How to Budget for Business

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  • "What should I spend on that new computer?!"
  • "What salary should I give pay the new secretary?!"
  • "What should I invest in that new product?!"

Don't fret; here's one solution:

  1. Define your expected return on the investment.
  2. Divide that return with your current profitability margin.
  3. You now have a budget for the investment! YAY!

Peep Example

If your company has a profitability margin of 25%, an investment should return at least a specific amount so that it won't drain that margin.

That is:

  • Investment's Expected Return / 25% = Budget amount!

YAY!

For instance:

  • A computer that costs $2000 should generate an additional $8000 in sales to maintain your profitability margin.
  • A secretary that costs $50,000 should return an additional $200,000 in sales.
  • A new product that costs $100,000 in R&D should generate at least an additional $400,000 in sales.

And if you suck...

Generating anything less than your current profit margin tells you this:

  1. "We could've used that money to put it in something else!"
  2. "We just left money on the table by throwing good money after bad!"
  3. "We would've made so much more $$$! OH NOES!"

You expect your dollars to at least produce the same return as before; otherwise, you drain $$$ down the tubes by weakening your position.

Say NO! to the Outlandish

Financially unoptimized-sucky-suck business folks think:

  1. "Hey! we have so much new money!"
  2. "Let's spend! Spend! Spend!"
  3. "Let's buy frickin' chairs for $1,000 each!"

Would that chair return $4,000+ compared to a cheaper one?

It might make you and your team feel a little more comfortable; and, if you're working with big purchases, it might just be worth it.

But for most folks, spending $1000 on a chair = bad!

Remember:

  1. Invest your dollars according to expected returns.
  2. Invest your dollars according to expected returns.
  3. Invest your dollars according to expected returns.
  4. Invest your dollars according to expected returns.
  5. Invest your dollars according to expected returns.

If you haven't defined an expected return before you make a purchase, sense TROUBLE!! OH NOES!!

The Good Model

Before you spend chunks of cash on something, ask yourself:

  1. What's the potential return I see on the investment? (>90% confidence)
  2. Budget accordingly (i.e., Multiply the potential return by your profitability margin %).

You'll see yourself budgeting where your dollars can achieve the most bang for your buck.

Some More Examples

Here's one:

  1. "I expect an additional $5,000 return on an upgraded computer."
  2. "So, I should spend no more than $1250 on a new computer."

Or another sex-ay one:

  1. "I expect an additional $100,000 return on a new assistant."
  2. "So, I should spend no more than $25,000 on the assistant's new salary."

Or one more:

  1. "I expect an additional $40,000 return on a new software system."
  2. "So, I should spend no more than $10,000 on the software system."

Freakish win.

And:

"What if I don't return what I expected?!!!!!"

  1. Slap yourself.
  2. Tell yourself: "It's okay!"
  3. Then, repeat: "I will not make the same mistake by investing that much in that piece of @^^% again! FREAK."

You'll gradually make smarter and smarter investment decisions until you're like super smart. Hooray for you.

For every item your company buys for the rest of eternity:

Budget based on expected return.

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Posted on July 02

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