It’s January, and for many businesses, that means fresh goals, fresh budgets, and fresh eyes on the horizon. And, for many businesses, despite these best-laid plans and intentions, it’s the start of a long year of “winging it.”
I’m writing this article today to help you avoid that particular disaster.
I’ve supported, invested, and led many companies in my time, and I’m repeatedly asked the same questions regarding budgeting and annual planning.
Here are my answers, one at a time.
Are budgets (actually) necessary?
Short answer: Absolutely.
In my experience, however, most mid-sized businesses do not follow a disciplined budgeting process. Many will have an annual budget exercise where they review prior performance, set future targets, plan for the best—but that’s usually as far as it goes. Few take the next—arguably critical—step to refine and iterate it throughout the year into a forecast as conditions change.
In these instances, what they’ve created is less of a budget and more of a wishful plan on paper with a few numbers thrown in.
A budget can be a powerful tool when wielded and maintained correctly. The Percipio team and I follow a disciplined annual budgeting process because it provides a point in time each year that aligns with changes to a company’s strategic plan. It allows undertaking a critical assessment of discretionary spending and the time to make changes, as necessary.
We aren’t trying to build a crystal ball; we’re intentionally capturing and monitoring the patterns that allow us to make better, smarter, and faster business decisions.
That said, I have started to pair the static budget with a rolling 12-24 month forecast to always look at least a year into the future. I’ve learned that managing against an annual budget isn’t enough—if you’re only looking a couple of months ahead, you quickly run out of track come the fourth quarter. Better to keep adding to the end so your company doesn’t fall off the rails.
How often should I review my budget?
Short answer: Probably more than you are doing now.
To reiterate the above, budgets aren’t a set-it-and-forget-it type of tool. They aren’t a pot roast in a slow cooker—they are an expensive steak on the grill. There’s an art to watching and knowing when to adjust.
If you are building (and adhering!) to a budget for the first time, I recommend scheduling time into your calendar and add a budget review along with your other financial reports. Look for unruly spikes in expenses or surprises in revenue—can everything be explained? Are there trends starting to come above water? Are there warning signs?
What’s better: A zero-based budget or one based on the prior year?
Short answer: A balance of both works best.
I don’t think there is a set rule here, and you can make mistakes by overdoing it in both directions.
For those new to budgeting (or who need a reminder), zero-based budgeting is when you use a disciplined approach of looking at all your expenses every year and deciding if each expense can stand on its own. If you think it can, then you resell the expense purpose to the company and share why that expense is needed to stay in the budget. It means every dollar you make has a purpose, whether it’s to spend, invest, save, or donate. It’s a fantastic idea, in theory, if you have the discipline to maintain, monitor, and make hard calls on the chopping block. If you insist on a disciplined zero-based budget, you’ll spend a lot of time and effort putting everything back on that chopping block every year.
Basing a budget on a prior year has its advantages—if past performance can predict future success (and it often can’t). On the other hand, if you only look at prior years, you will end up with a lot of stuff you are paying for that is no longer used or needed (e.g., old subscriptions).
Again, balance here is critical, and striking it is part of your annual budgeting exercise. Over time, you’ll learn which categories are the ripest for review and which ones are necessary for current and future growth.
How do you compare your budget to industry standards, and can you explain when to (or how to) deviate from the norm?
Short answer: Focus strictly on cash and forget what everyone else is doing.
There’s a reason why cash wears the crown. Businesses can lose money for a long time, but they shut down quickly if they run out of money or have a liquidity crisis. Focus on the income statement but understand it within the context of where you are in your business journey. If you are in a period of growth, your inventory and your A/R will be growing, which consumes cash. You need to keep an eye on that when you are in growth mode.
How do you know when it is a good time to add another employee?
Short answer: When the existing employees start to make an unhealthy amount of noise about needing more staff.
Hiring someone new is always the path of least resistance. When people have to start working more, harder, or faster than they are used to, the gut reaction is to add another seat at the table. There’s more at work than “who” is at work—investing in better processes, software, hardware, or templates is almost always less expensive (and more efficient) than taking the time to find, hire, train, and pay another salary.
A business is typically most profitable when its employees are working to a point they can sustain over a long period. If they are so overworked that they burn out— you have gone too far. If they are just complaining—and not offering any viable non-personnel solutions— then you probably are not there yet.
A good rule of thumb is how quickly an employee can pay for themselves in revenue, contributing to a healthy workplace, and overall time freedom and growth capacity for you, the owner. Until it makes sense, look to tools and processes first—it will end up paying off when it is time to hire!