Episode 13 RYOB: Financial management and budgeting - Part 2/2

In this episode we will take a look at key figures and how they can help you in your financial management running your own business.

Working with key figures

Key figures are one of the concepts I at first did not understand at all and when the coin dropped, they became a central part of my work. Key figures are simple adjustment points that you select in order to be able to follow and make adjustments to your company's development over time and with greater accuracy than by only looking at the annual return. Key figures are often adjusted monthly, but you can choose other intervals too.

The main thing is that you need to choose a regular interval and then continuously take measurements for each adjustment. In this way, you will be able to learn to see variations over the year and see trends in your company's development, for example is it going steadily upwards or is it a temporary peak? Has it turned down financially without you noticing it because you are busy with other things and still get no time left over or give too many discounts so that even if you sell a lot you still get less results? The key figures are the entrepreneur’s beacons to navigate by.

Examples of key figures

Which key figures you choose depends on what you think is relevant to measure. This differs from business to business, depending on the type of product and industry. To give you a better idea, we will run through the example of a coaching business. You can use this example and apply this thinking to your own company, while keeping in mind the particularities of your product and industry.

Hourly rate, number of clients, hourly income, hourly cost

The usual key figures for consultants and coaches are chargeable time, meaning what percentage of your total working time is actually charged by an invoice. This is calculated easily by dividing the number of total hours worked per month by the number of hours you actually invoiced during the same period. Set a goal for how much it should be and regularly check if you meet it. Comparative figures can be, for example, ICF's global coaching study from 2015, where external coaches say that they spend 38% of their working time on actual coaching, which is usually the time you as a coach can invoice. This would mean that to reach the average, you must have 38% chargeable time. 

Many choose other key figures such as the number of clients or hourly income. The latter is calculated by summing month by month what has been invoiced in total and then dividing it by the total number of hours worked. This will show you how much you actually bring into your company per hour. This is a useful exercise that will help you maintain your price levels. Your hourly wage is not the hourly rate you invoice but the hourly rate you have per hour worked.

The cost per hour worked is another indicator you can use for making adjustments to your financial planning, which some people think helps in decisions about long-term cost changes. It can help you answer questions such as “what difference does it make if I take the more expensive office?” You sum up your costs for the period and divide them by the number of hours worked.

Turnover, costs, and profit

Earnings and sales are two of the most common key figures used by entrepreneurs and freelancers. You probably know them best from all the other figures. Turnover is usually the equivalent of the total sales - all money that comes in your company. The profit is calculated by subtracting all the costs from the turnover.

Operating margin

The operating margin is a key figure that is often used when comparing different industries. It is also used to determine the change in profitability over time when new pricing, services and working methods are introduced. The easiest way to calculate your operating margin is by dividing the profit by sales. The resulting percentage is your operating margin. For example, if you have a profit of  $1000 and a turnover of $10.000, you have an operating margin of 10%.

You choose which key figures you use, how often you look at them and what you use them for. They are your gauge points and the main rule is that they should be easy to understand and measure, and give you the information you need to be able to make the right financial decisions. 

A few concluding words

As you can see, we have not talked about accounting here at all - because that is a different thing. Accounting is the practical presentation of the company's figures. Financial management is on another level. This is where you make the financial decisions about what to do with those incomes and expenses that your accounting shows. See it as the two different tasks they are. Many choose to hire an accountant. That can be wise. However, financial management is part of the management of the company. That's your job as a freelancer or entrepreneur. It's worth learning, perfecting, and keeping under your control.

See it as looking in your wallet before you shop. In good times, it is wise to calculate how much you can spend without having too much of the month left until you get your salary. In tough times, it is good to know that the money in your wallet is enough for what you now pick up before you stand at the checkout and have to pay. In the same way, financial management is your way of taking control of the cash flow in your company. Control it wisely and it will make your freelancer or entrepreneur experience more fun.

Episode 12 RYOB: Financial management and budgeting - Part 1/2

Your path to control and self-determination

So far in this series we talked about the process of starting a company, how to structure and share your work with others, and how to find customers. Now we come to the part where we talk about the source of power: self-employment, and financial management and budgeting. I know many people tend to feel a little dismissive of that hassle of money, but believe me, it's worth embracing it wholeheartedly. This is where you have the control functions and power over your workday. Control your finances instead of letting it control you. It will be so much easier and so much more fun!

There are many words that are unfamiliar to those of us who are not economists. We have not acquired the technical language and it is easy to miss out on important details. But as a freelancer or entrepreneur, to run your own company, you don’t need to be an economist. This is why in this episode we will go through the basic tools that you need to have to gain a good understanding and control of your finances and company.

Budgeting

Let's start with the framework: your budget. The first budget made in a company is often the start-up capital budget and a first profit budget. As a first definition, budgeting refers to writing down in advance the expected numbers for an event or period in your business. You can do this in ready-made templates (in Sweden you can use the templates from Almi or in Nyföretagarcentrum's business plan, which can be downloaded free of charge from the respective website), or you can write on a napkin. The form is not the important thing here. The content is what truly matters. 

Now, with all that being said, in the beginning it might nonetheless be wise to use a template. This will give you some guidance, as well as offer you more credibility in case you apply for a loan or funding. Bear in mind though, that many details of what a budget needs to include is still up to you to figure out yourself. This is where you will exercise your freelancer or entrepreneur analytical skills and creativity.

Start-up capital budget

The start-up capital budget is written in the early stages, when you plan to open your company. In simple terms, a start-up capital budget is an enumeration of the costs incurred by starting up the company, together with a description of where that money will come from. 

Visually it can look similar to two columns with numbers: expenses and available funds (including loans you may need to obtain to get started). To be able to start, the assets must be equal to or greater than the expenses. You probably recognize this principle - not at all more complex than simple household finances.

Budgeting for new ideas

When you are running your business and want to make new investments, you make a similar setup for this particular idea, an investment budget. In the same way, you write down all the costs associated with building this new product and then you look at what resources you have. Are they enough or do you need to borrow/save? This is the mindset that you as a freelancer or entrepreneur need to adopt to make wise decisions about new ideas.

Performance budget

To then assess whether this is a good idea, you also need a performance budget. In the profit budget, you write down your expected sales and under it all the minus items - meaning all the costs you can see that the company will have during that same period. The usual time frame for this is one year.

Start by making as accurate an estimate as possible of how much you realistically think you will actually be able to sell, the market contact you have, and the number of hours you have at your disposal. Sometimes it's nice to budget for two years: in the first year you will probably still work on getting clients, and then the second year will reflect how your by-then already setup business will run. Other entrepreneurs and freelancers work with alternative scenarios: a pessimistic, a probable, and a successful budget - you can try this as well.

Adjust your expectations about time

Never count on doing 40 hours a week of salesperson/marketing/performance work. It takes time to run a business. You have to take care of administration, market yourself, network, further train yourself, clean the office and so on. As a freelancer or entrepreneur you cannot put all your time into selling your product.

Think about costs

After you figured out what your expected turnover is, it’s time to look at the expected costs - from small to large. Try to include everything from paper clips to monthly rents. The clearer you are at this stage, the more accurate your budget will be. Budget templates come in handy here because they list the most common expenses a company has. Those suggestions will be a good starting point.

Calculating the profit

From then on it's simple math. Income minus expenses gives you a total. This will be the profit on your work. If you have a sole proprietorship, a simple rule of thumb in Sweden is that half here goes to you, half to the tax office. If you have a joint-stock company, you should also count in the salary and employer's contribution among the costs; any surplus from there is the company's profit. Check the laws and taxes in the country where you are running your company to make sure your calculations match.

Performance budget

Use your expected profit to create a performance budget.The performance budget refers to predictions you make about what you can/cannot afford in the future based on your expected profit. For example: “If my profit will be $10.000, I will be able to invest half of that into developing a new product and the rest of the money I will divide between marketing and savings. However, if my profit will be $5000, my salary will shrink by 10% and I will invest the profit into marketing.”

During the year, you should regularly check on your budget and make budget adjustments. Put your plan side by side with your actual balance sheet and see how close to the truth you came up with your guesses. Maybe you are selling more than expected. Then you can think about whether you want to invest in new office gadgets, developing a new product, or taking a higher salary. If you sell less than expected, the earlier you realize this, the easier it will be to decide what to do and how to cope with that: increase the marketing efforts, or reduce some costs?

You are the one at the helm of your company. The budget and budget adjustments help you predict the future and make conscious proactive decisions instead of being reactive. Budgeting gives you the opportunity to choose, based on your context and resources, how and when to invest and see what is required for you to be able to afford to do what you want.

Set time aside for an annual budget

At least once a year you should sit down and make a new annual budget. As the years go by, it will go faster and faster. Then you can probably copy over last year's figures and then focus on what you want to change. But take your time and do the job. Should sales be at the same level? Have you lost or gained a large customer who can be expected to bring your numbers to the next level? 

If you invest in education and set aside time for a longer education process, the income will probably fall that year, you will not have time for as many customers, while the expenses will increase for travel, literature and course fees. What happens to your salary then? Is it worth it? Take the time to think about these issues. Choose where you want to invest your money this year and write your budget like that. 

You decide. Then it's also up to you to deliver. The fun of budget work in working as a freelancer or entrepreneur is the direct feedback it gives on your own efforts.

In the next part of this episode on financial management and budgeting we talk about working with key figures.