Budgeting & planning or how to explain the world with financials (a)
Budgeting and financial planning have a lot of advantages and can significantly improve the management of a business. Here it is important to note, that it is not so much about getting the numbers right – instead it is more important to use the forecasting process to create financial awareness within the company. As previously mentioned in another post “the method is not that important – it is more important that these numbers are agreed upon by everybody who can actively influence them (top, middle management at least)”.
eCFO Tips: Budgets and planning gives you, the CFO, the opportunity to teach people the relationship between financial figures, strategy and operational decisions. As a planning and supervisiory tool, financial planning and budgets are absolutely essential. In a well managed start-up you will be controlling costs through the methods described in the liquidity controls – so budgets are not used in the “traditional” way, more established businesses might be using them, e.g. to allocate resources and prevent overspending. Rather, they help you to raise everybody’s awareness of the impact their actions have on the financial results.
Here a couple of quick reasons why planning is a good idea:
- Budgets provide reference points once actual data is collected
- Each department head and manager has to strategically think about the numbers she promises to the CFO
- The CFO will get a good understanding of operational / management skills of each employee
You need to get a good understanding of the 12 months forecast. It does not matter if you really hit these numbers. What matters is that you can compare your actual vs. planned numbers and understand why they might differ. Make sure that these numbers are shared and communicated with everyone in your organization who can directly influence these figures.
You can either go bottom-up or top-down for this forecast.
Bottom-up: Estimate the costs of running your business or various departments and provide these costs in an easy to read way to your CEO/department head. Costs should never be guesswork and they are your domain – even if you only have 3-5 months of operational figures, costs should be fairly easy to project and deviations from your estimates should be below 10% – if this is not the case make sure you check back on your liquidity controls and find out where and more importantly who in your organization is responsible for (potentially) over-spending.
Where it really becomes interesting is planned revenue. NEVER provide estimates of these figures. Always let your operations manager make the assumptions. Often you will be very surprised either by the timidity and fear displayed or by the total failure to remain realistic. Here is where your work starts!
In your initial discussion you should:
- Create a clear relationship between cost and revenue e.g. “Wow you are planning to increase sales by 500% but you are not planning to hire any additional staff? Why is that?”
- Make your counterpart explains the operational assumptions behind sales forecasts e.g. “Wow you are planning to only reach the figures from last year in total but so far you have increased sales by 30% every month last year – why would this not continue?”
- Segmentation of assumptions: Split revenue into existing and new customers e.g. “So you are planning to just continue to generate the revenue you are currently getting from your existing customers. Why is that?”
As you can see from the points above this is really an exercise to visualize strategic goals, assumptions and estimates with the help of financial figures. Most CEOs and department heads you will encounter (whether in start-ups or billion dollar companies) will be operationally focused and will mostly rely on “instincts” and their “gut feeling”. As an eCFO your job is to help translate instinct and gut feeling into financial figures. You will also have to challenge operating assumptions and make sure the decisions are based on sound financial reasoning!
In my next post I will continue the discussion with a description and advice on how to implement a “top-down” approach.