Transcript:

When I get on an airplane, I trust that the aircraft's pilot knows exactly where they're going. They've got a plan in place for how they're going to get us from one airport to the next.

I would be terrified if the pilot was winging it. Pun intended.

Listen, if your business doesn't have a budget and projections detailing the path you're taking to scale, you are, unfortunately, flying blind. You don't have to be terrified, though.

You can easily understand your path forward. You just need a budget!

Welcome back to The Profit Plot, a podcast where we help small business owners unlock the story behind their profitable business by unpacking one complex financial topic at a time. I am your host, Jeremy Millar.

Now, most people would think of budgeting as not the most exciting financial topic in the world. Oftentimes, we think of budgeting as a terrible exercise in which we're trying to project future numbers with fixed numbers from the past.

It's something that feels pretty reactive, is based on history, doesn't always feel effective, and isn't always helpful. That is typically what we find with traditional budgeting.

It's that zero-based, every dollar has a place reactive outlook based on history, typically reviewed once a year kind of budget.

It doesn't exactly give you the biggest or best grasp on your business as a whole, and it certainly doesn't allow for a lot of flexibility as you go forward in the year.

Contrast that view with strategic budgeting.

It's the concept of an adaptable forecast that accounts for the history of where your company has been while projecting the future of where you want to go. Using goal-based planning in a continuous form of rolling forecasts, you can reevaluate and restructure projections on an ongoing basis.

The goal of strategic budgeting is to align the financial plan for your entire organization based on the goals for your business. And this is completely different from how we typically think of traditional budgeting!

It supports a far more informed and strategic decision process because you are able to adapt and change your strategic budget on a whim if things change, if economic conditions change, if you want to roll out a different marketing program, if something happens to your headcount, if you want to grow exponentially, whatever it might be.

Strategic budgeting can help be an adaptable form of planning for the future, and that's what every business owner really wants, right? To be able to know exactly how much money they're going to make if a certain scenario should happen if they are going to play out things in the way that they think they're going to play out.

Now, when it comes to budgeting and finance in general, we often think of finance as a pre-planning function: an after the fact thing.

Money came in, maybe money came out, profit was made, or it was a loss. There's nothing we can really do about it.

We don't often think of finance as this continuous and ongoing component, and that's where strategic budgeting is extremely helpful for lots of small businesses. We shift from this reactive approach to managing our finances in the past to a proactive flywheel approach.

We begin to review these decisions each quarter, each month, and game plan, what the goals of the organization are for the future.

Now, this is where we get that pilot analogy.

As a business owner, we want to make sure that we are piloting our plane, our business, to a goal, to a destination, and we know exactly the points to chart along the way in order to arrive there.

We have goals in our businesses that we want to accomplish, and we can use our financial foundation in order to accomplish those goals. To detail out the exact map of where we're going and how we're going to get there.

You see, one of the most important components of creating a strategic budget in your business is that you actually have to create an operational plan of what your goals are and then put that plan into place.

Ultimately, a strategic budget is only as good as the plan that you have for your business. The ultimate goal, the destination that you want to arrive to, because every component of your plan plays into how you're going to get there.

Whether it's increasing your marketing spend, hiring new sales reps, adding on a different product, whatever it might be. Putting that plan into place is what allows you to actually arrive at a destination and map out how you're going to get there.

From there, you can actually begin to measure these points.

You can create Key Performance Indicators (KPIs) of items that you want to track along the way and review those things on a monthly or quarterly basis. You need to review your financial position, measure continuously as things change.

Strategic budgeting introduces this process of measuring and then implementing.

Implementing and measuring, implementing and measuring.

Oftentimes, it is alternating from this execution to measurement in a continuous cycle. It's an ongoing process rather than a static form of measuring your finances.

In 2021, Strategic Finance Magazine interviewed the financial management team at Hilti, a global Swiss manufacturer doing 6 billion in revenue.

Hilti moved away from traditional fixed financial planning and analysis and shifted its entire financial culture to a flexible planning system.

They use a flexible relative target-based system instead of fixed figures when projecting their sales; they implemented a self-adjusting incentive system for their employees to promote fairness; they began using a system of rolling forecasts and planning, and they implemented a consistent measurement system by identifying KPIs.

Now, whether you're running a multi-billion dollar Swiss manufacturing firm or a small business doing $500,000 a year, the way you approach budgeting has massive implications for your business.

Creating a strategic budget and forecast allows you to plan ahead for the needs of your business. When it comes to marketing, you can identify exactly how much you want to spend.

You can actually dive into your pipeline and understand your customer journey. How many customers as leads do you get when people first come to your website? And then from there, how many appointments do you set and how many appointments do turn into actual paying customers?

When it comes to staffing, you can understand what your goals need to be in terms of supporting those customers, onboarding new customers, whatever it might be in terms of the headcount that you need to keep things running from an operational perspective, you can budget out and understand exactly the administrative and general expenses that you might need in your business to sustain itself in the growth rate that you're hoping to achieve.

Budgeting with a strategy focus ensures that you're meeting and exceeding your goals by continuously monitoring where you're headed.

It's this kind of direction, this kind of forethought and planning that helps small business owners go from a place of stress and uncertainty to confidence and clarity in their business.

When you work with any kind of accountant, or financial advisor, or financial coach, they'll often tell you that revenue (or sales) is the hardest, most difficult component to actually effectively model in a budget or a forecast for your small business.

And that's true because if you think about it, there are so many factors that go into the income that your business is making.

How many referrals are you getting from your network connections?

How many leads are you generating from your website?

What are the economic conditions that are going into this business environment that you're in?

How can you weather the storm of a recession or capitalize on excellent growth years in the future?

All of these things have massive implications for how your revenue is going to increase or decrease depending on the environment that you're in. But using a few different methods, we can actually project a revenue goal by making assumptions about what's going to happen in the future.

And there are typically three major modeling methods that most accountants, most financial planners will use when looking at a business's revenue numbers.

First, we have the top-down approach in this approach.

We take a final number, we take a revenue goal that we want to see at the end of the year, and we work backward from there.

We structure our expenses, all of our headcount, we structure our software costs, our cost of goods in order to fit into that revenue goal.

This can be a really effective way of planning to hit a certain number.

And then we have the bottom-up approach focused on past performance to identify sales capacity and outline customer acquisition.

This approach is extremely useful if we have a goal based on the expenses that we are incurring throughout the year. We want to understand exactly what our business needs to be operational, our break-even figure, and then work upwards from sales into a figure that we are comfortable with or that the management team is comfortable with.

Finally, we have the pipeline approach, and this one is my personal favorite because it analyzes sales pipeline metrics and determines the time to close for each customer.

It's taking a look at the customer's journey and how they're passing through your business and ultimately becoming a client.

How do these people convert from a lead or an introduction into an actual client? What's the time that it takes? How many do you have currently in the pipeline over the next two, three months in terms of sales that you can expect in the future?

Now, not every business is able to do this kind of revenue projection on their own, even strategic budgeting, monitoring your finances, in adjusting your goals to be more flexible based on the environmental conditions that your business is facing.

These are difficult things to implement as an owner on your own.

Instead, you need an expert financial coach or an accounting team to continually help you through this process, whether it's by projecting your revenue or trying to understand exactly how much you're spending or what your goals should be.

It's important to work with an accountant or a financial advisor who knows what they're doing.

I completely understand that these ideas of continuous forecasting and strategic budgeting might sound lofty and impossible to reach for most people.

How do you create a continuous system of financial planning and analysis?

How do you adjust your goals based on past performance and make flexible targets for your sales team to hit?

Much of this can be done with basic tools like QuickBooks and Excel.

Other tools like Fathom, Mosaic, and Clockwork are platforms that are designed to help make the FP&A process more accessible for small business owners. Many small business owners are far more visual. They need to see graphs and charts that help them understand exactly where their business is at, and that's what these modern platforms are doing.

But in my opinion, the most valuable service comes from an independent third party who can offer insights and opinions into your goals.

Are they actually reasonable based on your history?

Are your flexible goals too loftier, too, too significant for your team to handle?

Having a third-party opinion can really help you understand exactly where your business is headed and can help to make sure that you are piloting the plane in the right direction, continuously implementing a strategic, proactive approach to your financial management rather than a reactive fixed mindset.

And that brings us to the end of today's episode on strategic budgeting.

Don't get discouraged if you're struggling to grasp how the process should work. It takes time and experience to unlock the full potential of tools like this.

Make sure that you're subscribed to The Profit Plot podcast on Spotify, Apple Podcasts, or wherever else you get your podcasts from. If you found today's episode particularly insightful, please share it with a small business owner in your life so that other entrepreneurs can benefit from this valuable information. The more knowledge we can share with one another, the better off we'll all be.

Join us again soon as we venture to unlock the financial story behind your profitable business. Looking forward to having you here with us next time, on The Profit Plot.