:49
Scott: So there's your monthly cost.
13:50
Scott: You can use that as a monthly cost for that individual.
13:55
Scott: And again, this this is the next step is so so we have all of our data set up.
13:59
Scott: You have the name, their title, hopefully their start date, department, and the monthly compensation.
14:06
Scott: And then let's allocate those monthly expenses out every month that the FTE is working.
14:13
Scott: So if we're using our Excel spreadsheet, you continue out to the right and you just say, okay, January, February, March, or if you're starting in June, July, August, September, October, and so on, and you month allocate that monthly expense every month that the FTE is working.
14:30
Scott: If they're not working, there's no expense.
14:34
Scott: There's a lot of multiple ways of doing this.
14:36
Scott: Um and we'll dig in, we can dig into the different ways another time, but that's just a a quick quicker way to map out what somebody's what your payroll expense would be.
14:50
Scott: A few other quick points to rethink about.
14:54
Scott: You had benefit, you might have benefits.
14:56
Scott: You definitely have salary payroll taxes, so don't forget 7.5% for your payroll taxes.
15:03
Scott: On the benefits side, think about what your benefits cost and have that as a flat rate for benefits, or you could do a percentage of salary and include that.
15:16
Scott: So if you're going back to our example, our hourly employee at$3,870 in compensation every month.
15:24
Scott: Let's say you contribute$230 uh per payroll for benefits, meaning that their their um their costs went from$3,870 to$4,100.
15:43
Scott: So now that's their total all-in cost.
15:45
Scott: And then you add in the payroll taxes on top of that.
15:48
Scott: That's a lot of people miss that.
15:50
Scott: They miss including benefits and miss including payroll tax, and then they wonder why their projections are low.
15:58
Scott: All right, so what if you want to hire somebody, or what if you want to get rid of somebody?
16:01
Scott: Well, you simply remove that exp that monthly expense, or if you want to hire somebody, you add in somebody at the bottom of your list and you put that expense out in the corresponding month.
16:14
Scott: So that's the payroll.
16:15
Scott: Recommend building out by person.
16:18
Scott: Uh, as we discussed, if you only have, let's say, two or three people and you know you're not gonna hire anybody, then fine.
16:24
Scott: You don't have to build out by person.
16:26
Scott: We'll talk about how, like, an average you can use.
16:29
Scott: But I really recommend looking at your people by your payroll by person.
16:35
Scott: So we talked about payroll.
16:36
Scott: The other big category is SGNA.
16:39
Scott: And again, let's take the KISS method here.
16:43
Scott: I highly recommend using a rolling average of four to six months, depending on your business.
16:50
Scott: That allow and and then allowing for manual input.
16:55
Scott: Look at your your SGNA and say, what is a four months long enough, or maybe it's six months?
17:01
Scott: But take a four to six month uh rolling average and use that historical the last four to six months, and then just roll that forward.
17:12
Scott: It's going to be close enough.
17:16
Scott: The second piece of that is to allow for a manual input.
17:20
Scott: That just means leaving yourself space to think about one-time expenses, think about seasonality or the ability to stress test um your operating expenses.
17:31
Scott: So, you know, maybe you know there's a$50,000 expense that hits every June.
17:36
Scott: So you want to put that in there as a one-time.
17:39
Scott: Um, so use a rolling average and allow for a manual input.
17:44
Scott: Uh, think about your RD, maybe, maybe of research and development expenses.
17:49
Scott: So think about that as another category, possibly, where you can think about because that impacts taxes, capitalization, um, and and you know, there's a lot of there's several accounting and working capital reasons to track that separately as well.
18:03
Scott: So, you know, if you don't if if you want to break the SGNA into multiple categories, uh, use categories.
18:10
Scott: This is where the categories become useful because you can use different rolling averages.
18:15
Scott: Let's say one category makes sense for a four-month.
18:17
Scott: Let's say another one because of seasonality, you need six months.
18:21
Scott: It can also allow you to put in one-time expenses and have a better sense of where uh where that might hit if you have two or three of these SGNA categories.
18:32
Scott: You can apply inflation per category, you can stress test per each category.
18:38
Scott: It also gives you a little bit more insight into trending if you have, say, two to three or four of these categories versus one large category.
18:49
Scott: Again, be careful about adding too many of these categories, but having a couple categories of the SGNA allow you to treat them a little bit different and really dig into uh some of the some of the different areas.
19:05
Scott: I like to wrap up each of these sessions, even one by myself, by sharing three takeaways.
19:12
Scott: And today I'm gonna I'm gonna summarize it up into three takeaways for how to bridge how to forecast your operating expenses.
19:19
Scott: One is is with payroll, and if you can, create it by person so you can understand when people are coming and going and see that big impact on your business.
19:30
Scott: For your SGA or your Sales General Administrative, break it up into two to five categories.
19:37
Scott: Use a four to six month rolling average per category, and then leave yourself a little room or leave yourself where you can put manual input for one-time seasonality, significant new expenses, and/or stress testing.
19:52
Scott: And then most importantly, is review it.
19:55
Scott: Review it monthly or quarterly and adjust as needed.
20:00
Scott: I think you'll find that it allows for a clean, clear eyes, and relatively simple operating expense projection or budget.
20:12
Scott: I asked all my guests for a good podcast to book recommendation.
20:16
Scott: The podcast I'm going to share is A Bit of Optimism with Simon Sinek.
20:22
Scott: I really enjoy this podcast because he takes an interesting approach with a wide variety of people and really pulls out, like it says, a bit of optimism or something positive to think about.
20:35
Scott: So A Bit of Optimism with Simon Sinek is a podcast that I recommend.
20:41
Scott: This has been great, but you can find more on me and more postings similar to what we're talking about today.
20:48
Scott: Uh Scott Geller.
20:50
Scott: You can find it on LinkedIn, look up Scott Geller on LinkedIn, or look up my fractional CFO business website, Capitus Advisors, at www.capitistadvisors.com.
21:04
Scott: All right, folks, that's it for today.
21:06
Scott: I'm Scott Geller, and I hope you join me next time for budget your business.