Build a Smart Budget... or Three

Tracking revenue and expenses is only the beginning of ensuring a healthy future for your brokerage.

March 14, 2013

1. The Operating Budget

Purpose: to forecast and track revenues and expenses.

Operating budget is what most people think of when they hear the word budget: a forecast of sales, or revenue, and an estimate of expenses based on that forecast. Breaking the components of your operating budget down by relevant detail—rather than forecasting one revenue and one expense figure for the entire year—will pay off. So resist the urge to go with lump-sum projections. Here are 5 steps for creating your operating budget. The chart at right corresponds with the steps.

  1. Estimate the number of transactions you expect to close each month. Because the amount you’ll earn from sales depends on home prices, revenue can vary greatly. It’s easier to forecast if you break closings into manageable segments. In the chart, the estimated closings for each month are broken down into four quartiles: (I) under $150,000, (II) $151,000 to $225,000, (III) $226,000 to $300,000, and (IV) greater than $300,000. Add all those numbers to get a yearly total forecast.
  2. Use your forecast to estimate monthly transaction revenue. Determine the average revenue per closing for each quartile, and multiply that by the number of closings you expect in each month.
  3. Calculate fee revenue separately. For a broker, fee revenue usually includes agents’ desk fees and referral fees. Desk fees are fairly predictable, but referral fees can be erratic, so look back at historical receipts in order to forecast.
  4. Calculate your cost of sales and subtract it from total revenue to determine your gross profit. With a rough revenue budget in place, you can calculate cost of sales (COS)—that is, the expenses directly tied to making those sales. Commissions and outgoing referral fees fall into this category. Since outgoing fees are typically the first paid after a closing, they should be the first addressed. Franchise fees are pretty straightforward. A common example is 5 percent of gross closing revenue after referral fees. But as with referral fee revenue, referral fee expenses can be hard to forecast. Again, use historical data as a starting point.

    Once you’ve addressed fees, estimate agent commissions. There are many types of commission arrangements; a common example (used for purposes of the chart) is 65 percent of gross closing revenue after fees. And if there are other expenses within your brokerage that fall into this category, estimate them in the same manner as commissions and fees and total them. The total cost of sales is then subtracted from total revenue to determine gross profit.

  5. Subtract general and administrative expenses, interest, and taxes. GA expenses include every other cost that isn’t directly tied to sales. Some examples are advertising, salaries, benefits, payroll taxes, rent, utilities, and maintenance. For the table at right, GA expenses are lumped together, but like the COS, they should be itemized in your budget. Refer to your records to ensure that all expenses are accounted for. Some will be fixed and, therefore, easy to forecast, while others will be seasonal. Subtract GA expenses from gross profit to get an estimated operating profit or loss for each month.

    To estimate interest expenses, refer to recent loan statements and use an online amortization table if needed. Don’t forget to account for additional interest expense if you’ll be borrowing money to pay for a capital project or for other needs. Taxes are subject to many variables; it’s wise to consult with a qualified tax professional on this aspect of your budget.

    Once you’ve subtracted interest and taxes from your operating profit, you’ll have a well-thought-out estimate of net income for the coming year. Now, review the operating budget as a whole. Does it correspond with your brokerage’s overall strategy? (or, if you’re an agent, with your individual business strategy?) Are your forecasts optimistic? If you don’t meet them, what will it mean to your net income? Remember, budgeting is not an end in itself; it is meant to provoke thought and to spur action if needed.

2. The Capital Budget

Purpose: to plan for major expenditures that will provide a return to the business over the course of several years.

Significant spending—such as the purchase of office equipment or a commercial rental property—should never be pursued on a whim. By conducting an objective analysis, you can compare potential investments and determine which are likely to have the greatest value for your business.

Consider two examples: Project 1 requires a $10,000 initial cash outflow and offers decreasing cash inflows over the next five years totaling $15,000 ($5,000 in year one, $4,000 in year two, $3,000 in year three, $2,000 in year four, and $1,000 in year five). Project 2 requires a $50,000 initial outflow and provides steady cash inflows of $15,000 per year over the five-year period totaling $75,000.

It’s easy to compare the two projects using an online calculator. Try the “Net Present Value and Profitability Index Calculator” at the Web site Calkoo ( Unless you’re versed in finance, some terms on the calculator may be unfamiliar, starting with “discount rate.” That figure determines how much future cash flows are worth today. The higher the rate, the more conservative your analysis.

Leaving the discount rate at the default 10 percent and changing the investment period to five years, input what you’ll spend initially in the “Individual Investment/Cash Out” column. Then input what you’ll get back in the first five years in the column headed “Cash-In” (don’t use commas in your numbers).

The net present value is calculated automatically on Calkoo. The NPV represents the value of each project today, and it’s determined by factoring in the size of the initial outflow and the amount and timing of subsequent inflows. The timing of inflows is important because the sooner they’re received, the more valuable they are (because of inflation and the potential returns that could be earned elsewhere). If the NPV is negative and you’re sure your inputs are correct, then you probably shouldn’t pursue the project any further.

In the examples above, Project 1 and Project 2 both have a positive NPV ($2,092.13 and $6,861.79, respectively). Therefore, you could justifiably pursue both projects because both are expected to add value. Usually, however, companies don’t have this luxury due to limited resources. So how do you choose what to invest in?

Frequently—as in these examples—the project with the bigger initial investment has a bigger NPV. But, does that make it a better choice? Not necessarily. That’s where the profitability index comes in. This figure (also calculated automatically on Calkoo) compares the NPV to the initial investment amount. The larger the PI, the better. In the examples, Project 1 has a higher PI (1.2092 versus 1.1372).

Still, after projects have been analyzed, you must review them through the lens of common sense. Buying new artwork for your office may be costlier than upgrading to the newest iPad, but only you know how to assess the importance of one over the other. It could well be appropriate to accept a project with a lower NPV or PI. Don’t rely solely on the quantitative analysis.

3. The Financial Budget 

Purpose: to forecast cash flow so that you don’t come up unexpectedly short.

The final piece of the budgeting phase is, in some ways, the most important. The financial budget is critical to a brokerage’s well-being because it addresses the most essential asset—cash. A shortfall in cash, even if only temporary, could cause an otherwise healthy business to become insolvent.

As might be expected, the financial budget begins with your beginning cash balance. Some guesswork may be needed if the first period of the budget is in the future. After that, the beginning balance will, of course, be the previous month’s ending balance.

Next, estimate cash collections for each month by referring to the revenue in your operating budget. Most closing revenue will be collected immediately, though this may not be the case with fee revenue. Referring to historical data should shed light: Examine the typical collection time for fees, and don’t forget to take into account the percentage that are never collected. For example, you might assume that 75 percent of fee revenue will be collected in the month it’s earned, 20 percent will come in the following month, and 5 percent will be bad debt. Because of the erratic nature of receipts, the cash collections schedule could look quite different from the budgeted revenue.

Now estimate cash disbursements for each month. Like collections, disbursements refer back to the operating budget—the expense side. The timing of expenses will depend on their nature. For simplicity, you might decide that expenses are all paid as soon as they’re accrued, so they affect the operating budget and the financial budget in the same month. And remember to include quarterly income tax payments in your financial budget. Past percentages of total revenue can provide a useful starting point for quarterly payments.

With a picture of incoming and outgoing cash from operations, you can address existing and potential financing. Outflows for existing loans should be easy to figure since they’re typically the same amount every month. The financial budget may uncover the need to borrow additional money to cover temporary shortfalls or to pay for capital projects. With a picture of your business’s cash situation in mind, you might want to go back and revisit some of your previous assumptions. Do you need to rethink how you’ll cover potential shortfalls? Will you need to bring in more sales in lackluster months? Will expenses or projects have to be scaled back? Or will your brokerage have extra cash? And if so, what will you do with it? Hire staff? Take on another profitable project? Invest it?

While creating these three budgets will require considerable time, they’ll provide valuable benchmarks for how well you’ve adhered to your overall strategy for the year. But don’t assume that every detail must be accounted for in order for the analysis to be meaningful. Just taking time to dedicate critical thought to the annual budget process provides substantial benefit.

Kristoffer C. Burnett is a certified management accountant in Wichita, Kan., helping small and mid-sized businesses create value. He can be reached at