Keep those receipts!
We’ve got to explain to our persnickety accountant what we spent, and why.
But will we be able to tell him what we’re going to spend next month, and why?
That’s impossible to predict, right?
Sure we can. For the firm as a whole, anyway.
Unless our business or our strategic direction changes dramatically, the firm spends remarkably similar amounts month to month.
So it’s not really that hard to predict for future months, and the fiscal year as a whole.
Let’s look at the last of the three components of our profitability forecasting tool.
Expenses.
Overhead expenses, if you like, but keep in mind that Overhead also includes Indirect Labor, while we just want to focus here on the firm’s non-labor expenses.
Forecasting expenses is very similar to forecasting Labor Expense, which we covered last week. We merely identify all of the expense line items needed to support and run the business (also referred to as “accounts”), or better yet, get them from our Income Statement. The Income Statement likely assigns each of them an account number, also.
Past income statements will give us a very good indication of our typical past monthly expenditures for each line item. What we will do now is estimate what they will be for the coming months, based on recent past history.
I like to group all of those many expense line items, or accounts, into the following groups, though you can use any method of grouping you wish, or none at all:
- Staff Benefits expense
- Occupancy expense
- Promotional expense
- Insurance & Taxes
- Miscellaneous
Just be sure to include every category of expense being incurred by the firm.
What we are striving for is something like this for each category of expense:
I’ve only shown the first 2 expense categories for simplicity. Now, complete all of your expense categories, and populate for all 12 months of the fiscal year. Total each month for all line items.
Now, you can easily explain what all those expenses were for, and even what they will be in the future!
And, as with our Fees and our Labor, we’ll get another chance every month to update our predictions. And if we see changes coming, we can simply adjust the monthly expense predictions accordingly.
Now that we’ve seen how we can forecast the first three items of our basic profitability formula, we’ll next look at how to bring them all together.
This will achieve our goal of predicting profitability before it happens, as we discussed in Solving the Profit Riddle.
Our accountant will be very impressed with our clairvoyance.