Seven Steps to a Better (and More Effective) Budget

posted in: Financial Modeling | 0

Ensure your budget prepares you for the trip ahead.

 

High-growth, early stage companies excel at identifying a gap in the market and creating products and services to fill that gap. They’re often very good at ramping staff, engineering workarounds and developing go-to-market strategies. In many cases, they’re also very good at raising money from investors, venture capitalists and strategic partners that rely, at least partially, on comprehensive business modeling.

In contrast, what they’re often not very good at is budgeting. Budgeting is distinct from modeling in that it specifically focuses on what you’re going to spend in a given period. It provides your department heads with bright-line guidance about what they can and cannot do, and forces everyone within the company to think of capital as a finite resource. Most importantly, an honest budgeting process requires the two most diametrically opposed participants in your business – the sales folks and the engineers – to work together in predicting how much capital will be needed to 1) operate the business, and 2) achieve the company’s growth goals.

In our work as on-demand CFOs for growth companies, we see all flavors of the budget process. Some companies won’t buy a pencil without it being accounted for in a budget, while others reach millions of dollars in revenue and 100+ employees without ever even spelling b-u-d-g-e-t in a meeting. In my experience, the larger the company becomes without a formalized budgeting process, the greater the risk of an unpleasant surprise down the road. A few pointers that can help make budgets a regular part of your growth company’s lexicon:

1. Bring your senior team into the process as early as possible. They are the ones that will have to live within their respective parts of your budget, so it is only right they are there at the inception. Importantly for growth firms, make sure all the company’s stakeholders have a chance to impact the promises made on their behalf by others around the table. This is where compromises that the enterprise as a whole can live with are made, which in turn aligns your senior staff behind the operations of the business.

2. Use your model, but expect revenue expectations to be optimistic and costs understated. Just make sure your team also knows there is no prize for leaving money on or off the table. Particularly with high-growth businesses operating at a loss, capital has to be allocated to where it is most productive, which is usually in hiring staff and buying equipment. Discourage your executives from inserting some sort of “buffer” just to make their numbers – it’s a disservice to the company and its investors, since capital could have been allocated elsewhere, and it misses the larger value of a budget in the first place.

3. Beware of over-active imaginations. Many growth company executives bring tremendous energy, ideas and skills to the enterprise, but are young and/or inexperienced when it comes to business administration. When it comes to budgets, this can be manifested in an unwillingness to commit to detailed targets and an aversion to granularly predicting the true costs of a project or product. Make them do it anyway – you’ll both be better off.

4. Make budgets realistic. Conversely, growth company executives that hail from large Fortune 100 businesses will be very accustomed to planning budgets. In fact, they may approach the process with a level of complexity that is unlikely to mesh well with a fast-paced, dynamic startup environment. Budgets should be approached with discipline, but be realistic. Almost by default, growth companies are in a near-permanent state of flux and evolution, so make sure those executives are going to be willing to roll with the punches without driving the rest of the team nuts.

5. Watch your cash. If all goes to plan, you should be able to forecast how much cash your business will burn or generate over the budget cycle. Particularly in high-burn situations, it is easy to budget based on your expectations of sales and expenses without making allowances for the vagaries of refunds, cancellations or accounts payable terms. Nothing will bust a budget faster than making a landmark deal with a blue-chip customer that, as a matter of policy, doesn’t pay its invoices for 180 days.

6. Use your finance department as a partner. Whether you’re working with an in-house CFO or director of finance, on-demand providers like Burkland, or a well-versed partner carrying the load until you can hire for the job, the finance folks should create a series of initial projections and metrics based on prior years or your model, and then refine/expand it from there – with the input of your senior team – to reflect the upcoming year.

7. Measure, Monitor and Message. The real value of a budget is as a roadmap, so keep tabs on how you’re doing through the year, and communicate it. Are you on or close to plan? What has come up unexpectedly that throws your projections off course? Do you need to re-forecast? Your senior team should be accountable to their portions of the budget, so keep it in front of them, and provide incentives to hit the mark. One company we work with ties a portion of each senior manager’s bonus to whether they come within +/- 5% of their portion of the budget.

Instituting the proper budgeting process into your company’s DNA will pay dividends down the road in terms of operational clarity and reporting. Plus, you’ll show your employees, advisors and investors that you’re just as serious about running a company as you are about gaining traction, going viral or disrupting the incumbents.

 

Photo courtesy of Christopher Michel