budgeting on MBA Mondays. Since the budgeting process works differently
in companies of various sizes, we are going to focus on three company
sizes; 10 people, 75 people, and 150 people. Today we will talk about
the 10 person company scenario.
As I said in a
previous post, I have been working with Matt Blumberg and Jack
Sinclair, CEO and COO/CFO of our portfolio company Return Path on these budgeting
posts. I have been involved with Return Path for ten years now and I’ve
watched Matt and Jack run excellent budgeting processes and so we are
getting the benefit of their work and learning in these posts.
Last
week, we talked about projections.
It is important to run a projections process before you turn to
budgeting. Think of budgeting as a refinement of the projections process
where the goal is to predict what is going to happen in a particular
calendar year.
I believe that budgeting should be done on a yearly
basis. If you want to start budgeting and you are in the middle of the
year, that is fine. Just budget for the rest of the year and then do
your first full-year budget in the late fall.
The late fall is
budgeting time. October and November are the best months to do it. If
you have a board, you should be able to present your budget for the next
year to the full board in December so they can approve it before the
year starts. If you don’t have a board, then you should be able to lock
into a budget with your team in December.
The budgeting process
starts with a financial model. If you have done projections, then you
should have a financial model already built. If you haven’t done
projections, then go back to the projections post,
follow the directions, and do some projections. Then come back and read
this post.
The first step in budgeting is to review the key
business metrics and lock them down based on what is realistic for the
next year. Be very realistic. A good budget is a conservative budget. In
a 10-person company, the budgeting process can be done by a couple of
the senior managers, typically the CEO and the most financially savvy of
the other team members. These two people can run the process all by
themselves without any input from the rest of the team. That will change
quickly as the company grows, but in a very small company you do not
need to involve the entire team in budgeting.
If the company is
pre-revenue as many 10-person companies are, then the focus will be on
hiring and people costs. And the budgeting process will largely be about
spending and how many people the company can hire and how much money
the company can spend and how long its cash will last before needing
another round of funding.
If the company has revenues, they will
not likely be large yet at 10 people, so the revenue forecast will be a
bit tricky. In the first few years of revenue generation, the revenue
model changes a lot and the drivers of it change too. I would encourage
everyone to be conservative about revenue budgeting early in a company’s
life. Most budgets are missed because revenue does not come in as
planned.
Make sure to include a cash line item in your budget.
Most budgets are done as profit and loss statements which is how they
should be done. But you should back into a cash projection based on the
profit and loss numbers and include that line item in your budget. If
this is new material to you, go back to my posts on profit
and loss, balance
sheet, and cash
flow to see how these three statements work together.
Once
the budget has been locked down and approved by the board and/or by the
senior team, you should share the budget with your entire company. Some
executives don’t like to share the entire line by line budget with the
team and I can understand that. Some executives don’t like to show a
cash line that runs out with the team and I also understand that. But
you should at least show the key business metrics and some of the most
important line items in the budget with the entire company. This will be
their roadmap for the next year and it is important that they
understand it if they are going to be expected to help you deliver it.
All
that said, I favor being as transparent as you can possibly be with
your company. It is hard to hide information from the company. The
important information leaks out eventually and if and when it does, you
won’t be there to provide context. So the more information you provide,
the better off you will be.
Once you have a budget, you need to
measure yourself against it. Each month report the actual numbers versus
the budget and track how you are doing against each key business metric
and line item in the budget. At some point during the year, you may
want to do a reforecast. We will talk about that exercise in a few
weeks.
Next week we will talk about how this process changes as
you grow to 75 people. It a very different process at that point.
(For more from Fred, visit his blog)
(Image source: Piperreport.com)