New Year New Budget (Part 2 of 2)

I was listening to a podcast today with ex professional cyclist George Hincapie who after retiring has now a number of business interests.? He was asked if he still sets goals to which he answered not really.? This worried me, as every business should have at the very least a set of financial goals or a budget in order to effectively enable a ?businesses to allocate resources efficiently, control costs, and make informed decisions.

Once set, some companies take a very static approach to reviewing the budget for the year with actuals reported on each day, week, month or quarter with no amendment.? However, with companies at all stages a great deal can happen in 12 months and I think modern day leaders need to be reacting and adjusting to challenges and opportunities. ?

Two concepts I like as part of budget management is firstly to always have an annual revenue and cash outturn ?that is effectively adding a forecast for the year to the actuals YTD based on the information you have at the time. ?It is important that this doesn’t just add the rest of the years budget to actuals as if the sales or marketing leads are lower than assumed, or if there is a revenue shortfall due to pipeline conversion not occurring as assumed, or there is a cash shortfall due to debtor assumptions or additional capital investment, knowing this at least 6 months ahead of time allows you to make course corrections and decisions by having an outturn.

This leads into the second concept of dynamic budgeting, also known as rolling forecasting or continuous budgeting, rather than the traditional annual budgeting process.

Instead of creating a fixed budget for the entire year, dynamic budgeting involves regularly updating revenue, overhead and cash forecasts based on real-time data, market trends, and changes in business conditions. This approach enables businesses to be more responsive and agile, allowing leaders to make informed decisions in a rapidly changing environment.

It can also allow you to scenario plan and develop multiple options to debate before making decisions. I do think by doing this you can make decisions quicker rather than either delaying further investment for growth to the budget planning cycle or sleep walking into a loss making and cash out position.

However, I think there are issues with a pure dynamic budget approach as it effectively allows goal posts to move and ?can mask issues such as imperfect management information data, poor forecasting, sales execution, cost of sales or overhead management etc.

To overcome this, one key way to improve forecasting accuracy is to develop a stagger chart, which was developed by Intel’s Andy Grove. The chart tracks actual revenue growth for the business as well as how the forecasts for a particular month have changed with time. When forecasts fall out of line, it’s a red flag for the team to investigate the cause, or causes, for the deviation.? Bridge diagrams are also very useful to understand why things are above or below where initially budgeted.

An alternative to full dynamic budgeting is advocated by well known venture capitalist and entrepreneur Brad Feld known as a ?“first half, second half” approach to budgeting if conditions warrant a midyear reset. As Feld points out in his blog, FeldThoughts, “this is just a practical, commonsense move, because if you are not tracking close to budget, then the original budget serves little purpose in the day-to-day operations of the company. If this is the case, trash the existing budget and come up with a new one for the second half of the year.”

I do think like Grove’s technique keeping an eye on under/over performance is important as the more consistent you can be with budgeting the more confidence it breeds for all stakeholders.

One other area I suggest always gets reviewed which in my experience gets less scrutiny when reviewing the management accounts is a focus on the balance sheet. I like to see a detailed balance sheet to fully understand any debtor or creditor stretching, pre-payments and accruals as well as revenue recognition that can often not be picked up in a P&L or cashflow review.

So whether you have just set your budget for 2024 or are currently planning for April month 1 having effective budget management is a cornerstone of financial success for businesses of all sizes.

Once set, by consciously thinking about these techniques for managing your budgets throughout the year, businesses can gain better control over their finances, optimise resource allocation, and drive sustainable growth.

I look forward to hearing your thoughts on how you approach your budgets.

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