DV August 2004• www.dv.com

Keeping Budgets Under Control
Frank Capria and Terence Curren

Successful companies approach their budgets as strategic tools. Budgets illuminate trends and help determine where to allocate more resources and where to cut back in order to maximize profits. Every company should have a general budget drawn up annually and tracked periodically. Each project, in turn, should have its own budget that goes into greater detail and is tracked more frequently.

For all of the formulas, tables, and back-of-the-envelope calculations that lenders, accountants, and the IRS expect us to generate, it all boils down to one, simple equation: Profit = Total Revenue - Total Cost. Every figure we calculate, estimate, predict, and guess somehow ends up feeding that right side of that equation. That is the essence of the budgeting process.

Download the spreadsheet for this article by clicking here (.zip file).

Opportunity costs and profits

The budgeting process typically begins by determining a target profit. How much does the business have to make? The first step is to determine the opportunity costs for running the business. How much would you make in your next best alternative business?

A good example is a videographer who opens shop after working for a local production company for the past few years. Had he remained with the company, he would have made $65,000 for the year. To get his business up and running, he invested $40,000 of his own savings for equipment and other assorted startup costs.

Let's assume that everything he's purchased will depreciate by 15 percent annually. We will also assume he kept the $40,000 invested and that he expected a 5 percent return for the year. The opportunity cost for the videographer's first year in business is $65,000-$73,000 in salary, plus $2,000 in lost investment revenue and $6,000 in depreciation costs. Because he can recoup $34,000 by selling the equipment purchased, that amount is not figured in the opportunity cost calculations (see the image on the following page).

Opportunity costs determine whether or not a business will be profitable. A normal profit is where profit equals opportunity cost.

Opportunity costs are important in figuring out whether or not the business is profitable to the owners. If our videographer's business makes $60,000, it will show an accounting profit on the books, but it will make no economic profit. Economic profit is the accounting profit minus the opportunity cost. A normal profit is where profit equals opportunity cost. Over the long run, free markets tend toward firms making normal profits.

The takeaway from our opportunity cost calculations is that if your business can't cover its owner's opportunity costs, you should be in another business. The opportunity cost calculation is a good place to start when you're setting a target profit. Opportunity costs for existing businesses and individual projects can be calculated as well.

The misery index is another important, though less formal, part of the calculation. How much happier will you be working for yourself, or what's the value of leaving a situation that you may not be happy with? There is no clear-cut equation here, but it certainly weighs into any consideration of what business to go into.

The cost side

There are two categories of costs-fixed costs and variable costs. Fixed costs are costs that are constant throughout the budget period, and are normally referred to as overhead. This includes rent, utilities, loan payments, and other contractual obligations. Some salaries may be considered fixed costs. Variable costs are the additional costs, such as equipment rentals, tape stock, project contract employees, associated with generating revenue. Overtime is usually a variable cost.

It's important to separate fixed costs and variable costs for several reasons. From a budgeting point of view, fixed costs land in the business's annual budget, while variable costs are recorded in project budgets. Many small business owners don't account for their own salaries in budgets, reasoning that they are paid out of the profits. Technically this may be true, but it's important to account for expected income in the budgets.

At the very least, the entrepreneur should budget herself at what she could get as a salary on the open market. This makes the budgets and balance sheets reflect the true costs of doing business. If the business doesn't succeed, you will be doubly disappointed if you never earned any money. Factor in your salary, but make it a permanent fixture and strive to fulfill it. This can be applied as both a smaller fixed salary plus an additional per-job amount, which will be easier for your company to absorb.

When budgeting at the project level, account for fixed costs based on the percentage of companywide resources the project is utilizing. If a project is using half of the business's available fixed resources for three months, the project should cover 12.5 percent of fixed costs-one-half of the fixed costs over one quarter of the year. With some not-too-advanced Excel work, this is a relatively easy calculation to make. I store all of my budgets in a single workbook, and dedicate one worksheet for the company budget and one worksheet for each project.

A bargain at $99, the BoilerPlate template for Microsoft Excel is useful for large productions. It's also very flexible for storing tax and payroll information for multiple locations.

Another approach for calculating fixed-cost contributions is to calculate the percentage of total costs that are fixed costs over a certain period, and simply add that percentage to the total variable costs in a given project. Provided the period represents a good sampling of the overall business, this can be a remarkably accurate method. Many production companies use this method and strive to keep overhead costs in the 10 to 15 percent range.

Fixed and variable costs also factor in the decision whether to take on unprofitable projects. If a project covers its variable costs, makes some contribution to fixed costs, and a more profitable project is not available, then it's worth taking on the project. If a project can't cover its variable costs, it's actually better to pass, unless there is some overwhelming reason to take on the project, such as its value as a marketing tool. Unfortunately, many small facilities overrate the marketing value of these money losers and drive themselves out of business before realizing any long-term benefit.

Many of us have encountered a client who offers a small amount of money for a manageable job, along with the promise of future business. Numerous hours of hard work and months after the project is completed, the client has yet to pay. Trying to evaluate the goodwill factor on a project that may not make any money is a chal-lenging part of the business. The trick is in judging who will be successful and loyal.

Where to begin

Start by pulling everything out of last year's file-past invoices, bids, previous budgets, and estimates. Don't forget bids and estimates that have been submitted to you by vendors and subcontractors. Next, begin matching estimates to statements of work and final invoices. List the discrepancies much like an accountant might-items that cost you more than expected in one column, items that cost you about what you'd expect in another, and line items that turned out more profitable than expected in a third column.

This is a crucial exercise. Even if it appears most jobs make close to the expected profit and the business performs as expected, it's critical for every business to know which are its profitable and unprofitable activities. We tend to know how the big-ticket items score, but miss some of the small things with high profit margins or those items where we take a bath.

By tracking these items individually, you may find ways to boost a section of your business, perhaps even justifying equipment purchases you previously ignored. A good example of a small line item that can add up in the profit department over the long haul is dubbing services. You may charge a premium of two to three times as much for dubs than a dedicated dub house. This can generate sizable income for your company based on equipment that otherwise would be sitting idle, and the client is happy because of the convenience of not mailing tapes to a dub house in Los Angeles or having to deal with security risks such as piracy.

Plotting the budget

It's easiest to work from a template. You can set up your own in Excel from scratch, modify someone else's, or hire someone to build yours. If you're less than comfortable in Excel, hire someone. Budget templates get large quickly, so it's easy to make a costly mistake.

The template does not need to include every possible line item you will ever need. In fact, trying to create the all-inclusive budget template may be counterproductive. A saner approach is to make your template scalable. Assign each line item a 4-digit account code. For example, all script-related costs can be in the 1100 category, producer's unit costs can be in the 1200 category, etc. It's helpful to assign your categories in chronological order: preproduction, production, and postproduction. You can base your codes on the film industry-standard codes or on your company's own system. For a company providing a variety of video-related services, standard film industry codes may be too limiting because there's no place to put DVD authoring, compression, or Web development.

Creating a line item for every type of expense encountered during production can be a time-consuming process. If the production is large, formatting the worksheets, creating printing macros, and designing categorized top sheets to be shared with the client can also take a lot of time.

Fortunately, there are some very good film and video production ready-to-use templates available. One of the best is from BoilerPlate Software (www.boilerplate.net), and with a $99 list price, it's a bargain when you count up the number of hours it saves you. It's as detailed as most users would need, but it's customizable as well. The functionality of the top sheet alone makes it worth the price.

Although the BoilerPlate template is very useful for large productions, it might be a bit cumbersome to wade through for a one-day shoot and two-day edit project. More appropriate for a regular business and budgets are QuickBooks Pro (www.quickbooks.com) and MYOB (www.myob.com). These applications make the budgeting process easier because you've already entered all of your data in your day-to-day bookkeeping. With little work, you can assign all of the items you'd like to various budgets, and QuickBooks Pro and MYOB make it a one-click operation to find out where you're at any time.

A manageable Excel template for a news magazine shoot is available for download by clicking here (.zip file). Before settling on any budget template, run it by a bookkeeper and an accountant. They may have suggestions to make the budget data more compatible with payroll and tax accounting systems.

Don't forget to include contingencies when creating a project budget. Many budgets add a contingency line at the end based on a percentage of the total budget. It's the realization that production is a complex process with many dependencies, and you can't guarantee that something won't go wrong. Clients want a small contingency; vendors prefer the added cushion of a higher contingency. A commonly agreed upon contingency is 10 percent.

Frank Capria created a template in Excel to manage his budgets for smaller projects. You can download this file by clicking here (.zip file).

Be realistic setting these contingencies and know the variables that can add to cost. Is an outdoor shoot in an area known for unpredictable weather? Is the talent on a very tight schedule? Is there political instability or corruption where you are traveling? Are you working with new technology? Have the key members of the team worked together before? Know the union rules: Where does overtime kick in? Where do more substantial penalties hit?

Go over past budgets. Compare initial projects with their outcomes, and see what stories they tell. Every producer has strengths and weaknesses. Some manage production quite well, but are less efficient in post. In that case, a live-to-tape production will need a smaller contingency than a 2-hour documentary. The point is to understand the likelihood of an overage and to come to an agreement with the client on it.

Think about giving a higher overage estimate to postproduction. Most productions rob Peter to pay Paul as they move through the production process. The problem is that by the time projects get to post, they have often used up their entire pad, so the phrase "fix it in post" just brings the problem to an area in which the budget has no leeway left. Taking extra time on the set to get the audio or lighting just right can save an enormous amount of time and money in post.

A few years back, a network reality show ran into major post budgeting problems when, after shooting, they found out that no logos, labels, or icons could be visible in the show. It cost the network a fortune in effects blurring to cover it all up. Needless to say, that was never planned for in the budget.

Who sees what?

Your costs are a trade secret. If they fall into the hands of a shrewd competitor, you're at a severe disadvantage. Although most of us are pretty careful to share only what's necessary with the client, many facility owners make the mistake of sharing sensitive information with employees and contractors. This industry is fluid, and today's trusted employee may be working for the competition tomorrow-or may even be the competition.

Trade secrets are legally protected, but seeking redress from a court or an arbitrator is costly and the results aren't certain. It's your job to run the business and make the financial decisions. Your employees need to know your rates, not your costs. When we were doing research for this article, several business owners declined to talk to us about their budgeting process in any detail. Margins are tight, competition is fierce, and the economy is barely showing signs of awakening. Facility managers realize their cost controls and fiscal planning tools represent a significant portion of their competitive advantage.

For the most part, competitors in a given market share the same variable costs. It's fixed costs such as lease payments and rent that vary the most. Those costs are reflected in overhead. A high overhead line item signals to the competition that you have little room to maneuver with rates. Consider removing overhead as a line item in project budgets. Instead, calculate your overhead and add it to rates directly-especially if your overhead charges exceed 15 percent.

Tracking the beast

In the heat of production, no one likes to take time out to track the budget. It is time-consuming, detail-oriented work, but it must be done. Countless productions have suffered from a rushed postproduction process due to budgeting overages not being discovered sooner. The earlier you know about a budget problem, the more evenly the solution can be spread over the remaining process. Weekly tracking of budgeted versus actual expenses is imperative to smooth operations. Keep fastidious records of all decisions with financial implications. It's easy to forget by Friday that you ordered an extra lighting package on Monday and rented a full-size van instead of a minivan on Tuesday.

Maintain columns for budgeted amount, actual amount spent, and the difference. Total the difference every time the budget is modified. You need immediate feedback on the implications of budget decisions. It's critical to know where you stand in regards to budget on all jobs.

The top sheet of a budget should give an overview of above-the-line and below-the-line costs. Each line can reference its own worksheet in Excel, as BoilerPlate does.

On one of his earliest jobs, Terence worked as a production assistant on a low-budget commercial. The director and the producer performed a location scout of the house where the shoot was going to take place. When they returned, the producer handed Terence a long list of items they needed for the day of the shoot. One item listed was a crow call.

Although Terence originally thought this was a joke, the item came in handy. In the middle of the shoot, the soundman called a halt to production because some crows were making too much noise. The producer had Terence drive a few blocks away to blow on the crow call, which drew the birds away, and the shoot concluded successfully. The astute producer had noticed the birds on the scouting trip. By investing a few dollars from the budget into a crow call, the producer saved the potential cost of calling in the actors for another day of work or renting a studio to pay for a mixer. This is a classic example of how fluid the budgets can be in this line of work. We aren't making widgets with an easily foreseeable cost structure. Production budgets are a living, breathing entity.

Final tally

Too often people focus only on the budget, but those budget numbers may or may not reflect reality. Don't forget to use common sense. The ability to predict future trends in the market with any degree of accuracy is near impossible to include in a budget. In our business alone, the coming world of HD with myriad formats available, presents an equipment purchase nightmare. Draw budgets carefully and keep your eyes open for potential variations that can make or break your plan.

Successful businesses view the budgeting process as a strategic tool, not just a chore. Use budget as a verb, not a noun. Learning where we are becoming more efficient and where we are losing our competitive edge is important for us to continue offering value to clients. It allows us to focus our sales presentations on our strengths as we address our weaknesses.

Budgeting Tips

Budgeting tricks are some of the most closely guarded secrets around, and getting people to talk about them is nearly impossible. But we managed to get a few tips:

Invoice for less money than originally agreed upon.
For example, let's say you quote a client $65,000 based on hard or direct costs at $50,000, but the job gets finished with hard costs at only $44,000, which leaves an extra $6,000 on the table. Bill the client $62,500 instead of the $65,000, showing good faith that if the costs are less, you'll charge less. Because you estimated well and brought things in at good prices, you should share in the underage or additional profit. The key to these business secrets is to share as little budget information as possible with the client while remaining clear in what isn't covered in case of overages.

Bid jobs based on 12-hour days rather than 10-hour days that lead to overtime charges.
Clients are happier paying more up front than being hit up later after a job. It may not work best that way in competitive bids, but it certainly does in noncompetitive bids. Nobody, whether an ad agency or a homeowner, wants a contractor to raise the prices after the deal is made (unless, of course, the deal changes greatly).

Pay vendors immediately.
Write checks on the spot to crew members. The real value in paying regular crew members and vendors quickly is that it builds up goodwill. Goodwill is a currency just like money. If vendors or crew members know you pay within 1 to 10 days, they are far less likely to bill for mileage or that extra 15 minutes. If you have a crew of 10 each at $500 per day, and they don't bill for an extra half hour out of goodwill, that savings adds up. If those 10 guys shave their rates to $400 per day on a thin job, you save $1,000.

Take a small loss so you don't seem petty.
When someone says his driving rate is $0.50 per mile but others commonly agree to $0.35, don't bust his chops about it. When you add up 300 miles driven, the difference is only $45.

Ask out-of-town vendors and crew members for their rates.
If their normal rate is $350 for a 10-hour day, offer them $400. If you have $500 budgeted, you've now made someone you don't know more comfortable because, right off the bat, you've given them a $50 raise (approximately 15 percent).

Be able to slide money from one line item to another.
The clients need to be aware that they are quoted a total amount and aren't holding you to subtotals on each line item or category.

Create as much goodwill as possible.
This makes perfect sense as long as it doesn't cost you too much money. Remember, this is a huge back-scratching business.

Updating Business Plans

Running a business is like taking a long car trip. A budget acts like the fuel gauge, telling you how fast you are burning through resources and allowing you to estimate if you have enough to complete the journey.

Business plans serve as your navigator. As part of your annual budgeting process, review and, if necessary, revise your business plan. Identify both new opportunities and new constraints. What client needs can you meet? Where is competition getting tougher?

So many of us get caught up in the day-to-day operation of our businesses that we fail to notice the ground shifting beneath us. Although the annual budgeting process is an important strategic tool, it's not a substitute for strategic planning. Budgeting quantifies opportunities; business plans qualify them.

Most business owners go through the arduous process of writing a business plan when launching the business. The document gets shared with accountants, bankers, and lawyers. Then it usually gets filed away. Years later, many business owners express surprise about how far their companies have drifted from the original plans. Many of these companies are quite successful, but many miss key opportunities.

Every year, pull out your business plan and revise it as necessary. A good time is during the end of the fiscal year, when you are steeped in financial data. Explore where your business has diverged from the plan in that past year. Determine if you've added a new service or a new class of clients, and what other opportunities those additions present.

Two good books

Two books we consider invaluable are Jeffry Timmons's Business Plans That Work (McGraw-Hill Companies, 2004) and Seth Godin's Free Prize Inside (Portfolio, 2004).

Timmons offers the nuts and bolts of business plan writing. He also serves the needs of existing small to medium-size businesses that are exploring new markets.

Godin has become a hero of ours. All of his books are great, but Free Prize Inside is especially useful to business owners (and employees) looking to jump-start innovation in their companies. Godin shows that reaching new customers and providing new services doesn't require months of expensive research, development, and marketing-it requires a good idea.

Download the spreadsheet for this article by clicking here (.zip file).

Frank Capria is the president of Kingpin Interactive, Inc., a consulting and design firm in Boston. He is a member of the summer master faculty at the International Film and Television Workshops in Rockport, ME, and an adjunct professor at Boston University. Terence Curren is the principal owner of Alpha Dogs (www.alphadogs.tv), a postproduction and design house in Burbank, CA. He is also an instructor of advanced editing techniques at Pasadena Community College.

Copyright 2003, CMP Media LLC