Marino

Fast Out of the Gate: Budgeting

Budgets are done in the tail end of the prior year, so why should budgeting be relevant to me now? This article addresses the three buckets that most entrepreneurs fall into:

  1. Budget? What do I need a budget for?
  2. We budget. I tell my CFO what my goal is for the new year and he puts it into a plan for our team.
  3. We build a bottom-up budget, and measure against it for the year. Sometimes we succeed, and sometimes we don’t.

The most exciting part of January, from a budgeting perspective, is that we all start fresh, regardless of which bucket you fall into. At this time of the year, there is little worry about variance to plan, and we are ever optimistic about our intention to beat our expectations in the new year. Let’s look closer at the most common buckets and how we can avoid their traps as a result.

Budget? What do I need a budget for?

Not all companies budget. In fact, the most overlooked benefit of budgeting is benchmarking for your team and subordinates. A formal budgeting process in your business can serve to set benchmarks to objectively measure performance of your team. Avoiding the process does not make for an easier year. On the contrary, it does little to objectively measure progress toward a company vision, and makes it extremely challenging to keep score. It is important that we take the time to establish targets and goals for revenue and expense so managers have a measure for accountability. Without it, performance will flow like water—to its lowest point—and take away your ability to objectively measure those in the organization as succeeding or failing.

We budget. I tell my CFO what my goal is for the new year and he puts it into a plan for our team.

Let’s assume that you successfully budgeted for the new year. Congratulations—you are ahead of the game. Before we give out too many compliments, did you use a top-down approach or a bottom-up approach? In a top-down approach, there really isn’t a good way to drive budgeting success. The underlying catastrophe in a top-down budget process is the response to a poor year with, “Well, that was your number, not mine.”

The most obvious con to the bottom-up process deals with “sandbagging,” or setting expectations too low. We must remember that the benefit we have as management is the ability to compare against last year’s performance along with the appropriate understanding of the back story. This insider knowledge allows us to challenge first drafts and ask for more. The appropriate amount of information, market knowledge, interaction, and comparisons to previous periods will vastly improve the bottom-up planning process to increase a vested interest in setting the targets and ultimately the accountable business metrics that will grade performance in the new year.

We build a bottom-up budget, and measure against it for the year. Sometimes we succeed, and sometimes we don’t.

You are in a good place, and way ahead of your peers in the other buckets. Your challenge is the volatility between success and failure as measured against the original budget. You must remember some key points as your year unfolds: the value of information as it becomes available and the unforeseen, uncontrollable circumstances that occur each year. In the private equity business, we expect our portfolio companies to re-forecast every 90 days. This allows us to take in new information as it becomes known and account for the unforeseen, but we also have a deep understanding of the “bridge” or reconciliation between three budgets: the actual, the original, and the re-forecast. It is this bridge that tells the story about what happened that is driving an increase or decrease in certain areas against the budget and why it is occurring. We also review our summary of information that compares: “actual” to “budget” as well as “forecast” and “prior year” against “budget” each quarter (see chart).

gameplan_janfeb

In each case the variance is measured against actual. The reconciliation discussion is how managers and leadership improve our ability to minimize the unforeseen and maximize our success to perform.

Budgets should not be an albatross, but a tool and guide to help us along our way for the year to improve our chances for success.

 

Gene Marino is partner at Evolution Capital Partners. Marino can be reached at (312) 263-5080 or gmarino@evolutioncp.com.

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