The importance of budgeting in a startup
“If you don’t know where you are going, any road will get you there.” — Lewis Carrol.
I spend the greater amount of my time the last few weeks of the year reviewing budgets and business plans for the year ahead. Our portfolio companies prepare their budgets and plans and present them to us. These budgets and plans have to be reviewed and approved by the Board of Directors of those companies.
This post is meant to ponder and discuss the importance of budgets and planning. Why are budgets important? Why must they be presented and approved? What happens when we don’t reach our budget goals?
In my humble opinion, budgets in startups are extremely important. While they are very hard to build and even harder to predict with accurate results, budgeting is an exercise that allows you to come back to the roots of your business and apply discipline to your hectic startup life.
Coming back to the roots of your business might seem simple, but in the chaos of running a company we sometimes forget the essentials: What are the drivers of my income? What is my source of revenue? What are my cost drivers? How and when am I going to make money? It is crucial to ask yourself these questions and budgeting allows you to do just that. I want to make sure we are on the same page with regards to budgets and plans: I am not talking about 50 page Word documents or 30 slide PowerPoint presentations. Budgets and plans are presented on financial spreadsheets where you can dig into the story of each line item. So don’t outsource the planning process to an outsider or don’t have your team do it on their own: roll up your sleeves and dig deep into the numbers, make sure you go through every line item and analyze the budget with the team members running that area.
Budgeting is about discipline, spending discipline above all else. All companies have limited cash, some more than others, but all companies, (specially startups) have limited resources to invest. Where we decide to invest that money is of extreme importance. Founders want to throw money at anything that will help them scale, but we must realize that all money spent is a trade-off; the money I invest in Facebook marketing is money I no longer have for hiring that top programmer I needed. While these investments are certainly not sinkholes and they will eventually (hopefully) bring back some cash, in the short term that cash disappears and is no longer at hand. So, it is key that every single spending point is detailed in your plans and that you become very disciplined in your investment and spending strategies. What do you expect to obtain from that investment? What will this expense generate as value in the future?
This discipline is not only important in the planning process, but most importantly in the execution. Its not enough to create a budget, you must review it constantly and make sure you are on track. As I mentioned earlier, budgeting correctly in a startup is extremely difficult, so don’t be too disappointed if your budget is off (for good or for bad). Projections might be proven wrong over the course of the year, but the important thing is that you understand why, the important thing is that you fully understand the assumptions you made and why you made them. And the most important thing is that you do something about it:
1. Adjust your budget to your new reality. If it’s the end of Q1 and you have reached your sales goals for the year, are you going to sit back and relax the rest of the year? I hope not. You must go back to your budget, adjust, evolve and set new goals. What assumptions did you make that were not a reality? It’s the same story if at the end of Q1 you are at 25% of your quarterly budget, or you had unexpected expenses: go back to your budget, adjust, evolve and set new goals.
2. Always have the original budget on sight. Even if you adjust your budget and set new goals, its important you always have that original budget on hand and on sight. While its important to re-budget and measure yourself against your reviewed metrics, its also very important you never forget what you had originally budgeted and why.
3. Understand what went wrong with the original budget you had created. Its OK to make mistakes, but its not OK not to understand them and correct them. You will have to rebudget this year and create a new budget next year, so understand your mistakes and precise them so that you don’t trip over the same rock twice.
Presenting your budget to your team is essential because it aligns the everyone with the company’s macro goals, it aligns everyone to where you (the founder or CEO) believe the company could go. Presenting the budget and plan to outsiders (investors, mentors, Board Members) is also extremely important for two reasons: second outside opinion and accountability. A second opinion from someone not inside the day-to-day operations is always very sane. There is a phenomena whereby your ability to see errors, mistakes, omissions or plain nonsense in your work decreases significantly after working more than X amount of hours on that particular task. In Spanish we call this phenomena “Ceguera de taller” which translates to “workshop blindness". One way to avoid this is by presenting your plan to someone with fresh eyes and ears. Presenting your goals and plans to outsiders is also a great way to become accountable: if no one knows my plans, no one will know if I failed or succeeded, but if I publicly say my goals, that creates additional pressure for me to follow through on those goals.
My final recommendation is to have only one budget. Many founders create budgets with scenarios (usually aggressive, base-case and conservative) which is OK; its important to know what your levers are and what the results will be in several different situations and circumstances. However, I do recommend that you have only one budget that you are presenting to your team, your board and that same budget must be the one you are using to measure and pressure yourself everyday. If you have one budget for your team, one for your board and one for yourself, then you don’t really know which one you are measuring yourself by and this creates an unnecessary complexity in an already complicated task.
On a final note, the most important thing of all is that your budget must be a thermometer for two things: burn-rate and runway. Burn-rate is how much cash you are burning per month and runway is how many months (on this burn-rate) your company could survive. All companies in the world fail for the same reason: they run out of money. So, if running out of money is essentially the one and only reason for going out of business, we better make sure we don’t. Creating a detailed budget, presenting it to your team, your investors and your board and reviewing constantly against reality is a good practice to avoid running out of cash.
Looking forward to your comments and keeping the conversation going below or on Twitter @adiezbarroso Alejandro Diez Barroso L