If you’ve not set a budget for your agency before, or if you have but you want to check that it’s actually going to help your agency successfully grow, then this post is aimed at you.
Hopefully, as you’re reading this post, you’re already aware of the benefits of having a budget but if not, take a look at our blog ‘Why every business needs a budget’.
Building a budget is like building a three-dimensional Sudoku puzzle, there are so many moving parts that all need to fit together for it to make sense. In this blog, we have focused on building a profit and loss budget but it is also important to budget for your balance sheet and cash flow. We’ll look at those in one of the future articles in our budget series.
The starting point for your budget is where you are right now
The best place to start is to look at your actual financial performance so far. We have seen many agency owners jump ahead to creating a budget for their business without knowing how their business is doing now. This is normally because their accounting records are either not up-to-date, not accurate or not accessible to them.
So step one is actually to get a handle on your current financial position. For us that means moving the records to Xero if they are not already on there, bringing the numbers up-to-date, and doing a detailed review of the balance sheet and profit and loss account to make sure everything has been accounted for correctly.
When we are comfortable with the integrity of your numbers we can start to pull out some useful information.
Bottom-up and Top-down budgeting
We look at your plans from two directions, bottom-up’ and ‘top-down’. Bottom-up involves starting at the lowest level of detail and building the budget up. The Top-down approach instead looks at your longer-term plan (ideally 3 years) for your agency and considers what you need to deliver in the next year to be on track to achieve that.
This means working through the profit and loss account line-by-line and creating a forecast for each fee and cost type. If needed this can be broken down further so that the budget is built up by team or division and then added together to come to the overall budget.
We then check that the budget fits with your agencies longer-term goals and through a process of review and discussion with the agency owners we bring the bottom-up and top-down forecast in line with each other.
Building the budget line-by-line
The easiest costs to forecast are your fixed costs so we start with those. These are costs that generally don’t vary with the level of fees you make or the number of staff you have. They include things like rent, rates, software costs.
These types of costs typically only increase in steps so, for example, rent stays the same from month-to-month until you need to move to a larger office at which point it will increase.
We initially make the assumption that fixed costs will carry on at the current level increasing only with inflation. Any known changes to these costs should be factored in, for example, rates increases are usually known about in advance and can be incorporated into the budget.
People related costs will be a key cost for your agency so are important to get right. Happily, it is not hard to budget for staff costs if you know how to do it.
The starting point is to have a hiring plan, this should be phased by month and include the level of the person being hired. Knowing the phasing is important as it will make a big difference to your staff cost budget. For example, hiring a director at £50k in the first month of the year will add £50k to your salary budget for the year whereas hiring them in the last month of the year will just add a little over £4k for the year.
We recommend that you have salary bands for your staff based on their level (e.g. Associate, Director etc). As well as salary costs, remember to also factor in other payroll costs such as workplace pension costs and Employers National Insurance.
Working out your direct staff costs is then just a case of multiplying your headcount by staff costs for each band of staff. If you want to be really sophisticated you can also factor in staff utilisation rates to your budget which is useful if you think it is likely to change over the next year.
Other headcount-related costs
Other headcount driven costs to consider include staff training, entertaining costs and recruitment fees. Recruitment fees can be substantial. As well as budgeting for new hires you should also factor in the cost of replacing any people that might leave in the year.
Cost of Sales
You can work out your cost of sales budget by applying your gross profit margin % to your expected fees each month. Your gross profit margin is the average profit made on delivering services.
It is worth thinking about whether there are any factors that might affect your gross profit margin over the coming year. For example, you may anticipate doing more work with a particular type of client where you know you can achieve a higher gross profit margin. Alternatively, you may be focused on growing your retainer income which may have a different gross profit margin to the ad hoc project work your agency does.
Forecasting fees can feel like more of a finger in the air job than an exact science but there are a few tricks you can use that will help get you to the right number.
Past growth rates can be a good starting point, that is, unless, you know of a particular reason why future fee growth will be different, such as a planned investment in marketing or hiring on new staff meaning your agency can take on more work.
The more granular you can be with your fee income forecast, for example by client type or by service type, the more meaningful it will be.
Consider whether you doing anything new to generate growth, for example investing in marketing or hiring a new sales-person. Any planned fee increases (or decreases) should also be factored in at this point too.
It is worth factoring any seasonality in your fee income into your budget otherwise as you move through the year it becomes difficult to see if you are on track to meet your year-end fee budget.
When your fee budget it ready it is worth circling back to your headcount numbers. There are a couple of metrics that are useful to help you sense check both your fee income budget and hiring plan. The first is the fee per head ratio and the other is staff costs divided by fee income. How does your budget compare to your most recent actuals for these metrics? If it is very different then perhaps you need to amend your headcount or fee assumptions or both.
Now it is time to think about any additional investments you need to make in the business (over and above an increase in headcount) and how these are going to affect the budget. It is easiest to start off by factoring in any costs that you already know you are going to incur such as new computers or servers just to carry on trading as you are.
Investments are not limited to things like buying new computers but can include things like a marketing budget (which should be backed up by a marketing plan), a training budget and any significant IT and software spend.
These investments should be linked to the goals you have set for your agency in your 3-year plan. With this already mapped out, it is easier to see what needs to be spent and how much.
Sense check your budget
Now you have the first iteration of your budget it is a good idea to circle back and compare your budgeted profit and loss with your most recent actual numbers to see if this throws up any anomalies.
Review metrics such as gross profit margin, net profit margin, fees per head, salaries as a percentage of fees, sales and profit growth rates and the number of clients per head and ask if these all stack up with how your agency is performing now. If any of these metrics have moved significantly it is important to understand why that is and if any of the budget assumptions need to be revised.
Finally, consider how the budget fits into your overall 3-year plan for your agency. For example, if you are looking to grow fees from £500k last year to £1m in 3 years then this year budget needs to fit with that. If it does not stack up then both the 3-year plan for the agency and the budget should be reviewed and iteratively updated until they both fit together. This review process can highlight where additional investment is needed in the business or alternatively where the 3-year plan needs to be revised.