New Year New Budget

I am on a number of boards as part of my role at Mercia Ventures as well as Chairing a Charitable Foundation and this time of year is budget planning season with most organisations having a calendar or financial year end.  

Traditional budgeting methods, with their static and inflexible nature, are becoming increasingly obsolete and it is common for modern business leaders to turn to alternative techniques to both develop and manage their budgets in order to navigate the challenges of the current market. 

It can sometimes be a painful process for business leaders and the boards approving them, but I don’t think it should be. I believe it should serve as a great opportunity to take stock and review the business and its objectives as a whole in order to develop a budget which then serves as both a plan and a method of keeping score on a daily, monthly, quarterly and annual basis.

In very simple terms, the key components of the budget involve forecasting what the likely revenue growth will be for the year, the associated overheads and the underlying cashflow including any investment requirements.

When reviewing and approving budgets I look for the historic performance in achieving budgets.  If they have always been hit, it is likely that they are generally conservative and alternatively if they are consistently missed there is clearly a disconnect between the budget and underlying reality within the business.  

At some organisations, intense pressure for rapid growth from the board of directors or indeed investors can push leadership teams to develop an overly aggressive and unrealistic budget. Whilst this keeps the peace in the short term, the likelihood that actual performance will fall short of budget projections leads to tension and distrust down the road (unless you are Elon Musk who knowingly sets targets that he knows cannot be met! ). 

If there is a step up in revenue especially in Q3 and Q4, it is important to understand what are the force multiplier factors such as new products, territories or channels as otherwise it is highly likely that despite hitting H1, the business is not set up for H2 in six-nine months time.

Meanwhile, hyper-conservative budgeting may bring the risk of setting the bar and underlying ambition too low and in turn missing the opportunities to grow and remain competitive. 

Getting this balance right is vital for building and maintaining trust with the board and investors.

While it is arguably easier to achieve budgeted expenses than budgeted revenues, even here surprises can throw a curveball into the budget. For instance, important customers may require extra R&D investment and customer support; unexpected employee turnover may lead to extra recruiting, training, and temporary employee costs; and technology transitions may result in higher operating costs.

The concept of zero based budgeting is becoming more popular in recent times to budget for the overheads components in a budget.  

Peter A. Pyhrr developed the idea of zero-based budgeting in 1969 while he was an account manager at Texas Instruments in the US. In 1977, he wrote his seminal book on the subject, ‘Zero-Base Budgeting: A Practical Management Tool for Evaluating Expenses’.

Essentially zero-based budgeting means budgeting by justifying and approving all expenses for each accounting period, rather than basing it on your past spending. It’s a structured process that can build a culture of cost management culture throughout the business.  

You therefore start from a ‘zero base’ at the beginning of each budget, and then analyse the return on investment across the business to allow meaningful debate with the leadership team on where to best allocate funds. 

As the saying goes if you look after the pennies the pounds look after themselves, and this process has been proven to develop deep visibility into the cost drivers and using that visibility to set aggressive yet credible budget targets and in turn drive accountability. 

McKinsey Consultants Shaun Callaghan, Kyle Hawke, Carey Mignerey along with Greg Kelly have studied zero based budgeting with their clients. They found that one company realised 11 percent savings in its operating budget within the first four months of a new zero based budgeting programme. Importantly more than 40 percent of the savings were then strategically reinvested in new teams and sales staff who spent all their time with customers. So rather than purely a cost saving technique it is a return on investment technique.

In part 2 I will share my thoughts on once the budget is built and approved, how there are various different techniques to then manage and review the budget during the financial year.

Meanwhile I would value your thoughts and comments on how you are approaching the budget this year.