While the annual budgeting process often is met with dread, effective leaders know that strategic budgeting is an exciting process to implement vision and opportunity. As we dive into the budgeting process, it requires a shift in mindset to think about what we are aiming to achieve and how to apply resources to accomplish that. Essentially, for every expenditure, asking ourselves, “what is the point of spending this money?” No enterprise just spends money. We spend money for an expected outcome.
shift your mindset
Embrace the fact that the budget is a reflection of your strategic goals and an articulation of the investment priorities to meet those goals. What is your business all about? Where is it going? When I work with clients to develop a strategy, we toss out money, people, and time—which are all resources to support a strategy. We have to first know the why and what, then figure out the how.
As noted, this is more of a shift in mindset than a defined procedural analysis. Certainly for larger spends we might want to create a formal analysis, but the trick is to apply this thinking of how this is true for all spending. A sound budgeting process must include a defined, and agreed upon, expected set of outcomes.
Limited funds should not change determined goals, but it may affect the speed at which strategy is achieved. (To demonstrate this point, one of the main reasons people raise capital is not so they can pursue a different strategy, but so they can achieve their strategy faster). Strategic budgeting and building the financial picture for your business starts with a clear strategy.
Example 1: Facility expenses. You spend money on facilities to create work space for your employees to do their work. Have you asked if you need a building in order for this to happen? Could you be more or equally effective with a distributed work force? What is the potential expense of trying such an approach? Perhaps a facility provides a more efficient space for employee collaboration and idea generation. If so, then the facility expense is positively linked to your revenue.If you aren’t asking and answering such questions – one of your competitors is. They can outpace you at a lower price point because they understand what expenses are truly necessary.
Example 2: Another easy example of assumed “smart spending” is outsourcing. The benefit of this savings needs to be clearly understood. For instance, if you outsource work that saves the CEO time, then where does their resource of time become reallocated and what is the expected return?
What do sales look like on a projected basis? What do we know from historical data? What do we want to achieve and why? In essence our revenue becomes the immediate pool of capital available to invest in our strategy. For many, this becomes a helpful guardrail to not grow beyond the means you can afford.
Then, shift toward strategic budgeting questions: If our revenue goals are XYZ, then what investments do we need to make to get there? Hire more people? Spend more in marketing? Improve product quality? Change the culture of the organization? That is, what are we investing in that is needed to achieve our revenue targets, which are linked to the outcomes defined in our strategy.
Tip! Rather than using prior year expenses strictly as a pre-determined amount for new projections, analyze if that expense is enough to achieve your new goals. Use prior year expenses as a basis to determine if those expense amounts align with achievement of your new goals.
Special Case: What happens if there is a gap? Or said differently, for the year more investment is needed than revenue available. If just temporary, then we can raise short-term debt for working capital. If longer term, other sources of debt or capital can be sought. In either case, knowing how your expenses (now truly the investment of others) links to outcomes and strategy is even more important and rigorous. What happens if the expected return won’t ever catch up to the investment expense you have identified for here and now. Well, that just isn’t economically viable. And you need to start to trim the budget in the areas which outcomes have less return than others.
Review Expenses and Match with Strategic Goals
Determine the percentage of overall expense related to each goal. The analysis might reveal, “Wow, I didn’t realize we are going to invest 60 percent of spend in Goal A and just 20 percent in Goal B.” If Goal B is more important, then our strategic allocation of resources is likely misaligned. This approach guides prudent budget reductions by goal, if needed, versus across-the-board cuts.
Budgets should reflect the underlying economic model that drives your business’s success. If we start with strategy and where the business is going, it naturally illuminates what investments and resource allocations are needed to achieve those goals.