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Monday, August 1, 2011

Budgets

Creating a Budget as the First Step to Establishing Reality -
Do we have enough money to start the business of our dreams?  As a first step we will have to determine what the costs and expenses of our business might be before we actually start to move ahead with business planning.

Costs and Expenses
There are expenses that you will incur once at the outset of your business and others that will recur from month to month. These are easy for your to discern: you can collaborate market prices for rent of space and other items such as furniture and fixtures, but how do you compute how much you will be able to sell?
Our market research should have revealed to us what our competition is doing in the way of sales and units sold. If we searched enough and made inquiries, that research will also have an indication of what the cost structure of businesses in the same industry are like. You have also computed what your expenses will be in the first month at least! So we have some information with which we can budget with.

Another issue to address is one of feasibility. Are there enough potential customers in your target market to purchase your product to make sales worthwhile? What happens if your target market is not big enough? What happens if your product is not one that people want to buy? If the answer to these two questions is "No", then don't venture out and start this business.

But if you determine that it is worthwhile after doing extensive market research, how do you figure out Sales? How much can you sell? AND I ask you at what price are you going to sell your product? Remember Sales is a function of Price times Units Sold (Sales = Price x Units Sold). If you look at this equation you have two elements with which to play - - Price (how much to charge in view of your given cost structure), and Units Sold (how much can you sell?). You can arrive at your sales goal in dollars if you lower the price and raise the number of units sold. Or, you can arrive at the same sales goal if you raise the price and reduce the number of units sold.

Take a look at the table below which is used to ascertain the price level and number of units to sell.


This table shows three possibilities whereby the entrepreneur is using varying numbers of units and several price points to determine if his cost structure can be covered with sales. In this budget he will use the average column to expand his budget from month to month. This "flexible budgeting" can be used with your prediction of how the economy will be: worst case, better case, best case to arrive at an average case.

Bottom Up Method
You can also determine a budget by using the Bottom Up Method. Here you would determine what profit you want to have, use your cost structure and then work backwards to determine the Net Sales that would give you the profit you desire. Thus, we are working from the bottom up.

Many people who use the Bottom Up Method have realized that to arrive at the profit that they are seeking they need to expand their business or add on extra help in order to achieve the scale that they desire.

Deviation Analysis
The budget that we have created can be used after we have begun operating for a time. We want to know how well we have done in comparison with what we thought we would do at the initiation of our business. We can take the budget that we have created and compare it do what we have actually done. We can then see how we have deviated from the original plan. Perhaps we have done much better than what we originally planned or maybe we have not done what we aimed for. Take a look at the format below to see how you can use the table above for the Deviation Analysis.


The Comments column is used to explain the variance, which is the differential between Actual and Budget, either up or down. We can write the reasons for the variance, like "we had to lower price to attract consumers and thus didn't achieve the sales level" Or, "due to increasing demand, we raised the price to $xx and achieved greater dollar sales". Or, we achieved greater Gross Profits because the costs of our goods went down". These explanations help management understand how to alter their operations going forward. Feedback enables fine tuning of the operations and makes for a more efficient operation. Thus deviation analysis helps management understand the effects of the economy and supply and demand on its operations.

Distrubution Channels

The method we use to get our product to the consumer can define our competitive advantage and reputation and add to the quality of our service. It can also mean cost efficiencies.

Direct Marketing
Direct Marketing is where the manufacturer sells directly to the consumer. For example, an Internet company which has its catalogue on the Internet would sell directly to the consumer and ship directly to the consumer either by parcel post, FEDEX or UPS. The advantage here is that the manufacturer has control over shipping and expedites the shipment via his "strategic partners" the U.S. Postal Service, FEDEX or UPS. It is also cost effective. The manufacturer is able to offer the product cheaper than if the product were offered in a retail store or department store. Case in point, you can purchase books and other items from Amazon.com, receive them in 3 to 5 business days and the shipping is FREE. The charge is cheaper than if you were to buy it in a store.

Levels of Channels
The more links you have in your distribution channel the more the costs are added to the product.
  • One Level - The manufacturer would use a retailer, like Bloomingdale's who would sell to the consumer. Bloomingdale's is going to add their cost to the cost of your product. Therefore, the consumer will be paying more for the product.
  • Two Levels - The manufacturer would use a wholesaler who would use the retailer who sells to the consumer. The wholesaler, like the retailer, would add on his costs to the cost of the product. The consumer would be paying more for the product.
  • Three Levels - The manufacturer would use a jobber (used for overseas sales), who would utilize a wholesaler, who would use a retailer who sells to the consumer. Yes, as you are now catching on, there are more costs and the end result is that the consumer pays for the product. The lengthier the channel and the more links in the channel chain the more costs are added to the product!
Designing the Distribution Channel
There are factors to consider when deciding upon the best method of distribution for your product. We must consider the nature and characteristics of our product, the buying habits and patterns of the consumer, the frequency of purchases and the amount spent.

Product characteristics
The nature and characteristics of the product will necessitate certain services offered by an intermediary. Is the product bulky, standardized or understandardized, does it require technical knowledge or increased service, or it is perishable or not? Some of these characteristics will require storage or salespeople who will be able to demonstrate, answer technical questions and sell the product. If your product is ice cream, it will require refrigeration in transit to the local retailer.

If your product is expensive (a large ticket item) then you may need a distribution channel which has the capability of offering financing for its purchase. Some wholesalers will offer advertising and promotion services because they know what the retailer needs and what the consumer wants.

Your business characteristics
The size of your company or business and its financial position will indicate whether you can handle your our distribution. How many products are you selling and are you capable of maintaining your own truck fleet to distribute the products to the retailer? If you can, then you will have little reliance on others to move your product.

Types of Distribution
  • Intensive Distribution - If you have a product which is inexpensive, may be considered a staple or a necessity, then you may want to have Intensive Distribution where it would be available in as many outlets as possible, like razor blades or batteries. They are almost everywhere you can think of.
  • Exclusive Distribution - Are you a designer of evening gowns? Maybe you would want to have your gowns sold exclusively -- in only one outlet in a certain area.
  • Selective Distribution - Perhaps you have a quality product and would want to sell it "Wherever quality products are sold". More than exclusive but not intensive.
Salesforce Distribution
Depending upon the kind and nature of your business, you may consider using your own salesforce. However, management of a salesforce has associated problems and considerations:
  • Personnel Management. You have to define the profile for selecting and hiring individuals for your sales team. You have to train them, assign them to regions or accounts, and your have to motivate them and hold their hands for them to sell. Once they sell something you have to pay them. How much will you pay them.
  • Evaluation of Personal Performance. What criteria will you use to evaluate their performance: sales volume, gross margins on product SOLD, call rate, average order size, or orders received vis-a-vis calls made.