Instead of budget approvals, monitor key metrics and give managers more flexibility
David Teten is an advisor to emerging investment managers and a Venture Partner with HOF Capital. He was previously a partner for 8 years with HOF Capital and ff Venture Capital. David writes regularly at teten.com and @dteten.
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How should a growth company manage its budget? Does an annual budget approval process even make sense in a fast-moving firm?
My friends who are executives at large, established companies complain about how fixed budgets lead to gamesmanship. An executive who wastefully spends down their travel and expense budget at year-end to justify an equal or larger budget next year may also fail to take advantage of a great marketing opportunity with a December 31 deadline — because they spent their budget on T&E.
However, in a startup, the most common scenario is that projections get missed. Paul Bianco, CEO of Graphite Financial*, says “entrepreneurs are characteristically optimistic by nature and often present their board best-case-scenario budgets and projections. Inevitably, things cost more and take longer than expected. I encourage entrepreneurs to correct course with a re-forecast early and often. The worst thing you can do is dig in your heels and hope things will miraculously get better. Being transparent enough to say ‘look, we expected X to happen, but now we expect Y to happen, this is why, and this is what we’re doing about it’ is an admirable trait.”
Here’s the solution I have recommended to some of my portfolio companies: “agile budgeting,” i.e., monitoring a few key variables, while giving managers significant flexibility. Entrepreneur Jeff Magnusson provides a sample agile budgeting workbook. Sean Colrock, Director of Client Partnerships at Wiss & Company, suggests at a minimum you track: cash on hand; fume date, and burn rate. The next most important set of metrics are sales by category; working capital (cash and other current assets, less current liabilities); EBITA and gross margin. Ben Horowitz writes that you can ruin your company with a bad budgeting process and recommends a similar approach.
Regardless of whether you take a traditional or agile budgeting approach, Robert A. Howell, Professor of Business Administration at Tuck, writes that you should turn your budgeting process upside down by “reformat[ting] planning and budgeting templates to highlight cash rather than accounting net income.”
This agile approach is not restricted to small startups. In Stop Budgeting, Start Improving, Brad Power writes:
