Each year with college football and Oktoberfest comes the dreaded ‘Annual Budget’. Many small (and large) business owners would rather suffer a 2nd root canal without Novocain than prepare yet another annual budget, which (they believe) is never used and out-of-date before it is even finished. Yet, the annual budget can be one of the most important items in your business tool kit. Done poorly, it is a root canal, but the following five ideas will provide some relief and, more importantly, highlight key business insights. For a budget is not about the numbers, but about what you learn in the process.
- Substance, not form
The universe of budgeting methodologies is very large: line item, performance, program and planning, zero-based, site-based and outcome-focused budgets to name just a few.[i] Depending upon your business model, one method might provide a bit more insight than another. However, the method is less important than the thinking required to actually pull it together: a review of prior years’ activity, forwarding looking projections, assumptions and dependencies, spotting potential storms or trouble areas. If, at the end of the budgeting process, all you have are numbers on a piece of paper or in an Excel file, you have great form but very little substance. Budgets should provide insight into what drives your business. If, in preparing your annual budget, you haven’t learned anything, even for a 20-year old company, you are just wasting time. Don’t waste time.
- Profits matter. In fact, it is the only thing that matters.
In his excellent book, Profits Aren’t Everything, They’re the Only Thing, George Cloiter argues that most annual budgets are calculated backwards. I agree. Most people prepare budgets by estimating revenues, subtracting expenses and seeing what comes out the bottom. Cloiter argues (and it makes sense) that every business owner should pay himself or herself first. After credible revenue projections are prepared, you should next determine the amount of profits you want before subtracting any expenses. At this point, you can now scale your expenses to meet your profit target rather than scale your profits to meet your expenses. Profits first, expenses second. It might require hard decisions in order to change your expense structure. But by locking in your profit number first, it will focus all your efforts on the only thing that matters: the bottom line.
- Hide the putters. Look at the drivers.
In the early 20th century, the Italian economist Vilfredo Pareto noticed that 80% of all his peas came from only 20% of his pods. In 1906, he applied this same ratio to the Italian countryside when he observed that 80% of the real estate was owned by only 20% of the inhabitants. Similarly, 80% of a typical budget will be driven by just 20% of the line items. Focus on these line items first. In doing so, you will get a “bigger bang for the buck” than chasing nickels and pennies in the corner. Don’t get me wrong: you will also need to focus on every nickel, dime and quarter possible: but don’t start there, end there. Tackle the big drivers first, then take out the putters.
- The Three Musketeers
Payroll is usually the largest line item on a budget. When times are tight, many companies simply roll the layoff dice, cutting payroll almost at random. And then, just like in Vegas, they are surprised and disappointed when they “crap out”. While layoffs might be necessary for survival in the short run, in the longer run, layoffs rarely do any real good towards making more money. More often, irrational layoffs delay the hard work of focusing on the real problems. All efficient operations have three key components: people, processes and technology. When it comes to expense reductions, companies tend to focus on the first only and rarely, if ever, on the next two. How would it change your company’s thinking if a 5% downsizing was accompanied by a 5% reduction in the daily processes required and a 5% reduction in the technology/software used? By considering all three – people, processes and technology – and not just the first, real solutions emerge and realistic budgets develop.
- Begin with the end in mind and your feet on the desk
Finally, before you even begin, put your feet up on your desk, stare at the ceiling and think! Why are you in business? What is your purpose, your raison d’etre? What gives you joy or a sense of accomplishment? Where do you want to be in 1-year, 5-years and 10-years? Only when these answers come into focus should you start working on your budget. But this time, the budget will begin with the end in mind and it will be a different: less a chore, and more an exercise in wish and goal fulfillment.
Brett R. Keenan is a Business Coach and Retained CFO/General Counsel for Small Businesses. Based in Chicago IL, BRKeenan & Associates has helped numerous large and small companies with Finance, Law, Operations and Strategy since 1999.
©BRKeenan & Associates, LLC. 2014