Four Steps To A Successful Budget Process

Yesterday, I wrote a post about avoiding the trap of building budgets for next year that set your team up to fail. 

Over the years, I’ve put together 4 steps that I take at the start of any budgeting process to give my teams the greatest chance of developing a plan that our company can successfully execute throughout the year.

Decide How Much Cash You Want To Have At The End Of Your Next Fiscal Year

I know this sounds obvious, but it’s suprising how often this step is forgotten until the very end of the process.

If you’re an early-stage startup, you’re burning cash. Somewhere in your future is your next fundraise. You need to make a decision as to how much cash you can burn before the end of next year. You want to be clear as to the level of ending cash you are targeting.

You need to draw a firm line in the sand here. It’s the one immovable object in an otherwise fluid process.

Extend Your Expected Year-End Expense Run Rate

Throughout your current fiscal year, you’ve been hiring, investing in new initiatives, and ramping expenses to drive growth. There is nothing wrong with that.

But before you unleash your leadership team to build their wish list of new investments for the next fiscal year, take your expected expense run rate at the end of the current fiscal year and extend it forward for the next 12 months.

It’s often an eye-opening exercise. That slow roll of increased investment this year is going to lead to higher than expected year over year expense growth rates even before you hire one more employee or green light one more project. It’s amazing to see the reaction across your leadership team when they realize that expenses in the new fiscal year are already going to be up 50% or more year over year before they get one more dollar.

Do Some Simple Math To Set Guardrails

Now you can start to put the financial puzzle together. Your P&L and Cash Flow are built on pretty simple math. Revenue – Expenses = EBITDA which is easily converted to cash flow.

You know how much cash you can burn next year. You can tie that back to a target EBITDA loss. Now that you’ve extended your year end expense run rate for 12 months, you know how much your current expense run rate is before you layer on any new investment.

Once you drop in your initial estimates for revenue, you will have an initial indication as to what level of new investment your budget process will allow for. If any at all. When setting up those initial revenue estimates, once again, please don’t set your team up to fail.

You want to show this preliminary financial roadmap to your leadership team at the start of any process. They need to understand that there are constraints on how much cash you can burn and that there is already a meaningful expense growth rate built into the current plan.

You can now kick off strategic planning having set some guardrails in place.

Strategic Planning Must Come Before You Start The Budgeting Process

Too many people treat the budget process like a spreadsheet exercise. They are only too happy to dive into spreadsheets before there has been any discussion about what you should be focusing on in the next year. That’s a huge mistake.

The budget process should be designed to support your strategic priorities for the year. So start by reviewing and agreeing on those priorities with your team. You need to figure out the answers to some very important questions before you open up a spreadsheet:

• What key milestones do you need to hit by the end of the following year? If you’re an early-stage startup, you’re always within 18-24 months of your next fundraise. What do you need to accomplish to ensure that the next raise process is going to be successful?
• What are your stop doing items? What is the 60% in the middle that will kill your company? What initiatives are sucking up time and money without delivering any impact? You need to root out these programs early in your process. They are strangling progress on more important work. This is one of the most critical parts of your budgeting process. It’s the path to unlocking cash for investment in initiatives that matter.
• Take a fresh look at the competitive landscape. We live in a year of constant change and disruption. What assumptions did you make when you launched your company that are no longer true?
• After all of this work and discussion, you and your team need to agree on outcomes for the following year and the areas of investment that will be most important. This is the output you need to start building your budgets.

Unleash The Spreadsheets

Ok, you can start budgeting now. The actual process of budgeting should be a more mechanical process, designed to support the planning work you’ve already done.

Of course, during the process of building your plans for the next fiscal year, new questions will arise, you’ll have to decide between competing priorities, and you’ll find yourself continuously revisiting the work from the steps above.

But at least you’ll have set a solid foundation to start the process.