5 Cost Drivers To Help You Make Accurate Expense Projections

By Ken Kaufman on 24 June 2011 (Updated 7 July 2011) 0 comments
Photo: Aseev

You’ve created an amazing forecast of your sales, month-by-month, for the next five years. You’ve got a good handle on your variable expenses, so you can give a good projection of how much money you are going to have left after you sell your products and services to cover your overhead, or Selling, General, and Administrative (SG&A) expenses. Better yet, your forecast predicts that you’ll have some left over as profit.

You’ve arrived at this scenario because you have broken down your sales cycle and you understand exactly what it takes to get a lead in the door and convert them into a paying customer. You also understand the costs directly related to the products and services you are delivering to your customers. But figuring out how your SG&A changes and scales as your company grows is tricky, especially the more you grow and further into the future you project.

Here’s an example of what I mean. It is not realistic to expect to pay the same $500 per month for rent when you grow from 2 to 20 employees by the end of year three in your forecast. But how do you set up your forecast to account for growth in what are often referred to as fixed expenses? And how do you make it so that one change in your sales growth rate doesn’t throw off your entire projection, grossly under or over-stating your profits?

This is where cost drivers come in. Every cost in your business model can be correlated to one of five main cost-drivers, or factors that determine how much the cost is.

Employee Headcount

Certain costs have a lot to do with how many employees have, and they will increase or decrease over time based on your headcount. Your projection should highlight exactly how many employees you will need from month to month, and then you can use the forecasted headcount to drive certain costs. For example, office supplies will often tie directly to the number of employees you have, and you may find that each employee generates about $50 in that expense each month. Other examples include rent (square footage allocated per employee times the monthly per square foot rent cost), software licenses, phone expenses, and professional development costs.

Sales Person Headcount

There are certain costs that are driven by the number of sales people you employ rather than your total headcount. Taking into account their expense accounts to woo prospective customers as well as auto reimbursements and travel expenses, the number of sales people drives these and other costs. The base salary and associated payroll taxes and benefits they receive and certain software licenses and subscriptions are also tied to sales person headcount.

Number of Leads Required

Are you able to decipher how many leads you will need next month to hit your sales target? What percentage of your leads will turn into sales revenue? How much revenue will each customer generate? The answers to these questions lead us to understanding exactly how many leads we need each month. Then, based on our tolerance for the cost per lead in our business model, we can determine how much we are willing to spend on advertising, marketing, public relations, social media, search engine optimization, pay-per-click, trade shows, and all the other costs associated with generating leads.

Sales

Some expenses are going to be a function of prior or same month sales revenue, like bad debt, merchant services, commissions, and insurance that is tied to the overall production of the company. These are actually variable expenses, but are usually accounted for in SG&A.

Fixed is Fixed

No matter how hard you try to pigeon-hole some expenses, they are fixed and will only change based on factors these drivers cannot predict. Banking fees, business licenses, professional fees, internet services, and postage often fall into this unpredictable fixed category. The best way to project them is to understand which drivers they generally connect with in the long-run and ratchet the expenses up with certain milestones in those drivers.

The hardest part of creating the long-term projection of the profitability of a company is not sales. If you know your sales cycle, the lifetime value of your customer, and all of your marketing, lead generation, conversion, and closing statistics, you can put together a credible and valid sales forecast. But entrepreneurs tend to under-forecast their SG&A expenses once they get two or three years into the future. But by applying these five most common cost-drivers, you’ll be on your way to more accurate projections.

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