Building the Perfect 2012 Budget!

For many management teams the month of December represents the Budget sign off time. However they are so often badly done. Frankly they are recklessly compiled representing the classic “hope over experience” document instead of an operational blueprint.

First definitions: a Budget is a set of rigorously thought through policy statements translated into a Financial Plan that you believe at the time is deliverable. The Budget is for you and your team to run the business better, to execute in a controlled, repeatable style and improve the odds of success. Own it. On that basis here are a set of tips to minimize your regrets at the end of next year.

The Big Picture

1. Set down the narrative of the Budget starting with the strategic positioning. Who do you want to be in 2012? This is not an easy question to answer. No matter how pretty the numbers are, you don’t want to hang a set of beautifully crafted financial metrics on top of a lousy story.
2. Once your big story is really compelling, it’s time to articulate key one pagers on the policy areas that matter: strategy & positioning, marketing, sales, product road maps (new & old), recruitment, finance, IT. These policies will align together like well written chapters of a book telling a story. These will prove invaluable as you explain the good and bad news of your performance against Budget during the year. It will force you to explain the logic of your actual trading. This will improve your ability to re forecast and it will develop your skills at auditing the signals from the market. These policies will now drive the numbers that make sense. Now nothing succeeds as planned (Joesph Heller) but as you analyze your business next year against that Budget, the rigor of thinking invested in your Budget will give you a rich understanding of where your market is heading, the pricing models that are working, the cost infrastructure to sustain growth and the realism of sales targets.

More Granular

1. Don’t build sales price increases into the early part of the year. You have no wiggle room if things don’t work out. Assume sales price rises, if any, later in the year. You can always bring them forward and look smart.
2. Watch underestimating sales staff turnover in 2012. Staff will have more choices. Build appropriate  recruitment budgets into the Plan.
3. Are your bad experiences in the current year reflected in changed tactics in the Budget? e.g. poor web experiences, over priced products, unprofitable customers, failing acquisitions, weak product sales of category x.
4. Are your launch dates for new products realistic? Are your early adopter sales optimistic?
5. Are the cost reduction programs really trapping all the extra costs of making the changes? e.g. redundancy, lease penalties, customer support for discontinued product lines.
6. Are the marketing budgets really sufficient to generate the monthly leads needed to fulfill the sales growth targets?
7. Are your training budgets sufficient to ensure the behavioral changes needed in sales, finance, IT, wherever, are actually going to happen?
8. Are you factoring in the real Accounts Receivable numbers to the Cash Flow Budget? Can you really continue to fund the business using Accounts Payable!
9. Merit increases, wage increases factored in and realistic given the changes expected in your marketplace?
10. Do Long Term Incentive Plans payout in 2012? Should old schemes be replaced?

Credibility Gaps

You’ve pulled together a Budget that is logical but does it align, does it pass the smell test?

1. Look at key metrics and compare with last year:  Sales per employee, all cost centers as a % of sales, headcount movements, cash generation % (EBITDA/free cash flow), GM%, EBITDA %, PBT %, Gearing ratios. So your travel budget is being kept at this years amount and sales are growing 25%, really?
2. Look at all product unit sales growth and validate why, what’s different?
3. Finally pull together a great little table highlighted below, which goes to the jugular of your Budget Story. Take this years best estimate of EBITDA and build a set of volume & yield reasons reconciling to the Budget EBITDA. This will pull out the key themes behind the numbers and bring into focus why the business is expected to improve. In this example it explains why $5m EBITDA will rise to $9m EBITDA.

Forecasts v Budgets

It is my belief there is only one Budget once it is signed off. As the new financial year kicks off, your views may change about the road maps to success. The place to articulate those changes is a Revised Forecast. There should be at least 11 Revised Forecasts. After one month’s trading, you should have the ability to flex your view of the full year and each new month brings new information. The Budget stays the same.

Finally whether you are reporting to a VC, a boss, a shareholder, a bank, I find it is always useful to have some sandbagging built into your promise

Sandbagging Tips

1. Sales Targets should sit at 130% to 140% of Budget Sales.
2. Sales price increases built in to the Budget as late in the year as possible.
3. Don’t assume rent free periods for office moves.
4. Work out travel budgets and add 10%.
5. Build contingency into marketing and recruitment to capture opportunities invisible to you today.
6. Currency; don’t use today’s rate but use a pessimistic rate to cover volatility.
7. All new product sales predictions should be 50% of what the analysis is telling you.
8. Add 2 months delay to any office move or product launch unless you are 100% sure you can deliver.
9. Build training budgets around a full headcount ignoring vacancies.

Give me your thoughts, budgets can be fun!