April 15 is almost here, and it’s time to spread out your records, last year’s returns, this year’s tax forms, a calculator, and plenty of scratch paper. Each year about this time we moan with frustration as we fill out our tax return, often including a remittance because once again we owe more than we’ve already paid. We vow we’re going to be more organized next time and budget better so this doesn’t happen again.
It’s probably too late to do anything to minimize your 1990 tax bill, but now is an excellent time to turn spoken vows into concrete action---and you can start by establishing a budget for your salon. Whether you’re just starting out or you’ve been in business for a while, you need a budget. At its simplest, a budget is a business tool that helps you set financial goals. As a decision-making tool, a budget assists you in planning for major purchases, renovations, savings, and other expenses.
Finally, a budget is of paramount importance in minimizing your tax liability. For example, if you’ve been carefully budgeting all year, you may find it beneficial if your salon is operating at a loss to postpone a major purchase until next year. Conversely, you might find that making a purchase before the end of the year is to your advantage if your salon is making a profit. Without a budget, you’re operating in the dark.
Once you set up a budget, you can compute monthly profit and loss statements, which are reports that help you identify your actual financial standing. A profit and loss statement forms the basis for figuring your financial history. From them you can understand business trends, track slow periods, and even determine which services are most popular and profitable.
SIMPLIFY WITH CATEGORIES
The two basic components of a budget are revenues and expenses. Revenues are your gross sales from services and merchandise. Expenses include any costs you incur in the operation of your business--- products, commissions, new furnishings, or ballpoint pens.
Any money paid to the salon is considered revenue. Revenues are clear-cut and usually divided into two categories: revenue from services (what you charge for service) and revenue from merchandise (your income from product sales). Expenses are also considered in two categories: fixed or variable.
Fixed expenses are any costs you incur that are not dependent on salon sales. These costs are usually called overhead. Rent is typically your largest fixed expense. In some lease, however, a portion of the rent is variable if you have agreed to pay a percentage of gross receipts in addition to, or in lieu of, a fixed rental amount. In this case, the fixed portion of the rent would fall in the fixed category, while the additional sales percentage would be included in variable expenses.
Utilities are a fixed expense, but they may vary by season and the number of customers you serve. Although the dollar amount may fluctuate each month, you can assume a base amount that includes water, electricity, telephone, and gas. Utility charges above this base amount will be categorized as variable expenses. Liability and fire insurance are fixed expenses that should not vary within a single year.
The decrease in value of salon equipment, called depreciation is an often forgotten fixed expense. For example, if you purchase a $100 chair that has a useful life of five years, you can compute the yearly depreciation by dividing the $100 purchase price by five years. The depreciation for the chair is $20 per year. Calculated at $1.67 per month, the amount seems minimal, but once you figure depreciation for all durable goods in your salon, you’ll be surprised.
This type of depreciation computation is commonly referred to as straight-line. Although you own the equipment and do not actually pay the amount budgeted for depreciation to anyone, the value should be put into a savings account because you will need to purchase replacements as the equipment wears out. Depreciation is an allowable tax deduction, but the IRS has its own methods that you must follow for calculating depreciation.
Fixed expenses are simple to figure into the budget because they do not change. Variable expenses are more difficult to determine because they depend on the salon’s monthly sales, something you can only estimate when preparing your budget. In a service-oriented business such as a salon, you should compute your variable costs as a percentage of service revenues. For example, if you charge $10 for a manicure, you could break down your variable costs as follows:
Variable Cost % of Sales $ Amount
Payroll 50 5.00
Payroll taxes 10 1.00
Supplies 10 1.00
Utilities 1 10
Employee Insurance 5 50
Total 76% $7.60
Profit and Loss Statement
Merchandise Sales $1,800.00
Miscellaneous (Interest, etc.)
Total Revenues $13,825.00
Operating Supplies $1,100.00
Repairs and Maintenance $75.00
Interest on Charge Accounts
Taxes (Payroll, Sales, etc.) $2,000.00
Merchandise for Resale $900.00
Total Expenses $12,025.00
NET INCOME before income taxes (Total Revenues
Minus Total Expenses Equals Net Income) $1,800.00
While percentages may vary for your salon, based on these sample figures, a salon owner could expect a 24% profit on every dollar of service revenues before deducting overhead expenses. In this case, your profit before deducting fixed assets is $2.40. Computing your variable expenses as a fixed percentage of service revenues greatly simplifies the figures instead of guessing your variable costs, you can state them as a fixed percentage of your service sales.
To compute fixed expenses as a percentage of service revenues, you’ll need to estimate your total monthly revenues. If you know you sell an average of $11,000 in services per month and your salon overhead is $1,100 your fixed expenses will be 10% of each sales dollar (11,000 divided by 1,100). Add this to 76% for variable expenses, and you know that just about 14% of your gross revenues will be profit.
Another important expense is employee commissions. If the salon earns $10,000 and employees earn 50% commission, $5,000 of the salon’s income will be paid to employees.
Operating supplies will also vary depending on the number of customers. Be sure to factor all salon supplies---such as pens, paper towels, toilet paper, business cards and letterhead---even if they are not used directly during the nail service.
Other variable expenses you may incur include payroll taxes, employee insurance (if offered), equipment repairs, advertising, and laundry.
Retail products are also a variable expense, but their cost should be a fixed percentage of your retail sales.
Once you understand revenues and expenses, constructing a budget will be much easier. Calculate and categorize your fixed expenses first.
Now tackle variable expenses. Established salons can use past months’ revenues to estimate their variable costs. For example, you should know how much product you use in a month. Estimate product usage by computing how many services you can do with one container of product, and then divide the cost of the product by that number. Do the same for brushes, cotton, and any other disposable supplies. Durable supplies, such as nippers, will be a fixed, depreciated expense. This may take an afternoon to figure, but it will allow you to closely estimate your cost-per-service. Repeat this exercise to estimate all your variable expenses. New salons may not have a revenue history, but you will know your fixed expenses. If you are deciding whether or not you can successfully operate a salon, you can prepare a sample budget to determine how much revenue you need to stay open and make a profit.
Calculate an approximate rent and research how much your utilities will be. Talk to an insurance agent to figure insurance expenses, and then investigate furnishings. Once you have an idea of monthly fixed expenses you can determine variable expenses.
You can now determine how much revenue you need to earn a reasonable profit. First, look at your fixed expenses to determine the minimum number of clients you need. For example, your research tells you that your fixed expenses will be $1,100 per month. If you think the majority of your business will be fill clients and you plan to charge $20 per fill, you deduce that you’ll need 55 clients per month just to pay your fixed expenses.
However, our earlier examples show that variable expenses take the largest chunk of each service ticket (unless you have no employees; then your variable expenses will be much lower). For simplicity, let’s assume you are the only technician in the salon and that variable expenses take 25% of each service ticket. So $5 of each service pays your variable expenses. When you figure variable expenses into the picture, you actually need 74 clients a month to break even. To make a profit and draw a salary, you will need many more clients, but at least you can determine if it’s realistic to expect to attract 74 new clients.
If you discover that the maximum number of customers you can serve will not allow a profit, you have to either lower your expenses or raise your prices. If you determine you need more clients, you have several options: increase advertising, hire technicians with large client followings, offer competitive, pricing, plan promotions, or offer the services other local salons don’t.
Failure to sit down and prepare an estimated budget has hurt many new businesses. According to the Small Business Administration, as many as 24% of new businesses fail within two years, and 63% fail within six years. Advance knowledge and planning don’t guarantee business success, but they do help you evaluate the viability of the investment.
A REASONABLE RETURN
Many people have started their own business only to discover they’re making far less money than they could working for someone else. If your primary motivation for opening your own salon is profit, you should budget a reasonable financial return on your time. Your time is valuable and you will spend much of it working for the salon---whether doing nails, balancing books, ordering supplies, managing personnel, or taking inventory. At some point you need to set a monetary value on your time and include it in your budget.
Reasonable return means something different to everyone. Unless you are able to support yourself without income from the salon, the reasonable return should be enough for you to live on. Beyond that, you must decide how many hours you want to work to earn the money. Obviously other factors will apply, such as the pleasure of being your own boss and pride of ownership. But at some point, you’ll have to weigh your investment of time against what you get in return financially.
THE BIG PICTURE
Once you have a budget, track your progress monthly with a profit and loss statement. While a budget projects what you think your revenues and expenses will be, a profit and loss statement reveals the actual figures after the fact. Record your actual revenues by category and total the numbers. Then list your actual expenses by category to get this total. Subtract your total expenses from your total revenues. This amount is either your profit or your loss.
Investigate any large variances (usually 10% or more) between your budget figures and your actual figures. There are bound to be some discrepancies due to wishful thinking or excessive caution, but large variances require corrective action. Perhaps a nearby salon is advertising heavily and drawing your customers away with lower prices or promises of better service. You can bring your revenues in line by advertising, holding in salon promotions, or taking other competitive action.
Comparative profit and loss statements list a prior profit and loss for comparison to determine if any changes you implement are having an impact. For example, if you had a special promotion one month, a comparative profit and loss statement would show the revenue increase. They also illustrate changing business conditions. As a business tool, your profit and loss statements cannot be overemphasized.
Not only do profit and loss statements take the pulse of your business, they help at tax time. While the IRS will not accept a profit and loss statement as evidence of a business income or expenses, they do evaluate them to summarize your business activity. Use these statements to estimate quarterly tax payments as well as to track itemized deductions. If you do a monthly profit and loss statements for the year and double-check the final figures against your records.
By using both a budget and profit and loss statements, you can begin planning for major purchases, renovations, and even expansion. A profit and loss statement lets you know if you need to incur, or can afford, expenditures, and a budget allows you to plan when you will incur the added costs.
Steve Burgess is a self-employed tax preparer living in Orange Country, California.