Mastering the Budgeting and Financial Control Process for Startups & Small Business
In today's competitive business landscape, effective budgeting and financial control processes are essential for long-term success. A well-structured budget not only helps organizations allocate resources efficiently but also provides a roadmap for achieving financial goals. This comprehensive guide will walk you through the critical steps involved in creating and managing a robust budget and financial control process, ensuring your business stays on track towards growth and profitability.
We will explore the different approaches to budgeting, such as traditional and zero-based budgeting, and discuss the importance of involving your team in the budgeting process. You'll also learn about tracking and recording your budget, implementing cash management and financial controls, and conducting variance analysis to ensure your organization stays on top of its financial performance.
By following the steps outlined in this guide, you'll be able to create a solid financial foundation for your business, allowing you to make informed decisions and allocate resources effectively. Whether you're a startup founder, small business owner, or financial manager at a larger organization, this guide will provide you with the tools and insights needed to master the budgeting and financial control process.
1. Determine the Budget:
The first step in building a solid financial planning and control process is to establish a budget for your business and departments.
Budgeting Cadences: What Should your Budgeting Cycle Be?
Budgeting can be done across any period (months, quarters, years, etc.). That said, the longer the periods are, the more budgets will be subject to change and adjustment. This makes them less accurate.
For example, think about your personal spending: You can probably say with 95% confidence what you will spend tomorrow (coffee in the morning, gas for your car, dinner out with friends, etc.). You probably wouldn’t be able to do the same over an entire year. Some things will be consistent and predictable – like your rent or car payment – while other expenses may take you by surprise – such as a unique investment opportunity or medical bill. The longer your horizon, the wider your margin of error.
Does that mean you shouldn’t budget on anything past a monthly basis? Not at all! You won’t be able to be perfect, but the process of creating and adhering to a long-term budget is a hugely useful one. It will help you to understand, for example, if you will have enough cash flow in 6 months to hire an additional employee or buy a new piece of software.
For most teams I work with, a monthly budgeting cycle is in the goldilocks zone for short-term budgeting with a more intensive long-term planning process occurring quarterly or yearly. This will help you to keep tabs on and control of your month-to-month spending (which you should be able stick to) while also giving visibility on a 12 month time horizon.
Different Approaches to “Set Your Numbers”
At the heart of budgeting is the process of determine which a given department can or will spend across various categories. I call this process “Setting Your Numbers”.
There are two approaches to budgeting: traditional budgeting which is based on previous spending amounts and period-to-period changes, and zero-based budgeting, where each category is zeroed out for each period, requiring re-justification and analysis of spending. Of course, each has its advantages and disadvantages.
Traditional budgeting
Traditional budgeting is, overall, the simpler and less intensive of the two processes. The traditional process, as I have practiced it, involves asking the two questions:
1. How much did we spend on this category last period?
2. Should we change that amount for this period?
This process is easier to put in place and requires significantly less mental capacity with each cycle. With traditional budgeting, you are starting with the assumption that you will spend on essentially the same categories that you did last period. This makes each category less of a debate and conversation, which usually streamlines the budgeting process and makes it a bit less tedious.
In certain situations, this is perfect. Managers only have so much time in a day and can make so many decisions before the quality of these decisions suffers. If each budgeting session is a knock-down, drag-out debate once or more per month then you may be detracting from other aspects of running the business.
That said, with traditional budgeting, it can be easier to continue spending through a sense of inertia. It’s a bit easier for categories and expenses to go unquestioned, which may lead to higher levels of spending.
A Quick Anecdote: Website Overspend
A few years ago, I was overseeing budgeting for a company which was expanding internationally. We had a division that was budgeting $4,000 per month to contract a website builder to create their regional webpage. Initially, this investment was justified and produced the desired results.
However, as we continued using a traditional budgeting approach, the $4,000 expense remained on the budget month after month without much scrutiny. Seven months into this arrangement, it dawned on me to ask what exactly we were getting from that amount. Turns out that the website was up and running after just one month, and at this point the team was only making incremental improvements.
In reality, we could have reduced the cost for this item to $2,000 after the third month without sacrificing the quality of the results. The traditional budgeting process allowed spending inertia to take hold, preventing us from optimizing our resource allocation. Had we taken a zero-based budgeting approach, we likely would have caught this sooner than we did.
Zero-Based Budgeting
Zero-based budgeting is a more rigorous and comprehensive approach compared to traditional budgeting. In this process, every expense must be justified and approved for each new period, starting from a "zero base.”
Unlike traditional budgeting, where you essentially ask two questions, with zero-based budgeting you should be asking several different questions for each category and item:
1. Why should we spend on this item?
2. What are we expecting to achieve with this budget allocation?
3. What tracking tools do we have / can we put in place to measure these outcomes?
4. Why can’t we leverage / prioritize other resources?
5. How much should we spend on this item?
6. Etc., etc., etc.
As you can probably tell, this process can be more time-consuming and mentally demanding, as it involves scrutinizing every expense category and justifying its necessity. The increased time and effort undoubtably makes budgeting a much more arduous process.
That said, zero-based budgeting usually leads to more efficient resource allocation and a better understanding of the organization's financial priorities. By forcing managers to critically evaluate each expense, it encourages a reduction in unnecessary spending and identifying areas for cost savings (consider the website example above). This approach can also help uncover inefficiencies and promote a culture of financial discipline within the organization.
A Hybrid Approach Usually Works best
For most firms, the right approach is a mix of traditional and zero-based budgeting, not picking one or another. Usually, teams will conduct a full, zero-based budgeting process semi-annually or annually (though, for fast growing, dynamic companies this might need to be done quarterly). Then, monthly, they will use a more traditional budgeting approach to plan for and keep an eye on how they are spending across the next 30 days.
Budgetary Engagement
This budgeting session, as a rule, must include representation from the teams who will be affected by the budget. Departmental leaders will have a far clearer understanding of what they need to accomplish their goals and it’s crucial they be able to articulate this understanding as a part of the budgeting process. Additionally, wider participation imparts ownership of the budget and resource allocation to a wider portion of the organization.
However, this is not to say that departmental leadership should set their own budgets. A strong manager will balance the (often legitimate) requests for more resources with the broader priorities, obligations, and strategies of the business. Usually, this means reining in spending and budget requests from departmental leaders.
Separate the Budgeting Sessions by Department
Additionally, I would strongly recommend having separate budgeting sessions for separate teams/departments. There is nothing worse than sitting in a meeting that doesn’t impact you. If you try to do one, combined budgeting session then most of your team will be twiddling their thumbs waiting for their turn. That’s a bad look.
2. Tracking and Recording the Budget:
The next step involves tracking, recording, and understanding the agreed-upon budget. This mostly involves capturing the conclusions of your budgeting process in a centralized and easily shared location.
Tools: Where to Track and Manage Budgets
For most teams, Microsoft Excel or Google Sheets will be the best tool to use. Building a budget sheet in your preferred spreadsheet tool will be more than sufficient for most startups or small businesses.
With that said, if you are a large company with a finance department and are struggling to produce financial insights in a timely manner, then you may consider a specific financial planning / budgeting software package. There are numerous software platforms available, including: Anaplan, Adapative, Jirav, Vena, and others.
To reiterate, unless you have an established finance department, hundreds of millions of dollars in revenue, or a uniquely complex and challenging business to model, you can safely ignore these tools. They will likely be more trouble than they are worth for small teams and introduce a huge amount of overhead into the process.
Structure of Budget: Adhere to Your Chart of Accounts
One of the most important pieces of advise I can give to teams building out their budgeting sheets and tools is to ensure that these sheets align with your company’s chart of accounts. As a refresher, your chart of accounts is the list of accounts that your accounting team uses to track financial transactions within the company. At its highest level, this starts with assets, liabilities, equity, revenue, and expenses before moving down to more specific accounts.
Using your chart of accounts as the basis for your budget sheet is crucial because it will make comparing your budgeted spending amount with your actual spending significantly easier and less painful.
Additionally, it will have the additional benefit of familiarizing you and your leadership team with your account processes. Familiarity with your numbers (as captured through your accounting processes and reports) is an important component of corporate leadership. Accounting is the language that investors and senior business speak so familiarizing yourself with these terms and your business’s numbers is always a good idea.
Integrating your Budgeting Process and Your Financial Model
If you can, it is supremely helpful to integrate your budgeting process into your financial model. At a high level, your financial model is a projection of your business’s financial status into the future. As you might expect, the process of projecting your financial needs into the future is precisely what you are doing in the budgeting process, albeit usually on a short-term basis.
In fact, at previous companies, our budget sheets were simply components of our broader five-year financial model. During our budgeting sessions, I would work directly within our financial model and send out copies of the relevant sheets to the managers after the fact.
The real benefit of this approach is that it integrates your budgeting and long-term financial planning processes – which, as I touched on above, are really the same process. Additionally, it ensures that your financial model always reflects your most recent understanding of the business – this will save you time when you need to prepare a financial model for board, investors, or broader team.
3. Implementing cash management and financial controls
Next, once your budget is set and recorded, your team will start spending against that budget. When this happens, you’ll want to be sure you have safeguards in place to ensure that no person, department, or unit can spend without proper checks and balances.
Why are cash management and financial control procedures necessary?
You may be thinking, “I trust my team. I don’t think I need to implement specific financial controls.” To be blunt, this is absolutely the wrong way to think about controls. Sorry, but it’s true!
First, by definition, no victim of fraud thought they would be a victim. Fraud, theft, and embezzlement can be done by anyone at any time.
Additionally, controls do not imply a lack of trust or faith in your team. Rather, they are safeguards put in place to protect all members of the organization. Setting out clear guardrails helps your organization understand where exactly the line is and avoid grey areas and potential heartaches in the future.
Hypothetical: Invoices, Upsells, and Missed Payroll
Imagine this scenario:
You lead a small team. Your Head of Marketing has a large invoice he needs to pay. One day, your Head of Sales posts an update to Slack that her team has just closed a large upsell deal to a known client. Woo!
The Head of Marketing sees this and pays his invoice early, reasoning that the team has more than enough cash to make the payment and he wants to clear it off his to-do list.
However, what the Head of Marketing didn't know was that the client signed the upsell deal with a payment term of 90 days. So, while the team had made a big sale, you won’t receive payment for another three months. You would be fine, expect that the head of Marketing has just sent a chunk of cash out the door. Now you are concerned you won’t be able to cover payroll – oh no! No you have a headache on your hands.
Safeguards Protect Well-Meaning Teams
Without proper financial controls in place, even well-meaning teams can encounter huge issues. In the above scenario, the Head of Marketing had good intentions and thought he was making a responsible decision. However, he didn't have a full picture of the company's financial situation and has opened the door to major challenges for the wider team. If there were safeguards in place which forced him to clear his transaction first, this situation could have been avoided.
Long story short: You much have financial controls in place; all mature organizations do and yours should be no exception.
Potential cash controls
There are a number of cash controls that you can put into place to limit access to cash and financial accounts. When selecting the right limits for your team and organization, you will want to be sure to balance a need for control against a business which can move quickly and efficiently. Some practical examples of financial controls that a startup or small business may put in place include:
· Requiring approval from executives for significant transactions (e.g., CEO approval required for expenses over $25k and VP approval required for expenses over $5k)
· Setting spending limits on company credit cards
· Conducting at least monthly expense reconciliation and flagging large or unexplained expenditures
· Requiring ‘four-eyes’ checks on transactions to ensure that multiple employees are required to confirm and log expenses or revenues (e.g., departmental leadership can approve invoices but only the accounting department can trigger ACH or wire transfers)
Picking the right mix of controls for your business
The exact form of financial controls and cash management processes will depend on the specific needs and circumstances of the organization. The tradeoff, in its simplest description, is between control (which reduces risk) and speed (which increases efficiency). By implementing controls – or choosing not to do so – you balance between these two.
Here are some factors to consider regarding what kinds of controls are right for your organization:
· Risk impact: What would be the impact if you became a victim of fraud, theft, or errors? Would you be able to recover? How challenging would it be to do so?
· Cost impact: What will be the cost to implement controls on an ongoing basis in terms of time, resources, and financial impact?
· Impact on operations: What will the impact of the controls be on your ability to attract, retain, and satisfy customers, partners, and other key stakeholders? How will the controls impact your team’s ability to pursue other initiatives or projects?
· Continuous monitoring: Can you effectively implement and monitor these controls in perpetuity?
4. Variance Analysis and Review
After the end of a budgetary period (e.g., a month), it is essential to analyze how your actual spending compared to your budgeted amounts. This step, known as variance analysis, is what gives your budgeting process a purpose and practical power over decision making. Simply put, if you don’t track how your team did against their budgeted amount, then there is little point going through the budgeting process in the first place.
Conducting Variance Analysis
Thankfully, the variance analysis itself is a simple endeavor assuming that:
1. You are tracking actual expenses through your accounting software (ideally with the assistance of a bookkeeper)
2. You aligned your budget sheet with your chart of accounts.
If both are true, variance analysis may be as simple as pulling a monthly spending report from your accounting software and comparing it to your budgeted amount. By convention, category overspending is considered a negative variance while underspending is considered a positive. The formula is:
Budgeted Amount – Actual Spend = Variance Amount
Then, analysis is as simple as reviewing variance across your categories with a particular eye to where your team may have over or underspent. Note: underspending is not necessarily a good thing! You should be just as interested in knowing why you didn’t spend on a given category as why you did. If you did not spend on a particular category, you may be falling behind on initiatives that are important to your team.
What If You Aren’t Tracking Actual Spending or Your Budget Isn’t Aligned?
First, you absolutely must track your actual spending. That’s a non-negotiable for financial management of a company. If you aren’t keeping track of your transactions, you’re flying blind. This is not a particularly expensive or time-consuming task if you have the right help. For small teams, outsourcing to a bookkeeper is almost always the right call – bookkeepers are cheap ($2,000 monthly or less) and unbelievably valuable. I have adored nearly all the bookkeepers I have ever worked with.
If, on the other hand, you haven’t been able to align your budget to your chart of accounts, you will need to get a bit more creative. Work with your bookkeeper to tag transactions and set up rules in your accounting system that will allow you to properly assign each transaction to the proper department. It will take a bit more creativity but, once you put a system in place, it should be relatively easy to scale.
Reviewing Variance with Your Team
The final step in the budget and financial control process is to review the variance analysis results with each of your teams. This helps ensure that the entire team understands their spending compared to the budget and identifies any areas that need improvement or further discussion.
Complete Your Reviews Over Email
Conducting a variance review can often be done through email, with only significant issues being addressed in person as a part of your next budgeting session. No need to add another meeting to your team’s schedule via email.
Final thoughts
Mastering the budgeting and financial control process is crucial for businesses of all sizes and industries. By implementing a well-structured budget, tracking expenses, and analyzing performance, you can ensure your organization stays on track towards achieving its financial goals.
Remember that the key to successful budgeting is striking a balance between control and efficiency. Involve your team in the process and be open to adjusting your approach as needed. Regularly reviewing your budget and financial performance will help you identify areas for improvement and make informed decisions about resource allocation.
As your business grows and evolves, it's essential to continually refine your budgeting and financial control processes. Stay informed about industry trends, best practices, and new tools that can help streamline your financial management. By staying proactive and adaptable, you can ensure your organization remains financially healthy and well-positioned for success.
