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Building a Better Budget, Part 3: Forecasting Expenses

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SKILL SETS: BUDGETING

Building a Better Budget, Part 3: Forecasting Expenses

by Marion Gropen

When you’ve learned how to get more from the process of budgeting and how to estimate the sales of future titles—see parts 1 and 2 of this series in the May and June issues—the next steps are relatively easy.

They involve estimating your expenses, including expenses for cost of goods sold, distribution, marketing, and other operating activities.

Cost of Goods Sold

Your cost of goods sold (COGS) should be divided into three pieces: royalties, PPB (paper, printing, and binding), and plant costs. Be careful. Plant costs are defined differently in our business than in every other industry. We’ll get to that difference below.

Royalties. You know what royalties are. Because they’re defined by contract, it’s conceptually simple to project the royalties earned as a function of the sales of each title.

Computations for royalty expenses can be a little more complicated. If you have a few titles, you can just multiply the dollar sales figure for each title (at list or at net cash) by the royalty rate that applies. If you have hundreds of active titles, you may be able to apply an average percentage to your total sales and be accurate about the total expense.

If you have more than a handful of titles, but not hundreds of them, you should probably have general formulas in your spreadsheets so that the calculations are automated.

Paper, printing, and binding. PPB costs are variable costs, the kind where the total for each title changes with the number of copies printed or sold (as opposed to fixed costs for such things as cover design, editing, or proofreading, which do not change when the total cost for the title changes).

Variable costs of goods sold almost all show up on your printer’s bill. All variable production costs should be included in PPB, whether they’re actually for printing, paper, and binding or not, and whether they’re included in the printing bill or not (rarely, some aren’t). And you should include variable costs in the unit cost of a book.

You can predict PPB quite easily. Just use quotes from printers responding to your RFQ or look at the printing cost of books you’ve done recently that were similar in size and printing requirements; then multiply the number of copies in your sales estimates by unit cost.

Book PPB into inventory and convert it incrementally to an expense as each copy is sold.

Plant costs. Do not include your plant costs in your inventory value, or in your unit cost. This can be a very expensive mistake, and it’s also unfortunately a common one.

Unlike plant costs in other industries, plant costs in publishing are not fixed costs related to buildings or durable equipment. Instead, we use the term to mean the fixed costs related to editing, cover design, and the like. All fixed costs of this sort are called plant costs.

Why use the same term with a different definition? I have no idea, but I do enjoy the odd quirks of our business, and this is one of them.

With accrual accounting, and for tax purposes, you must accumulate those expenditures as an asset, and then amortize them over the expected lifetime of a book, deducting a portion each month, or each year, from your assets, and then adding it to your expenses, until the entire asset has been expensed.

What’s the “expected lifetime”? You can define it as any period that’s reasonable. If you’re doing mass-market fiction, the lifetime will be much shorter than if you’re producing evergreen titles that are likely to sell for decades. But you are no longer allowed to move all the plant costs from asset to expense on the publication date of a book, regardless of whether that was ever acceptable.

To expense this asset, you can choose from among several methods, and then you must use what you’ve chosen for all books of each type that you publish. Examples include straight-line amortization MACRS (this stands for Modified Accelerated Cost Recovery Schedule and is described in IRS publications). I usually choose straight-line, for its simplicity.

If you’re producing a similar number of books in similar ways each year, the choice of method doesn’t significantly change your taxes, or your financial statements. That being the case, go with simple.

If you expect your books to sell for one year, and you’re using straight-line amortization, then budgeting this expense is easy. Estimate total plant costs (as we in publishing define the term) for each book. Include editing, proofing, indexing, design, art, and all other fixed production costs. Then divide that total by 12, and stick the number you get into the plant expense line for each title in each of the 12 months after the book is released.

If you keep doing the same type of book, with similar numbers of pages, you can probably safely assume that each title will incur roughly the same expenses per page or per category.

Distribution

This is the simplest expense to estimate. It is usually determined by your distribution or fulfillment contracts. Simply apply the contract rates to your estimated sales (and figure returns in if and as necessary).

If you are doing your own selling, warehousing, and fulfillment, then rely on your past experience (or, if you’re brand-new to publishing, use your worst-case estimates) to determine the hours of labor, the rates for that labor, and the costs of materials, facilities, and so on. Remember to add a margin of error, and a multiple for inflation.

Make distribution expense a separate line on your budget and on your income statements, so that you are reminded how large a chunk of expenses it is. A clear view of distribution costs may stimulate you to find ways of bringing your books to your readers more economically.

Marketing

Marketing expenses may already be laid out in your marketing plans. If so, test them for cost-effectiveness, and consider whether the plans are plausible in terms of their intended results. Then update the marketing plans, and add a line for marketing expense, or a line for each type of marketing expense, to your schedules of expenses.

If you don’t already have an explicit marketing plan for each frontlist title, this is the time to create them. Start by assessing the target readers. Who are they? Where can they be found? How many people will see each element of your marketing campaign? How many of them will be the people who might want or need your book? How many of those people will buy after encountering your marketing material—1 percent, 2 percent, as many as 5 percent?

When you have estimated a marketing campaign’s results, figure out how much it will cost to achieve those results. Include the cost of ARCs and other complimentary copies, as well as the costs of shipping or postage, packaging, list buying, travel, ancillary materials, and on and on.

Now compare a book’s expected dollar sales minus the cost of printing and distributing that book to the expected costs for each major campaign. Then ask yourself: Is there something I can do to improve my margins on these sales? Is there some way to use the same marketing efforts to support more than one title? Are there better ways to market this book?

Keep fine-tuning until your sales projections are satisfactory, and the expenses required to support those sales leave a sufficient margin to keep your company afloat and cover unforeseen events.

General and Administration

These are all the “business” expenses, also called overhead. You know the ones: rent, utilities, wages and benefits, office supplies, travel and entertainment, and on and on and on.

You can simply apply a fixed increase to the total from last year and call it a day. But, and this is important, if you spend a little time now, you may be able to plan a way to reduce these expenses.

Given the discounts, COGS, distribution, and marketing chunks that come out of your revenue before it begins to cover these lines, a dollar cut out of your overhead can have the same effect on your profits as six or even ten dollars in increased revenue.

Of course, not all cuts in overhead spending are wise. But if you can cut these lines, and do it without undue hardship or large cuts in sales, it’s worth a few hours of thought once or twice a year. And this is a good time to look at your leases, at whether you actually need all the items you have in storage, at your staffing requirements, at your supply contracts, and at similar sorts of dull, not-book-related items.

All Together Now

When you’re done with the full panoply of estimations and projections described in this article and the two earlier articles in this series, summarize all the details and pull them together into a cover sheet that looks something like this:

Hypothetical Company, Inc.

Budget for FY 2011

Income Statement Summary Sheet

Revenue

Gross sales, after discounts

$1,000,000

Returns

$ 250,000

Net sales (of copies of books)

$ 750,000

Subsidiary rights, after author’s share

$   50,000

Total sales

$ 800,000

COGS

Royalties

$150,000

PPB

$175,000

Plant

$ 80,000

Total COGS

$405,000

Distribution

$165,000

Gross margin

$230,000

Operating expenses

Marketing

$  50,000

General and administrative

$150,000

Total operating expenses

$200,000

Operating income

$ 30,000

Extraordinary items, interest, taxes

$   9,000

Net income

$ 21,000

Reviewing, Reality Testing, and Revisiting Strategic and Operational Issues

So far, you have estimated all the expenses and sales for each title in your frontlist, and for the backlist as a whole. And you have assembled the aggregated sales and expenses by type into an overall summary sheet.

Now look at that summary. It’s time to start asking yourself, and your management team, some hard questions:

• Is the income line large enough?

• If something explodes in our faces, do we have enough “margin of error” to cope with the consequences?

• Can we actually put all our plans into action simultaneously, given our resources?

• How realistic have we been?

• Is there any “friction” in our operation that uses resources unnecessarily? How can it be removed? What will those changes

cost, and what will they yield?

The list of questions should also include some about your long-term future, such as:

• Where do we want to be, as a company, in five years? In ten?

• Does this plan help us get far enough down that road? And if not, what more do we need to accomplish?

• Where is our industry headed? What will e-books do to our part of it?

• Are we able to provide value to our readers in the e-book environment?

• What can we do this year to enhance what we will offer to readers in the future?

• What can we do to help our authors become better at promoting their own books? Can we help them help us more in this wired

age and in light of the developments that loom ahead?

When you’ve answered all these questions, and many more of the same ilk, go back and revisit your budget with an eye toward tactics.

• Now that you have goals to meet, how can you make the books you have in the pipeline help you meet them?

• What other types of projects can you add to the pipeline that would help?

• Where would you look for them?

Then, when you are satisfied that you have planned your way to the best possible future for your firm, you need to give yourself a reward and take a small break. There’s more budgeting work to be done (and more to come in this budgeting series), and then there’s the work required to execute your plans. But for now, you’ve done a good job and deserve some downtime.

Tune in next month for Excel-based tips and tricks that will help you tackle number crunching in an easier and more efficient way. The following month’s article will focus on the cash flow budget, and on making sure that your working capital is sufficient to meet your needs.

Marion Gropen consults with micro- to medium-sized publishers on financial and operational issues and offers consultations by the question for smaller publishing companies. She recently published the first part of her e-book series, The Profitable Publisher. To learn more, visit GropenAssoc.com. You can reach her, with questions about this article or other publishing issues, at Marion.Gropen@GropenAssoc.com.

A Slot for Subrights

Subrights are often handled as an afterthought to the budgeting process, maybe because the revenues they produce (which can be substantial) pertain to sales but do not pertain to the involved practice of estimating the sales of copies of a book.

When you sell the paperback rights, audio rights, or any other rights to a book’s contents, you split the funds received with the author, but the rest of the money drops, almost untouched, straight through to your bottom line. And subsidiary rights sales can also help you create marketing buzz for your books. .

For budgeting purposes, you can project subrights sales in two ways: either as a fraction of the total sales projected for your frontlist, or on a title-by-title basis. If you choose the latter, I strongly suggest that you reduce the amount projected by at least half, to allow for the fact that not all titles will have rights sales, and for the natural optimism of publishers who fall in love with their own lists.

 

 

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