Budgets

Effective budgets lead to accurate provisional billing rates that ensure total cost recovery and maximize net operating profit. In short, they provide financial guidelines, help identify and capture all costs, provide targets and goals, and plan for profitability and success. It’s an important and time-consuming chore. That’s why many government contractors find the task of completing a budget to be overwhelming. But it doesn’t have to be. Creating a budget is less daunting and time-consuming if you have the correct, efficient, and effective methods to gather the necessary data.

Budgets are the foundation of forward-looking rates and are a critical step in planning for success. Budgets are not simply a constraint on spending; they are a target for success and profitability—budgets help us develop proposals and billing rates. Remember that budgets and rates can be adjusted over time.

Three Perspectives of Budgets

We approach budgets from three perspectives:

  1. Enterprise
  2. Project
  3. Proposal

Enterprise

The enterprise budget is, as it sounds—a corporate budget for the entire organization. Enterprise budgets include both direct and indirect costs. The enterprise budget results in indirect rates for the organization to use in proposals, provisional billing rates, and applied overhead in Enterprise or Manufacturing Resource Planning (ERP/MRP) systems utilizing standard costs.

Project

Project budgets are developed for a single contract, project, or job, focusing on the direct costs necessary for that effort. Note the exclusion of indirect costs—those are applied to the project or job based on enterprise budgets, standards, or experience depending on the accounting methodology of the organization. Project managers use project budgets to track direct costs. Project managers have no control over, nor responsibility for, indirect rates—those are managed by the functional areas (engineering, manufacturing, administration, etc.).

Proposal

Proposal budgets are a combination of Project and Enterprise budgets. The project portion is clear—you must propose direct costs that support the RFQ/P. The enterprise portion is more elusive to some contractors. You must update your enterprise budget only as it applies to the specific proposal. You are not updating or changing your enterprise budgets or provisional billing rates on existing contracts. You are calculating new enterprise rates as if you won the current proposal (think “what-if” rates). This is required for significant proposals. While there is no FAR definition of “significant,” we define it as a proposal that would increase your top-line revenue by 20% or more. Most businesses can absorb 20% of new or additional direct work with little or no impact on indirect costs. However, “significant” contracts often require additional indirect costs such as supervisors, administrators, facilities, or equipment.

Three Approaches to Budgets

At Left Brain Professionals, we present budgets from three approaches:

  1. Top-down
  2. Bottom-up
  3. Hybrid

Top-Down Budgets

Top-down budgets focus on revenue and the direct costs necessary to support those budgets. Top-down budgets should be assigned to business development and program management since they understand the backlog of awarded work, outstanding proposals, and resources necessary to complete that work.

Revenue includes:

  • Backlog
  • Pending Proposals
  • Other Filler Work
Backlog

This is the awarded or committed work, the undelivered work on confirmed contracts. You should have high confidence in the timing and delivery of this work. The backlog of work should be clearly and easily identifiable from unfilled sales orders in the accounting or ERP system. These should have planned or contractual delivery dates with clearly defined scope and identified resources.

Pending Proposals

This is a weighted analysis of outstanding proposals. Based on experience, feedback, and intel, you know that the client will win a portion of this work. This is the sum of the weighted analysis applied to each outstanding proposal.

Other Filler Work

Most companies have additional regular but unidentifiable work. These may be small orders or projects that come and go over time.

COGS/Direct Based

The other aspect of top-down budgeting is identifying the direct costs necessary to support the billable work. You should have proposal budgets with updated estimates of the time and costs necessary to complete the work. Remember that direct costs fall into one of five cost elements:

  • Labor
  • Material
  • Travel
  • ODC
  • Subcontractors

With revenue and COGS/direct information, we have completed our enterprise budget’s gross margin portion.

Bottom-Up Budgets

Bottom-up budgets are expense based and focus on fixed or known costs for which you have historical information. Bottom-up budgets can include both direct and indirect costs. Bottom-up budgets are best assigned to accounting staff and department managers who have access to historical data and knowledge of planned expenses in the coming year.

While applying a fixed escalation percentage to all historical costs might be easy, it’s probably not accurate. Some expenses are contractual and often have predefined increases. Other expenses may remain steadier regardless of the number of employees or the amount of revenue. Still, other expenses may experience higher increases because of economic issues. Do your homework to develop the best budget.

Direct

Why are direct costs in both the top-down and bottom-up approaches? For the top-down approach, we need to know how much direct cost is necessary to deliver the work generating revenue. For the bottom-up approach, you must see how the existing workforce and other direct costs align with revenue requirements. Also, business development and program management personnel usually define direct labor as hours or full-time equivalents (FTE) by labor category, not dollars. Accounting and HR must convert those hours and FTE into dollars based on existing or projected salaries.

Current employees and union agreements comprise a significant portion of known direct costs. Most companies do not rush to hire or fire employees as contracts change or work fluctuates. As such, we often have legal, strategic, or moral agreements for these costs.

Fringe

Fringe costs are fixed in nature and very predictable for budget purposes. Consider the following:

  • Employer Taxes – fixed percentage
  • Paid Absences – defined PTO packages
  • Health Insurance – fixed amount per employee and coverage type
  • Retirement – fixed contribution percentage

With this information, you can easily prepare a fringe budget based on the number of employees and their salaries. Conceptually, Fringe is the easiest portion of the budget because of the predefined costs and rates.

Overhead

Overhead costs tend to be fixed in nature when you consider the following items:

  • Labor
  • Rent
  • Utilities
  • Telephone
  • Supplies
  • Training

You’ll usually have historical trends for most of these costs and often have contractual commitments for things like rent, utilities, and telephone. Other, more variable costs may be predictable in terms of dollars per employee or percentage of revenue. For example, we know that more direct work requires more shop supplies, and historical records might indicate 0.25% of revenue.

G&A

Like Overhead, G&A costs tend to be fixed in nature when we consider the following items:

  • Labor
  • Accounting
  • Business Development
  • IT
  • HR
  • Professional Fees

Hybrid Budgets

Hybrid budgets marry top-down and bottom-up versions. Hybrid budgets help identify gaps or overlaps, such as too few or too many direct employees or the need to acquire additional resources, such as office space or equipment.

Fringe

Increasing or decreasing the number of employees means altered fringe costs. Luckily, these percentages or fixed amounts per employee are easily adjusted using formulas.

Overhead

Hiring more employees may mean increased costs for office space, computers, supplies, and other items. Contractors may need additional equipment, facilities, or other resources to support increased direct work.

G&A

You generally see stability in the G&A pool unless there is a planned expense for additional staff or new enterprise software. Most companies can process additional employees, invoices, and such with little or no additional administrative cost. The fluctuation in G&A rates is usually related to changes in the base, which is composed mostly of direct costs—winning or losing direct work with little or no change in indirect expenses will have the most impact on rates.

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