Labor Day has come and gone, and with summer in the rearview mirror, 2020 budgeting season is here. The next four months will be filled with companies of all shapes and sizes kicking off strategic planning, setting revenue and EBITDA goals, and haggling with their Board and management team over levels of investment.
I’m going to dig into this topic over a series of posts. A few thoughts as your budgeting process begins.
The way you start this process is incredibly important. Budgets have multiple purposes that you need to be aware of from the start.
Your Budget Should Not Be Built Upon Your Most Ambitious Goals
The biggest trap of the budgeting process is to build your plan against your most ambitious growth goals, as some demonstration of confidence in you and your team.
Perhaps you know that you’re going to have to start fundraising again by the end of next year. You want a higher valuation. If your company can grow by 100% year over year, that fundraising process will be a huge success.
Yo know that your board expects huge revenue growth next year. You want your company to be excited about the prospects for higher growth.
But momentum has stalled a bit. Your company ‘only’ grew by 25% this year, and that growth rate has declined each quarter. You can convince yourself that with ambitious growth goals, your budget spreadsheets will magically change the momentum and accelerate growth on their own. You can start to believe that setting high goals in your budget will be enough to will your company and your team to achieve them.
But you know that it doesn’t work that way. Don’t build your budgets on hope.
Budgets Are a Compensation Document
Many founders fall into the trap of building overly ambitious budgets because they believe that setting lower goals will become self-fulfilling prophecies. They think that their team will be happy to settle for hitting lower growth plans. That your final budgets will represent all that the company will accomplish in the new fiscal year.
It’s worth noting that if you have a leadership team that is happy to settle for ‘good enough’, you have a problem with your leadership team.
You can create incentives and goals that drive your company toward outperforming your budget.
Treat your budget as your baseline plan. Set an expectation with your team that the budget represents minimum levels of performance and then incentivize and inspire your team to beat those plans.
Your leadership team, in particular, should have a significant part of their cash compensation tied up in incentives for beating your annual budget. But to make this work, the budget has to be achievable. If you haven’t paid out on your bonus plan for the last three years because you’ve missed your budget goals every year, no one is going to believe in the value of the incentive, and it’s no longer going to serve its intended purpose.
Budgets Set Spending Expectations That are Hard to Unwind
When you build budgets against unreasonably aggressive revenue goals, you will end up budgeting levels of expenses and investments to match.
As your budget process progresses, and your leadership team sees the level of high growth you’re expecting, they will push for investments to be made early in the year to drive the desired growth later in the year. You’ll end up with accelerating expenses in the first half of the year, and a revenue growth plan that is likely back end loaded into Q3 and Q4.
If things don’t go according to plan, and you know they never do, you’re going to end up burning a lot more cash than you expected.
Once you’ve communicated budgets and investment plans to your teams, it’s also very hard to unwind those plans. If you tell your engineering team that they have the approved budget to double the size of their team in the first half of next year, that hiring machine is going to ramp up immediatiarly. Everyone in engineering is going to know that this big investment is coming. It’s exciting when teams are growing, reflecting a feeling of positive momentum and enthusiasm.
If you have a weak Q1 and then have to pull those hiring plans back, it’s going to create a sense of fear, concern and frustration at the whipsawing of plans.
It’s so much easier to ramp into
Your Budget Has a Huge Impact on Morale
Budgets set the guardrails around employee morale for your next year, particularly within your leadership team. It’s the official scorecard of whether your team feels like it’s winning or losing. If you set unattainable goals in your budget, you and your team will be reminded of your shortfalls every month. In every budget vs. actual report that comes out of your accounting team. In every board report that you assemble.
Regardless of how upbeat you are, and how you spin it to your team, if you come out of the gate in Q1 with missed revenue and EBITDA versus your budget, your team will feel like they are losing.
You’ll find yourself reforecasting downward throughout the year. Reducing costs. Canceling planned projects.
Don’t set your team up to fail. It will make the year feel like one long slog.