RETAIL BUDGETING PROCESS
This is a step-by-step outline to the retail budgeting process
You will learn about:
- Retail Budgeting Steps
- Importance of Budgeting & Planning
- Retail Budgeting Missteps
- Mastering Retail Budgeting
Here we will talk about retail budgeting process & the importance of planning
We will be covering in details :
- Retail Budgeting Process
- Importance of Budgeting
INTRODUCTION TO RETAIL BUDGETING
Retail budgeting process is a multi-step activity done on a yearly basis to plan for one year ahead. The ultimate goal when you budget for a retail store is to generate a realistic final P&L budget for the business that lays out the expected revenues and costs associated with the business, and the final net profit figure for next year.
It is also an essential step to perform before starting a retail business to check the feasibility of your operations before committing or investing in it.
Read Also: New Store Financial Projections
As we go through the process you will get to know why this activity is so important and why mastering it makes a big difference.
Retail Budgeting Importance
The budgeting process is a key planning activity for any business, and should be mastered by the manager in order to avoid any discrepancies or surprises throughout the year.
Having an accurate sales budget will lead to having an accurate retail buying budget (OTB) and this is very important to avoid overstock or under-stock issues.
Read More: Open to Buy: The Complete Guide
Besides its importance to plan for buying merchandise in proper quantities, the retail budgeting process will generate an estimate about the costs associated with the business and the revenue needed to cover these costs to end the year profitably.
A business could be able to generate good sales, but the costs associated with running this business could keep branching out to the extent that they are no longer covered by the sales, which would make the business non-viable.
That’s why before starting the year all the revenue streams should be listed and forecasted and all the cost lines should be planned in advance and adhered to throughout the year
Steps of The Retail Budgeting Process
- Step 1: Sales Budgeting
- Step 2: Cost Budgeting
- Step 3: P&L Budgeting
In this chapter we will cover the first step in the retail budgeting process
We will be covering in details :
- Sales Budgeting
- Growth Estimation
STEP 1: SALES BUDGETING
Sales budgeting is the first step in the retail budgeting process and is the most important step.
As you will see later on, all the other budget lines will be dependent on the sales budget in the first place, so failing to forecast a realistic sales budget can result in loss for the business, as costs will not be in sync with the actual sales generated that year.
In order to master the sales budgeting step, the manager needs to be well rounded and takes into consideration all the external & internal factors that might affect sales for that given year.
Having this particular knowledge and experience will allow him/her to make a realistic forecast for next year.
It is very important to be realistic in your sales budget because your buying budget will be determined based on this forecast, and rectifying this in the future will not be an easy process. When you start planing your Open to Buy in Excel sheet or in an OTB calculator, you will need your upcoming sales data. If this sales data is wrong or unrealistic, it will result in wrong purchasing and this will again affect the sales and margins for that period.
Sales will be budgeted as a function of growth or de-growth percentage on sales from last year. For example, you could project that next year the business will grow by 3% on last year’s performance, or vice versa. This growth/de-growth percentage will then be applied to this year’s sales data and the new budget is formed.
When the business has no reference from previous year, other methods are used to determine a benchmark for sales for the first year in business. (We explain this in details in the Sales Budgeting Blueprint – see below)
Included in the sales budgeting step will also be the margin budgeting.
At what margin are you going to deliver those sales? This will depend on the cost of goods sold as well as the number of events (promotions) you will be running throughout the year to meet your sales targets and will be drafted in your marketing calendar for that year. The more discount/promotions the less will be your margin.
Determining the margin is as important as estimating the sales, because it is the gross profit that pays the bills, not the revenue itself. it makes the biggest difference on your profitability if you deliver 100,000$ at 55% margin vs 100,000$ at 40% margin.
Furthermore, the gross margin determines the cost of goods sold (COGS), which will determine the purchasing budget.
Read More: Gross Margin Types
Once you have estimated your sales forecast/budget and your margin %, you will be able to calculate your gross profit by multiplying your sales by the margin %.
For example if your sales are 100,000$ at a 45% margin
Gross Profit = Sales x Gross Margin (%)
Gross Profit= 100,000 $ x 0.45 = 45,000 $
SALES BUDGETING BLUEPRINT
Our sales budgeting blueprint explains the step-by-step process of budgeting sales & margins for a retail or ecommerce business. It is available in our members area
In this chapter we will cover the second step in the retail budgeting process
We will be covering in details :
- Cost Budgeting
- Cost Lines
STEP 2: COST BUDGETING
After you have determined the estimated revenue & gross profit for next year through your sales budgeting process, you will start to determine your operating cost budget.
Ideally you want to keep your costs at the lowest level, but at the same time not too low, that it starts hurting your operations or customer experience.
You will find, year after year, that your costs could be optimized by tweaking something here and there or negotiating a better deal with one or more of your vendors.
Cost budgeting will include different lines summarized as below:
- Selling & Promotion
- Admin Expenses
It is obvious now, why sales budgeting has to be the first step. Basically because the cost budgeting will be affected by it.
Usually costs like manpower (staffing) and marketing & advertising are determined as percentage of sales (see benchmarks below). This serves as a guideline to determine whether or not you are overspending on staffing or marketing, but in some cases you might find that reducing the manpower below a certain level will start affecting your sales, so treat the % benchmark as a guide only.
Rent will be pretty much fixed, with annual increments depending on the rent agreement, but in case of falling sales figures on last year, you might find that you will need to start negotiating your rents with the landlords or considering your options for the particular stores with declining sales.
You might find that your sales are not supporting that big size of a store, and the best way forward is to downsize the area either by giving back some space to the landlord/mall or by relocating to a different, smaller store.
That’s why we recommended in our guide to Starting a Retail Business to always make sure you have an exit clause in your lease.
Read Also: How to Rent a Retail Space?
Selling & Promotion Expenses
Selling & promotion expenses include:
- Marketing Communication
- Credit Card Fees
- Loyalty Program Points
- Shopping Bags
- Other S&P Expenses
Admin expenses include:
- Licenses and Govt. Fees
- Phone & Internet
- Professional Services
- Other Admin Expenses
Retail Cost Budgeting Benchmarks
For reference, these are common benchmarks for a retail business’s cost budget. they are listed as percentage of revenue (sales)
- Store Rent: 10-12% of sales
- Store Employees: 10-15% of sales
- Selling & Promotion: 3-5% of sales
- Admin Expenses: 4-5% of sales
In this chapter we discuss the final step in the retail budgeting process
We will cover:
- P&L Budgeting
- P&L Definition
STEP 3: P&L BUDGETING
The final step in the retail budgeting process is the P&L budgeting, and it is dependent on the previous two steps.
P&L stands for profit & loss, and this statement is also referred to as income statement.
Read all about P&L in our complete guide on P&L Management
Revenue & Gross Profit
At the top of your P&L budget will be your revenue, and we have determined this in Step 1. Together with the cost of goods sold (also determined in step 1) this will give you the gross profit budget.
You will then subtract your operating expenses (determined in step 2) & depreciation from your gross profit (determined in step 1) and you will get the operating income. (here it is store EBIDTA and is calculated automatically in the sheet once you enter all expense lines)
However; this is not your final net income for the business. To determine the net income you will then subtract the other non-operating expenses, which include taxes & interests.
The final figure will then be the Net Profit of your business. This is the main figure of this entire budgeting process and your aim is to maximize this figure year after year.
Note: You will find that in the sheet we used Store Net Profit and Net Profit. Also EBITDA here is store level EBIDTA and not full business.
This is the case when you are running a business with multiple stores and this business is supported by common support functions out of the stores (such as warehouse and office teams).
You will separate the common office & warehouse costs from the store operating costs and then allocate them at the end to each store proportionally.
This is useful in judging whether a store operation by itself is unprofitable or is it profitable on store level but with the common costs it is generating loss.
This separation allows you to make better decision on store openings and closures.
CONNECT THE DOTS
We packed together everything you will need to create a financial & inventory plan, including demo data to practice on.
*Available for Premium Plus members
In this chapter we will discuss considerations linked to creating a retail budget
We will be covering in details :
- Retail Budgeting Mistakes
- Mastering The Process
RETAIL BUDGETING MISSTEPS
Below we will list common mistakes that happen in the budgeting process and how they can affect the business.
Budgeting High Sales
Some managers get too optimistic or fail to properly assess the market condition around them and budget a very high growth in sales on the current year.
Besides this leading to high inventory buying, that the business will be busy clearing throughout the year, it will also result in false cost budgeting for other operating expenses, which will exacerbate the losses at the end of the year.
Budgeting Low Sales
That will not affect the costs as they would have been reduced and probably leading to long term efficiencies. However, this will result in less buying and missing the opportunity of making more sales.
Budgeting Inaccurate Margins
It is very important to budget the margins accurately, because, at the end of the day, it is the margins that actually pay the bills.
Usually budgeting wrong margins is a result of not knowing the costs of merchandise properly, the realistic price points for this merchandise to sell successfully, or not planning for the required marketing promotions and events to deliver the targeted sales budget.
In many cases, the manager finds that the sales budget has been put too high, so he starts running frequent promotions to try and catch up on those numbers. This not only affects the current year’s margins, but could also affect the margins for years to come.
MASTERING RETAIL BUDGETING
In order to master the retail budgeting process it will take some time & experience in the market to be able to accurately forecast next year’s figures and get used to the process.
A good practice is to re-visit your budget at different intervals throughout the year (e.g every quarter) and start adjusting your forecast for the remaining months based on the current sales trend and recent developments in the market. It will not affect your current budget, as it is final, but it is a good practice that will help you understand the cause & effect of certain circumstances and market conditions.
We have also found it very helpful to maintain a “Notes” diary or field in your budget excel file, that links exceptional sales figures (too high sales or too low sales) throughout the year to the specific events that lead to such exceptional behavior. This way you will be able to normalize those figures for next year’s budget if such events are to be absent, and know what to expect if such events are to happen again.
Our tools & guide are designed to make your planning & budgeting easier
How they can help?
- Sales Budgeting Blueprint
- Pricing Blueprint
- Higher Profits Blueprint
- Planning Markdown Levels
- Buying Budget Calculation
- Profit Projection
- Cash Projection
Now that you have acquired the basic knowledge to start budgeting & planning for your retail or ecommerce business, it is time to put this knowledge into practice. Our membership plans take you to the next level of learning and implementation.
We have created interdependent tools & guides that take you through the entire financial planning process for your retail or e-commerce business.
In one place you will learn how to:
- Set a retail sales budget
- Set the right prices for each category
- Plan your initial margins based on your markdowns
- Calculate your buying budget by product department/category (online or Excel)
- Plan your entire P&L and project profits in advance
- Plan your cash flow and project cash on hand in advance
- Connect your cash forecast to your buying plan
- Improve profits by making simple tried & tested tweaks.