5 Methods to Rock Your Budget
Are you on the right track and read to crush 2024? Now that the calendar has flipped to October, its time to start thinking about the upcoming year and your goals. That probably sounds daunting!
A good budgeting process can sometimes be exciting! Yep, exciting! It’s an opportunity to think about the future, upcoming projects and goals, and how departments can collaborate to reach big organizational goals. Crushing goals and getting the team aligned is fun for everyone. So, get your leadership team together and start planning and budgeting.
But, you might be thinking, “This isn’t fun, I don’t know where to start. I don’t have a clear or well defined process.” That’s common. The lack of process or knowing how to start is often the source of the dread and fear. Fear not, this blog post helps demystify the process and some common methods that will help you get on the right track for 2024.
Of the 5 different methods and tools, we cover there is no one tool to use. The correct answer on which budgeting method to use depends on your business, resources, your team and industry.
Companies often use several (sometimes all) of these methods together, so feel free to use any and all of these methods to plan.
Let’s dig in.
Historic Results Method
A common starting point for most budgets is looking in the rearview mirror – figuring out your starting point. What happened historically and do we largely expect similar results in the future?
The window of historic results may depend on the nature of your business.
For instance, seasonal businesses, like ecommerce, often see the bulk of their sales at the end of the calendar year. Seasonal businesses using historic results as a guide should look at their last 12 months as a guide and pay attention to seasonality. On the other hand, less seasonal businesses, like health care, could consider a shorter window, say looking at the last 3 or 6 month historical average, to guide their budget.
The historic results method is most useful for stable businesses without much growth or structural change. Companies often take an average of results and apply a buffer to cover unexpected costs and inflation (say 5%). This method is often useful for existing expenses like the costs of existing employees or consistent costs that do not experience large fluctuations (e.g. office expenses).
Percent of Revenue Method
For companies with large variable costs and fewer fixed costs, the percentage of revenue is a really useful method. This method is useful for mature companies where the relationship between revenue and expenses is consistent and well established.
The concept is of the percent of revenue method is the organization looks at historic relationships of expenses relative to revenue. If a company expects its revenue to increase 30%, then the expense should also increase by the same magnitude.
This method work best against variable costs that scale with revenue like COGS, gross profit, sales commissions, and transaction fees.
$ Per Hire Method
The concept of $ per hire is pretty simple. Costs increase linear based on headcount and changes in headcount.
This method is useful when trying to figure out a capex budget, travel, or how dues and subscriptions are expected to scale. If a company is looking to add extra headcount, those new FTE’s will likely need new computers and equipment, and subscriptions to your various vendors. The process works both on incremental hires or for the total head count of your organization.
Fixed Cost Method
Some costs are known in advance. Your organization may have fixed costs on rent, professional services, insurance, or other expense items. For the costs that do not vary or scale based on activity level, the fixed cost hard coded assumption is a useful method.
Applying this method usually means hardcoding in the values and making notes in your budget about the contract or agreement.
Just remember to make sure folks know the value is hard-coded!
Beware of the Achilles heel of budgeting! Hardcoded numbers that are not well marked.
Collective Budgeting Method
Collaborative budgeting is the most time consuming and labor-intensive method, but it is worth it. Organizations engaged in this practice are better aligned and the pro’s and con’s of each project or initiative are discussed. Often, functional leads will come together with a wish list of projects, hires, or other expenses for the coming year and the team will incorporate those inputs into a comprehensive budget. Collaborative budget discussions are often colorful and maximum buy-in is found in high-trust organizations.
This method is often the most preferrable method because it creates larger organizational buy-in and leadership may gain insight and perspective that they did not previously have. It also creates greater accountability for the functional lead as they helped shape their budget.
Wrapping Up
Forecasting and budgeting is uncertain by nature, but hopefully this post demystifies budgeting for you. The process is often more art than science, but success in a budgeting process often requires multiple meetings, internal syncs, communication to relevant stakeholders and clear documentation of assumptions.
The budgeting process is often a force function to get alignment from the team about the year ahead, key objectives and initiatives, and the resources available to accomplish the goals. It is a gift and opportunity to reflect on whether you are on the right track.
If an organization does not know what needs to be true for their budget to remain true, they will struggle to identify causes of variances and how to improve processes for future periods.
To be fair, budgeting and forecasting can get more complex particularly with organizations with costs that do not scale linearly or embarking on significant changes like M&A, adding a new facility, introduction of new product lines, and other large changes.
One thing remains true the more your organization budgets, the better you’ll get.
Just remember to detail your assumptions and methods so you can learn from past mistakes and successes!
If you want to talk budgeting or need accounting help, please reach out to us:
SanitasAccounting.com / LinkedIn / Email
We’re also proudly located in Boulder, CO.