Difference between revisions of "The Operating Budget"

Revision as of 20:24, 2 February 2011

JOHN ROLLINS, YALE

Introduction

What is a budget? Simply put, a budget is a detailed financial plan that shows estimated revenues and expenses for a given time period. Typically, a complete operating budget consists of not only a projected profit and loss statement but also a supporting cash flow statement, as well as a balance sheet. An operating budget usually covers a fiscal year, which for many of us corresponds fairly closely with the academic year and our parent institution's fiscal year. If it is to be meaningful, an operating budget will not stand alone, but will closely relate to a press's other planning efforts. Long- and intermediate-term goals and objectives should be consistent with those of the budget. Usually, the budget will be the same as the first-year projection of a long-term plan. Careful thought must be given to the operating budget to make sure that it is in step with assumptions concerning the nature, scope, and size of future operations.

Budgeting and budgetary control are central to a press's planning and control process. Participation in the budgeting process promotes a sense of cooperation and teamwork. Participation also creates commitment and strengthens the individual's feeling of responsibility for the performance of his or her area. As budget proposals for each activity are completed, they are progressively reviewed, often revised, and finally approved by the chain of subordinates and supervisors that reaches from lower to senior management and finally to the press director, board, university administration, and, in some cases, state officials. All of this takes months, and it is fair to say that in a sense, budgeting never stops. It is an ongoing process. As soon as one operating budget is finally approved, we begin collecting data, making comparisons and assumptions, and deciding upon goals and objectives that will be used to prepare the next budget.

The operating budget must be reviewed, discussed, and coordinated by a press's director, financial manager, and department managers. The director's involvement in the budgeting process is extremely important. The director should provide subordinates with initial guidelines, review all proposals as originally submitted, request revisions, resolve differences between subordinate managers, and ensure balance and consistency in the final budget. Budgeting should be essentially a line function carried out by line managers. The financial manager and staff should provide information and other technical support, but budget negotiation and decision making should involve only those managers who are in some way responsible for a particular function.

Budgeting often takes place from both the top down and the bottom up; in other words, from the sales forecast down and from net income or loss up. The sales forecast may be where the budget starts, but an organization's bottom-line objectives will influence how it is modified. If a press must break even, generate a certain level of profitability, or limit its loss to a certain amount, revenues and expenses should be budgeted in a way that will permit the press to achieve its financial objective.

Constructing the Budget

Form

A university press's operating budget is usually presented as a projected profit and loss statement. As such, it involves preparing estimates of future revenues and expenses. Revenues typically can be divided into sales, other publishing, and nonpublishing income. Expenses are usually divided into cost of sales-related, operating, and nonoperating.

An operating budget should be submitted and/or presented with whatever supporting statements and schedules are appropriate. A proforma balance sheet often accompanies an operating budget so that managers, board members, and investors can evaluate the effects of the proposed budget on the financial condition of the press. Proforma financial statements are described in a separate paper in this manual. Some presses operate on a cash budget, but for those presses that use accrual accounting and budgeting, it is desirable to prepare an accompanying projected statement of cash receipts and disbursements and a projected statement of changes in financial position. These statements will explain the projected changes in a press's cash and working capital during the budget year. Examples of some other typical operating budget supporting documents include a manufacturing budget, a salary roster, a capital purchases budget, and a detailed breakdown of projected subsidiary rights income.

Sales, Cost of Sales, and Other Publishing Income

Sales is the largest and most important source of revenue for any established university press. The sales forecast is normally prepared by the marketing manager with input from the director and chief financial officer. Since many subsequent financial and operating decisions will be made based upon the sales forecast, it is extremely important to prepare this forecast carefully, in detail, to ensure relative accuracy. This means that sales projections should be done on a title-by-title basis for the budget year for at least a press's front list. It may also be desirable to do title-by-title projections for the spillover list (i.e., books published in the current fiscal year that will be recent backlist during the budget year) and for important individual titles from the backlist. For a very small press, it certainly would be possible and appropriate to do title sales projections for the fiscal year for the entire list, both front and back. A larger and established press, however, would probably assume a certain aggregate sales contribution from its backlist and to this add whatever title-by-title projections it feels are needed to come up with an overall sales forecast. It is also important to forecast your returns against sales so that you have both a gross forecast and a net sales forecast. Title sales histories, title budgets, and historical sales reports broken down to show sales contribution by frontlist/backlist, subject category, cloth/paper, trade/text, etc., can all be helpful in sales forecasting. Your press's sales reps can be a source of useful advice about the sales potential of individual titles as well. Sales forecasting is the subject of a separate paper in this handbook.

Cost of sales at a university press is typically made up of manufacturing costs from inventory, plant costs, inventory write-down, royalties, and freight-in. The AAUP Annual University Press Statistics Survey also includes cost of frees in the cost of sales. I personally feel that cost of frees is more properly recognized in operating expenses. A first pass at budgeting the components of cost of sales can be made by looking at the historical relationship between these components and sales. Often these relationships are fairly stable from year to year. For instance, if you are successful at achieving your target gross margin for most of your titles, it very well may be that your manufacturing as a percentage of sales remains about the same from year to year. However, when budgeting cost of sales, it is not enough to say that since manufacturing was 25 percent of net sales this year, it will be 25 percent of net sales next year. You need to carefully examine your proposed list for the upcoming year to see if any of these titles will have unusual effects on manufacturing, royalties, or plant costs. You must also review your inventory with regard to your write-down policy to see if your write-down will be higher or lower than normal.

Other publishing income is primarily subsidiary rights-related. Reprint rights, permissions, bookclub, translation, and foreign coeditions are probably the most significant types of subsidiary rights income. With the exception of permissions, subsidiary rights income is the category most directly related to a press's newer titles. When budgeting subsidiary rights income, you need to carefully consider the rights potential of your new books and review already existing subsidiary rights agreements. Journals income, remainder and hurts sales, and special editions manufacturing income may also appear in this part of a press's budget.

Operating Expenses

Operating expenses are typically those expenses which occur in the course of everyday business that are not related directly to the production of books or the financing of the press. For the business world in general, operating expenses usually relate to selling or administration. Manufacturing, royalties, freight-in, inventory write-off, and interest are never operating expenses. However, the treatment of editorial and production and design expenses can be confusing. Some publishers treat manuscript editing, proofreading, and design expenses as part of the cost of producing a book and hence a form of plant cost, while other publishers treat them as operating expenses. I think it is fair to say that most university presses show them as operating expenses, as does the AAUP Annual University Press Statistics Survey. For a university press, operating expenses are usually those expenses associated with its editorial, production and design, marketing and sales, fulfillment, and administrative departments.

It is not really surprising that the operating expenses section is generally the most accurate portion of the budget. Expenses are usually more controllable than income and are more easily estimated as well, because detailed historical records exist and many types of operating expenses are relatively fixed (the most significant being salaries and benefits). Once set at the beginning of the year, the staffing level, salaries, and benefits generally stay more or less stable for the rest of the year. Since these expenses are the single largest component of operating expenses, it is not surprising that they have a large influence on the predictability of total operating expenses.

Budgeting operating expenses has many advantages. It provides a means to coordinate all the activities of a press and a way of communicating institutional objectives and challenges to a staff; it provides a plan to be followed and a means of self-evaluation and control. It obligates a press to maintain careful and thorough financial record keeping; promotes conservation of a press's resources; and exposes both efficiencies and inefficiencies. A well-prepared budget enables a publisher to anticipate problems and manage resources appropriately.

By its nature, the operating expense budget involves a broader group of employees than does any other aspect of budgeting. It is also the most clerically burdensome. Budgets must be prepared in detail for every activity that the press carries out. This inevitably involves almost all of the managers of the press and requires managers on all levels to focus on the press's future operations. Of course this means that these managers must be familiar with the press's goals and objectives and any program changes that affect activities for which they are responsible. Managers should prepare budgets only for those items that they can control. Wide staff involvement is beneficial. The employee in immediate contact with and responsible for an activity should be able to make the most reliable estimate of the expense of that activity, and participation in preparing the budget will increase an employee's commitment to the budget.

Press financial managers are intensely involved in the physical preparation and later the administration of the operating expense budget, but they should act as facilitators and communicators and refrain from becoming involved in strategy or programming decisions except in those operating areas for which they are responsible. The financial manager and staff do the technical work of preparing budget forms, distributing instructions, making sure that submissions are made on schedule, providing historical information, and compiling the consolidated budget. The financial manager should obviously have a full understanding of the press's publishing program and assumptions concerning staffing, size and nature of the list, and available funds.

Once completed and finally approved, the operating expense budget serves as an important control mechanism. Operating expenses are usually spread or shown by month or quarter within the budget. This allows evaluation and comparison at the end of any reporting period during the year. For each reporting period, a budget report should be generated that compares actual to budgeted expense and shows a variance from budget for all significant types of expenditures. If the variance is large, it is examined, and corrective action can be taken when appropriate.

An operating budget is a means of control, but it should remain flexible and responsive. It is often in the best interests of a press to exceed certain approved budgetary amounts because of unforeseen factors. The management of the press should be prepared to allow extra expenditures when they are appropriate. Many university presses formally revise their budgets at midpoint during the fiscal year. This gives the department managers and other staff the opportunity to alter their expense budgets in light of changing conditions. Even though you may revise your budget, the original budget should be kept for comparison.

Salaries and Benefits

Salaries and benefits easily constitute the single largest type of operating expense for a university press. Typically, more than one-third of sales revenue is spent on this type of operating expense. Salaries are usually budgeted and reported separately for each department, but since the process is the same for all departments, I am going to describe it just once.

Salaries are often the most accurate item projected in the operating budget. Once salary levels and staff positions have been set, for the most part they tend to stay the same for the balance of the year. However, final details of salary adjustments are often not known at the time the annual operating budget is prepared. It is therefore not unusual for press department heads, the financial manager, and the director to work within general university guidelines at this stage. The budget may be prepared with an average salary increase built in, with the final detail being provided later once individual adjustments have been decided upon. It is often the case that the financial manager will play a heavier role in the preparation and coordination of salary estimates for the budget than he or she does in the preparation of any other type of departmental expense estimate. In addition to salary adjustments for existing employees, the salary budget must include new positions, part-timers, temporaries, overtime, midyear adjustments, and termination pay.

Budget salary estimates should be prepared in great detail. Start with a list of all employees and their current salaries. Break the list down by department. Add to the list either specific or average salary increases as described by your university's guidelines for each employee. After consulting with your press director and department heads, add to the list new positions and accompanying salaries that are likely to be created in the new fiscal year. Also add to each department's section of the list an allowance for overtime and temporaries.

Finally, try to make allowances for staff who may be leaving the employment of your press during the year. The retirement of senior employees may mean the press will have to pay out serious amounts of accumulated vacation leave. It is wise to try to learn about items of this sort in advance and allow for them in the budget. Add all these figures to the salary listing and sum them up, and the total becomes the proposed salary budget for the new fiscal year. This salary proposal may have to be reworked if the overall operating budget is unacceptable. The final details of specific salary increases may have to be worked out after the budget is prepared and approved, but if good assumptions have been used, the salary budget as initially prepared will be surprisingly accurate.

Budget estimates of employee benefits and social security can be prepared in much the same way as salaries. Make a spreadsheet of employees with different columns for medical, dental, life, and disability insurance, as well as retirement, social security, and any other benefits paid for by your press. For each employee, enter each type of benefit cost with an adjustment for increased premiums or costs. Your university can usually provide you with percentage estimates of the cost increases for the various types of benefits. The social security administration can provide you with the social security rate and salary cutoff for the next calendar year. It is important to remember that the social security rate and salary cutoff will probably change at some point during your fiscal year, and your budget should allow for this. I feel that estimating benefit and social security expenses in this detail is the preferable way to do it, but it is not the only way. As an alternative, an overall percentage of either net sales or salaries can be used to estimate benefits expense for the operating budget. Historical cost figures can be used to derive this percentage and/or your university may provide you with a percentage estimate of benefit expense.

Editorial Expense

For budgeting and reporting, editorial expenses are often divided into acquisitions and manuscript editing. Salaries typically are around 70 percent of the expenses in each of these areas.

In addition to salaries, acquisitions expenses usually consist of readers fees, travel and entertainment, and miscellaneous expenses such as copying, supplies, subscriptions, submission fees for prizes, etc. Miscellaneous expenses, as they are for other departments, are usually small and tend to be fairly stable. Readers fees obviously vary with a press's reading policy and the number of projects moving through acquisition. If a press is expanding its title output, its readers fee budget will need to increase one or more years in advance of the planned increase in title publication. Acquisition travel and entertainment is probably the largest departmental travel budget for the average press, and is primarily devoted to travel to professional meetings/exhibits and campuses for manuscript scouting. Departmental travel plans need to be reviewed carefully before this budget is prepared.

Besides salaries, copy or manuscript editing expenses are made up of freelance editing and proofreading, as well as miscellaneous expenses similar to those found in the acquisition budget. Freelance fees will vary depending on in-house staffing and the volume and timing of manuscript work flow.

Neither editorial area offers a very good target for short-term budget cutting. Most of the editorial budget is tied up in salaries; discretionary spending is relatively small; and cuts in other accounts will often result in reduced manuscript output, which will have a long-term effect on sales. Editorial travel can sometimes be carefully cut for the short-term without significantly disrupting manuscript acquisitions.

Marketing Expense

The marketing department budget contains more discretionary and therefore controllable expenses than any other department. Its budget is also bigger than any other department's except general administration, and its budget is probably the most complex. In this department, broad and well-informed participation in the budget preparation really pays off. It will result in better estimates to begin with and better control later on.

Marketing and sales salaries typically are less than a third of this department's budget, while promotional expenses—space advertising, catalogs, direct mail, publicity, and exhibits—make up about half. Marketing department managers involved in preparing their department's budget must carefully review individual title marketing plans and related promotional plans and schedules before putting together their budget proposals. Since promotional expenses are discretionary, they present an obvious target for budget cutting if financial problems occur. However, this cutting has to be done cautiously, because there are trade-offs involved in press visibility, author relations, and sales.

Space advertising is generally thought to be more directly related to a press's image and its relations with authors than to sales. Space advertising can usually be cut with care without appreciably hurting sales, but not without disappointing authors. For many presses, catalog expense is limited to the expense of producing two seasonal catalogs and books in print. Books in print in its traditional print form is becoming less and less important, because electronic alternatives are taking its place. It can be eliminated in any given year without causing serious problems. Direct mail expense usually generates sales. It should be one of the last areas to be cut in a financial pinch. The exhibit budget is more important for waving the press flag and maintaining author relations than it is for immediate sales impact. Short-term cuts can be made in this area without hurting sales much. For all this talk of budget cutting, it should be remembered that marketing needs to be one of the most responsive, flexible, and creative departments in your press. It is the only department where expenditures can have a relatively direct and immediate sales impact. To be effective, it must have an adequate budget.

Production Expense

The production department's expense budget is simpler and more straightforward than any other department's. Often it contains just three types of expenditures—salaries, freelance fees, and other small miscellaneous expenses—and represents a relatively small portion of the total operating expense budget (in the case of the typical press, 4 to 5 percent of net sales).

Freelance fees are usually the most important controllable item that a production and design manager has in his or her department budget. These fees can be used for design in general, layout, paste-up, illustration, and other work related to the design or production of press publications. Freelancers are used in addition to, or in some cases in lieu of, regular staff. The production manager should review the future publication schedule and the present staff resources before making a budget proposal for freelance fees. Past experience can be used as a guideline in deciding how much should be allowed for each individual freelance job.

If budget cutting becomes necessary, the production department's operating expense budget is a very difficult area to make any reductions in. The only significant types of expenditures are salaries and freelancers, and cutting either of these areas may make it more difficult to meet production schedules.

Fulfillment Expense

Fulfillment expense relates more directly to sales than does any other type of expense. If sales increase, fulfillment expense will probably increase in a similar fashion. Fulfillment expense usually includes the expense of order entry, customer service, credit and collection, shipping, and warehousing. A press may perform these functions itself, it may contract with an outside supplier for these services, or it may have a mixture of internal and external fulfillment.

If your press buys fulfillment services from an outside supplier, then budgeting is normally pretty straightforward. In this case, your expense budget is determined by the contract with the supplier and will follow directly from your sales, returns, collections, and inventory forecasts. External fulfillment expense may appear on only one line in your budget. Internal fulfillment is a little more complicated to budget. Office and warehouse expenses are usually separated. Office expenses include salaries for order entry, customer service, and credit and collection; equipment maintenance, rental, and depreciation; 800-number telephone lines; PubNet and EDI fees; supplies; bad debts and collection expense; temporary employee's wages; and other small miscellaneous expenses. Warehouse and shipping expenses include salaries and temporaries' wages, occupancy costs (rent, utilities, janitorial, insurance, etc.), equipment rental, depreciation and maintenance, supplies, shipping charges net of recoveries, and small miscellaneous expenses.

Salaries for both the office and warehouse are budgeted in the previously described way. It is, however, necessary to remember that university press sales are seasonal and that there may be a need for seasonal fulfillment employees. Equipment costs usually can be derived from rental and maintenance contracts and depreciation schedules for equipment that has been purchased. Most of the press's fulfillment-related data processing costs appear under equipment costs. Depreciation will later be described in greater detail. Fulfillment supplies in the office and the warehouse usually will follow sales pretty closely.

Bad debt expense represents those accounts receivable that you expect to write off during the coming fiscal year. Your press may write these accounts off directly to expense, or, as is preferred, it may charge a planned amount to a reserve for bad debts each fiscal year. The latter method has the virtue of smoothing out bad debt expense and building up a cushion to protect a press from unusually large write-offs. When establishing a budget for bad debt expense, you can use the historical experience of your own press and other presses, as shown in the AAUP statistics survey, as rough guidelines, but don't forget to temper your figures for your press's special circumstances.

Unless you are actually making changes to your warehouse's physical plant, occupancy expense usually stays fairly stable from year to year. It often needs adjustment only for inflation.

Unrecovered shipping charges are tricky to budget for. Ideally, most of us probably want to minimize these charges, but that is easier said than done. Special postage and freight offers from marketing have to be taken into consideration when budgeting this item, and rate increases have to be allowed for. A percentage of net sales can be used to budget this item, but the post office and other carriers should be asked about possible rate changes beforehand.

General Administration

Finally, we come to budgeting for general administrative expense. G & A is to a certain extent a catchall for those operating expenses that cannot be attributed to other departments. Typically, in addition to salaries and benefits, G & A expense includes travel and entertainment, occupancy, some EDP costs, telephones, office supplies, professional fees, copying costs, membership fees, insurance, depreciation, expensed equipment, university assessments for services, general office costs, postage, and other miscellaneous expenses.

Travel and entertainment is normally fairly easy to budget. This type of expense usually represents management and business office travel for fund-raising, workshops, AAUP meetings, possibly ABA, Frankfort, etc. Except for small presses, it probably does not involve acquisition travel or exhibits at academic meetings. Budget this type of expense after reviewing proposed departmental travel plans for the new fiscal year. It is usually a fairly stable item, and it is also controllable and therefore a target if cuts have to be made.

Occupancy cost includes rent, janitorial, maintenance of your building, heating/cooling, and utilities. It is relatively straightforward to forecast. Obviously, it does not relate directly to publication level or sales. Some of the factors that you need to consider are leases and contracts, wage increases, utility rate increases, inflation, and weather. Weather affects heating and cooling expenses tremendously, so in budgeting for next year, allow for at least an average year, if not a bad year. Don't fall into the trap of setting utility and heat/cooling costs unrealistically low for next year based upon this year's mild weather. For many presses, occupancy cost may be covered by fees paid to the university. In this case, the university can be of help in setting the budget.

Some EDP or electronic data processing expenses are often allocated to general administration to cover accounting- or administrative-related computer expenses as opposed to order fulfillment-related computer expenses.

Telephone, telex, and fax expenses can be significant for university presses. It may be shown in each department's budget or forecast solely in G & A. Budgeting can normally be based upon old bills, adjusted for inflation, while also making allowances for growth in staff and new types of service (i.e., fax, voice mail, 800 line, different long-distance carriers, etc.).

Office supplies include stationery, pens, pencils, file folders, and all the many other readily consumable items that most departments use every day. It does not include equipment, nor does it include data processing or fulfillment supplies, although deciding what is what can be difficult.

Professional fees are normally legal and audit fees. The auditing portion of this expense will vary depending upon the nature of your audit. Is it done by internal or external auditors? Is it complete or partial? Does the press pay for it, or does the university? Has there been a change in the way you do business or in your financial reporting? The legal portion of professional fees is more irregular than the auditing portion. Legal fees tend to be related to contract and lease negotiations, and to lawsuits. These occurrences cannot be precisely anticipated. If your press must pay its own legal fees, then you do need to allow for this in your budget. The chances are, however, that actual expense will vary quite a bit from year to year.

Copy costs can be budgeted and reported by department, or they can be consolidated in G & A. Copying costs include both internal and external costs.

The most important components of membership fees for most university presses are AAUP and AAP dues, but other association fees and duties may also show up in this budget and expense category.

Insurance expense most commonly consists of property and liability insurance premiums. Insurance expense will vary from press to press depending upon whether the press is covered under university policies and whether the university expects the press to pay for insurance. Often, press insurance experience is mixed. For instance, the university may provide general property and liability coverage to the press free of charge, but the press may have to pay for special publishing-related coverage.

Depreciation is a systematic allocation of a fixed asset's original cost over its useful life. Budgeting this expense is a matter of taking scheduled depreciation from the previous year and adjusting this figure for new purchases and for assets that have become fully depreciated. Depreciation will normally change from year to year by relatively modest amounts unless your press has made a major purchase, such as a new computer system or a building. In setting a depreciation budget, you need to take into account the varying methods and duration of depreciation for different types of assets. There are two methods of depreciation: straight line, and accelerated, which can take several different forms.

Sometimes, because of funding or financial factors, a press may prefer to recognize the entire cost of a piece of equipment in a single year's budget and financial statements. This practice is called expensing equipment. If you follow this practice and you plan to buy a $30,000 postal and shipping system for your warehouse, then the full $30,000 would appear in your budget instead of just the first year's depreciation. Expensing equipment is probably more common at presses that use cash-based financial systems or that have minimum dollar value requirements for capitalization of equipment.

University assessments for services may take the form of specific charges tied directly to services that the press receives, or they may be more generalized charges meant to support a wide spectrum of university administrative services and overhead. The university is normally able to provide the press with guidelines for setting the budget for these types of assessments. University practices regarding assessments vary greatly from campus to campus. Some presses pay nothing, while others pay their parents fees of several hundred thousand dollars per year.

General office postage does not include direct mail postage or postage for orders. Besides postage, it also includes alternate carriers such as Federal Express and U.P.S. when these carriers have been used for general operations. This can be a good item to cut if you are desperately looking for savings. Many of us spend more than we should on overnight express, and this expense can be trimmed by cutting back to lower grades of service.

The Bottom Line

Subtracting projected cost of sales and operating expenses from sales and other publishing income leaves operating income or loss. It is this line that reveals the financial outcome of a press's publishing operations. Everything that falls below this line is an item relating either to financing or to an activity unrelated to a press's purpose as a scholarly publisher. Just because these items are not publishing-related does not mean they are unimportant. The most significant of these items for most university presses are institutional operating subsidy and endowment income. Other common nonoperating income and expenses appearing below the operating line include interest income and expense, and discounts earned. After these nonoperating items are taken into account, a press is left with its ultimate bottom line, either a projected net income or a net loss. If this projected bottom line is unacceptable, then the budget will need to be reworked to establish a more acceptable outcome. This process should involve the same people who were active in the first round of budget preparation. Ideally, the final operating budget will have involved broad participation from the staff and consensual decision making that will result in staff commitment.