Before you even consider starting your own engineering practice, you have to have some idea of how much it's going to cost for you to run the business --- never mind trying to make a profit. One of the first things you have to do is to prepare a budget.
A budget is nothing more than a financial plan. It's something you need to do to help you to stay out of trouble, and to help you to provide for contingencies when financial trouble hits --- and it will.
Here is a basic list of accounts for a financial plan:
• Gross Revenue Gross receipts --- actual amount of cash and checks received.
• Billed Expenses Expenses billed to clients will be part of the gross receipts and must be subtracted from income. The fees charged by laboratories, outside consultants, or job-shoppers used on projects should be included in this category, as they are expenses billed to clients and not income attributable to your labor.
• Net Revenue Gross Revenue less Billed Expenses yields Net Revenue, the gross income derived from your client labor.
• Client Labor Total sum of salary by you and/or your employees attributed to billable hours. Note that the ratio of Net Revenue to Client Labor is the mark-up used to establish your consulting rate.
• General Overhead Labor All other non-billable labor. It may be convenient to break this down into other categories, such as marketing labor, proposal labor, sales labor, and accounts receivable. This may help monitor your efforts and help you to identify problem areas.
• Holiday, Vacation, & Sick Time An easily overlooked category of time because it's time not-worked, but it must be considered in your overall budget.
• Recruiting Expenses The expenses associated with finding, hiring, and potentially moving an individual to your location for employment. This item may not be important to the small one-man consulting office, but can be a considerable expense for any firm who hires employees.
• Payroll Related Expenses All those expenses related to employees, such as medical insurance, unemployment insurance, disability insurance, long-term care insurance, educational expenses, etc.
• Retirement Plan Contribution This is also a payroll-related expense, but it requires special attention. You must plan ahead for your future.
• Advertising Expense The expenses, other than labor, incurred in promoting and advertising your services to prospective clients.
• Sales Expense The expenses, other than labor, incurred in attempting to secure a project --- whether you get it or not.
• Marketing Expense The expenses, other than labor, incurred in general marketing of your business, like attending professional meetings, developing standards, public speaking, or taking part in governmental task groups, etc.
• Office Expense All those expenses incurred in running an office, i.e., office supplies and office equipment --- only that which is not required to be depreciated.
• Automobile Expense The costs associated with operating and maintaining a vehicle for the company, such as gas, oil, maintenance, and insurance --- not the cost of the vehicle, however.
• Telephone Expense The cost associated with installing and maintaining your phone system, including equipment, lines, monthly charges, etc. Also, internet charges can be included in this category.
• Postage All charges associated with postage, including stamps, express mail, and Federal Express and UPS packages.
• Utilities Often overlooked as expenses to the home office, these are true expenses to all offices. They include charges for heat & air conditioning, electricity, water, gas, sewer, etc.
• Rent Rent paid for office, lab, shop, or storage space.
• Insurance Insurance coverage other than those covered under Employee-Related Expenses and Automobile Expense, like Errors and Omissions insurance, General Liability Insurance, etc.
• Maintenance Expense Like it or not, things will breakdown and need repair. The office will require routine cleaning and maintenance
• Library Expense The costs associated with maintaining your professional magazine subscriptions, technical books, literature searches, and library fees.
• Dues & Fees Membership fees for professional societies and the entrance fees into exhibits and symposia.
• Professional Services Fees associated with services rendered by lawyers, accountants, and other professionals necessary to maintain the business.
• Contributions Actual out-of-pocket contributions to charitable fund raisers. Unfortunately, your time is not considered a contribution expense.
• Interest and Service Charges Interest income or expense, or service charges on bank accounts, loans, credit cards, revolving accounts, etc.
• Miscellaneous Tax & Fees There will be other taxes and fees that don't fit into any of the above-stipulated accounts, such as business registrations fees, local property taxes, etc.
• Depreciation Unfortunately your business will require equipment (vehicles, computers, desks, office furnishing, etc.) which will be an expense to the business, but in the eyes of the taxman, the items cannot be "expensed" as the costs are incurred --- they must be "depreciated". That is, a portion of their costs is incurred as an expense over several years, depending on the expected lifetime of the equipment. This account can be very large as it carries over from year to year. During an expanding business cycle purchasing depreciable capital equipment can be a real drain on cash, however, when business is declining and purchases stop or decrease to a trickle, the depreciation expense carry-over can be a lifeline for cash flow.
• Earnings Before Taxes Subtracting the sum of the expenses from the Net Revenue will yield the Gross Profit, or Earnings Before Taxes.
• Federal, State & Local Taxes When you finally make a profit at your business, you'll find that you'll have to give a major chunk of it to the local, state and federal governments
• Net Profit Finally, whatever is left over is PROFIT.
Run through this budget and apply your best estimates to these costs. Try several different income scenarios like averaging 1 day/week, 2 days/week, and 4 days/week to see what happens if things are slower or busier than you expected. Remember some of your costs will increase as your income increases, while others may decline. Attempt scenarios using a different mark-up structure.
When you really start to get a feel for this budgeting process, try doing it on spreadsheet on a monthly basis. Unless you have projects in-hand on the day you start your practice, your client time will be ZERO for the first three to six months. You'll see how hard it will be to get to even your worst-case annual scenario. And all that red ink at the bottom of the page where it says Net Profit, that's all of the money that will have to come from your savings in order to stay afloat.
The reality is that you need a sufficient amount of cash to finance you and your business before the venture can start paying off. The same will be true when business turns down.
In order to survive you need to understand the financial aspects of your practice, and you must continually monitor the financial well-being of your business, with contingencies for slow times as well as busy times. The best way to plan for these contingencies is through budgeting.
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