Business planning tip - Calculating payroll costs

When doing financial calculations for a business plan or 1023 application, don't underestimate payroll costs and other government-mandated overhead.

For instance, see the Payroll cost worksheet sample below.

Labor Base Rate (1 employee@ each rate)	Wage or Salary/mo	FICA/SS	401K (or other benefits)	WC Ins (2.65/$100)	SUTA (1.53%)	FUTA .06% of $7000	Health Insurance	Other	Estimated Hrs/mo
$10.00	$1,600.00	$120.48	$90.00	$42.40	$24.48	$42.00	$100.00	$-	160
$11.00	$880.00	$66.26	$45.00	$23.32	$13.46	$42.00	$-	$-	80
$12.00	$1,440.00	$108.43	$67.50	$36.16	$22.03	$42.00	$75.00	$-	120
$13.00	$2,080.00	$156.62	$90.00	$55.12	$31.82	$42.00	$100.00	$-	160
Total annual w/o benefits	$72,000.00

Cost/Mo.	Annual Total Actual Cost	Payroll Overhead
$2,019.36	$24,232.32
$1,070.05	$12,840.58
$1,791.12	$21,493.49
$2,555.57	$30,666.82
	$89,233.20	$17,233.20

I often see clients disregard these costs, or only include part of them when I review projections for business plans or 1023 applications. The overhead significantly increases the cost of labor. In this example, it is 19.3% of your actual payroll costs.

As a rule of thumb, I generally recommend adding at least 20% to your base wage or salary rate for the first year, and increasing the cost by at least 3-4% for subsequent years to allow for wage or tax increases.

If you fail to account for significant mandated costs it will seriously affect your cash flow, selling price of goods or services and your profit margins. If your target adjusted net profit (profit after all expenses and deductions from income) is in the 5-10% range, you can easily see how you could wind up in the red at the end of the year. Coming up with an extra $1436 every month is significant for any new enterprise.

Nonprofits are particularly prone to disregarding the cash flow realities of being in business.  If your cash flow depends on donations and program-focused grants, you MUST allocate funds separate from most grant funding to pay these relatively non-negotiable costs. Typically, these costs are paid from unrestricted donations, and to know your target amount, you must know your needs.

Don't lowball when it comes to estimating other overhead. I once saw a business plan that allowed $500 for an annual financial audit. After checking with a few accounting firms in the area, the actual cost was between $2500 and $3500.

You do yourself no favors by painting the most optimistic picture of your operation. First, it will leave you scrambling to find the money to pay for all the unaccounted-for costs, and second, investors, lenders or grantors will see right through that fog of optimism.

If your target income or revenue won't cover the actual projected expenses, you may have to adjust the target. Raising your selling price of goods might be an option, or adding contracted income from fees could balance the equation.

And yes, there is a chance that you will discover that your business or nonprofit can't generate enough cash under any scenario to stay afloat.

It's far better to know that now, than discover it after you are already deep in debt.

When the 1023EZ may not work for you

Ever since the IRS released the new short form application for filing for charitable status, my inbox has overflowed with requests to help people file it.

The first thing I have to say to all of you is:

READ THE INSTRUCTIONS FIRST.

There are some specific areas that may require you to file the long form application instead, and there are some implied drawbacks.

The two areas that sentence applies to are organizations already incorporated as LLCs and organizations that envision grants as a primary income stream.

Part II of the instructions specifically prohibits LLCs from filing using a 1023EZ, although they can apply using the long form. Sole proprietorships, partnerships and "loosely affiliated groups of individuals" are excluded as well.

Of perhaps greater importance to most of the people contacting me is the $50,000 annual revenue restriction for the first three years

For organizations hoping to access grant funding, the 1023EZ simply doesn't indicate or require enough basic verified data that is available in the public domain to satisfy the background checks required by most grantors or institutional funding sources. (The EZ does not require any sort of verification of your claim that you will not exceed the 50K threshold, such as the financial projection worksheet in the standard 1023.)  Just remember that when you file, you are "attesting", i.e. making a legally binding statement that you are not going to exceed the revenue cap.

While it is probably true that nearly all new organizations will not exceed the revenue cap in their first three years, and thus are only required to file the 990-N (postcard) report, that document is not accepted by grantors, again because it doesn't require or report enough data to make a determination about your effectiveness or financial integrity.

If you exceed the cap and have filed a long form 1023, no  harm, no foul. If you have applied and been approved using the EZ, the IRS might have a problem, or more accurately, you might have a problem with them.

There are also certain mission categories that require more information to be submitted to the IRS than is contained in the short form application. These include, but are not limited to, charitable risk pools, credit or financial education or assistance, schools, colleges and universities, organizations with donor advised funds and churches or church associations.

Having said that, some organizations are quite well-qualified to use the short form. One that comes to mind is a group that wanted to provide cross-translated children's books to ESL students, i.e. have the child's native language story books contain the English translation displayed under the native language text, and make those books available as videos or PowerPoint presentations to any bona fide community organization, library or educational institution that needed them. The translations were all being done by qualified volunteers, so their initial capital needs were quite low.

Of course after the three year qualifying period, should your organization suddenly come into significant funding, you can file the long form 990 and provide the appropriate reporting to satisfy the IRS as well as donors.

I do provide an initial feasibility study that can help you decide if your organization should file the EZ, as well as a review of your prospects for survival through those first critical three years.  For more information visit http://www.cloudlancerwriting.com and click on the consulting link.

Taking the scary out of start-up

One of the most overwhelming aspects of starting a new business, whether it is a nonprofit or a for-profit, is feeling like you're lost in a maze. Once the initial excitement wears off, it can feel like trying to navigate Africa without GPS or even a map.

The solution for that feeling lies in gaining knowledge and experience, but trying to do that completely on your own can be time-consuming, expensive  and just plain scary.

There are tons of resources for would-be entrepreneurs, from the local SCORE office to a myriad of books, podcasts and videos to one-on-one consultants like me.

   

So why do so many startup owners seem to flounder for so long? Why do 70% of all start-ups fail within five years?

I think part of it is because people who start businesses tend to be highly independent folks.

It takes a certain type of person to say "I don't want to exist within the corporate world."  They are quite willing to give up the perks of the corner office to make an impact on their own. They tend to be driven to achieve a goal, sometimes to the point of disregarding anything but the vision of that goal already attained. They are dedicated, but not patient.

As a consultant, one of the first things I do is ask about the basics. Does the enterprise have the structure needed to survive and grow?

Often I find that in the entrepreneurial mind, following rules, i.e. having structure, equates to being suffocated by bureaucracy. I explored that in my previous post "Structure Without Stricture".

Some rules of business exist almost as laws of nature. If you are a for-profit, you have to sell things for more than they cost to produce in order to survive. If you are a non-profit, you have to be able to show a real positive change in a circumstance or condition that provides benefits over the long term to prove your value to donors.

None of that precludes innovation or imagination. You can approach problems with new methods or define a successful outcome with new metrics.

I recently had a client who started his email with "People tell me I am doing everything right. I'm  active on social media, I attend local events, I contribute to local charities and all that stuff. My service is far better than my competitors. But I'm still going broke. Can you help me?"

This person was doing all the soft-skill stuff well. But he missed an important point. The service he was selling cost more to produce than he was selling it for, which he attributed to needing to be competitive.

When I pointed out that being competitive meant staying in the race, he simply didn't understand what I was saying. He had a business strategy problem. He thought that by being the cheapest supplier he was going to get enough market share to become profitable.

To set the stage a little on this, this gentleman had been an employee of a firm providing a service to homeowners. When the business abruptly closed, he started a business doing the same thing.

He knew that his former employer had been charging a certain price that was pretty closely in line with the competition, but he felt that if he sold the same services for just a little more than he had been being paid as a wage by his former employer, he could get more customers and undercut the competition.

That part worked. He rapidly had more business than he could handle, but he still couldn't pay his bills.

The problem was that he had never taken the time or wanted to spend the money to find out how much he truly needed to charge to stay in business. Things like having to pay the employer's share of taxes, or carry liability insurance or the cost of advertising were never considered when he set his rates. When those costs suddenly had to be paid, it took what little profit he was making and then some, forcing him into using his savings to stay in business.

There is a reason why consultants insist on boring exercises like constructing business plans and cash flow projections or developing a marketing strategy.

Just because you are an entrepreneur doesn't mean you should ignore the basics. If you plan well and use the tools developed by others before you, you can take a lot of the scary out of being a start-up. 

Why waste money on a business plan?

Received from "Fred" (not his real name).

"I guess I need a business plan writer. I am trying to recruit board members for my new nonprofit and all the ones I want on the board want to see a business plan, preferably one done by an outsider. I don't understand why I should do a business plan. I'm going to be a nonprofit, not a business.  Even if it was a business, what's the use of filling out a bunch of phony financial stuff when I have no idea what the numbers really are? And why do they care about my "competitors"?  I think this is just a waste of money, but I would like a quote so I can explain why I can't do this right now."

Have you ever felt like Fred? You're supporting your nonprofit (or your fledgling small business) with your own credit cards, and now someone you apparently respect or at least see value in being associated with, wants you to spend more money on something other than your mission. WHY?

First, Fred doesn't seem to understand the legal responsibilities inherent in serving on a board. To him, these are just names in front of titles. The people he is approaching know that isn't true. Before they commit, they want to know that this has a chance of (a) succeeding) and (b) will not expose them to unnecessary legal complications.

Second, it was fairly obvious that Fred hasn't thought about the financial realities of being in business, even if that "business" is a charity.  Like so many people, he assumes that because the goal is awesome and a lot of people will be helped, the money is just going to flood in to support the mission. That's probably why his potential board members want an outsider to do the plan.

What the business plan will do is give focus and clarity to the process of fulfilling Fred's dream. It will ground him in the day-to-day realities of making that dream a reality.

 

Might it also force him to see that the way he wants to go about realizing that dream isn't feasible at the beginning? Absolutely.

That's what I think stops a lot of people from writing a business plan. Sometimes it's simply a case of them not knowing what it takes to get to the end goal.  Sometimes it's a case of not wanting to know.

I write business and strategic plans, and the number one frustration for my clients is that the plan doesn't support their idea of how much money they will make or attract on the timeline they envision. In other words, reality doesn't line up with the timeline of the dream. Done properly, business plans will sidestep the pitfalls of unreasonable expectations.

I can tell them what the norms are, what's a reasonable rate of growth, research competition or funding streams and get average cost of doing business figures, but if they need or want a six figure income and I don't see that happening in one year, I can't tell them that it will happen.

You do, or have a business plan done, to prepare you for reality. Then you can show potential associates that you recognize not just the benefits, but also the problems. You can show you have a strategy to deal with the problems so the benefits are realized as quickly and efficiently as possible. You plan to manage challenges, instead of being managed by them. A plan helps you to realize that your dream involves entering a marathon, not a sprint.

I gave Fred his quote and wished him luck. I hope he follows through and his dream comes true.