Budgeting best practice for startups.
Tips and tricks: Why a budget doesn't work for start-ups? As someone who has transitioned from CFO in medium-sized companies to startups VCFO, I would like to share something I learnt after working with over 100 different startups… budgets does not work for startups. Let me explain why.
Start ups need an agile and adaptable approach
Coming from a background deeply ingrained in budgeting practices, I quickly discovered that the dynamic and fluid environment of startups renders many budget assumptions irrelevant within a matter of weeks. The very nature of startups, with their ever-changing market landscape and rapid innovation, demands a more adaptable and agile approach.
Rolling forecasts are a game changer
Budgets often take a very long time to create, especially if the company adopt a bottom-up approach. And with their fixed targets and long-term planning horizon, can become obsolete in the blink of an eye. The fluidity of the startups necessitates a financial planning method that can keep up with the pace of change. Enter rolling forecasts – a game-changer for startups.
Rolling forecasts offer the flexibility and real-time adaptability that traditional budgets sorely lack. By continuously updating financial projections, startups can align their plans with real-time data, market shifts, and evolving customer demands. This agility enables founders and directors to make informed decisions, prioritise initiatives, and allocate resources where they will have the most significant impact.
Proposed revenue targets
During discussions about the need for budgets with founders, we often come across several common arguments. One argument is that budgets help provide a clear aim for the company. Our counter to this is that startups operate in such a dynamic environment that it can be challenging to accurately forecast revenue. All it takes is one large customer deferring their sign-up, and suddenly the budget becomes irrelevant.
I often pose this critical question. "How many times have you found that the actual financial results closely align with the budget?" Surprisingly, almost all of them respond with a resounding "ZERO." This highlights the common discrepancy between budgeted projections and the actual financial outcomes experienced by startups.
Another argument in favour of budgets is that they help hold managers accountable for their revenue targets. In response, we propose setting revenue targets for the year instead of creating a budget in the traditional sense. By establishing clear revenue objectives, managers can be held accountable for achieving those targets, while also allowing the flexibility to adapt and revise strategies as needed throughout the year.
Cash flow is the lifeblood
Lastly, some argue that budgets are necessary to provide managers with spending guidelines. Our counter to this is to question whether it makes sense to adhere to a budget if revenue targets are not met. If a manager falls short of the revenue target by a significant amount, should they still be allowed to spend according to the budget? Another resounding “no”. This raises doubts about the efficacy of strict spending guidelines when the financial situation does not align with projected revenue.
One of the most critical aspects for startups is effectively managing their cash runway. Cash flow is the lifeblood of any business, and startups often face unique challenges in this regard. This is where a dynamic rolling forecast proves invaluable. By continuously updating financial projections based on real-time data, market changes and changes in business model, startups gain the flexibility to adjust their plans in response to shifting circumstances.
Moreover, a dynamic rolling forecast enables startups to identify potential cash shortfalls in advance. By monitoring their financial projections regularly, startups can proactively take steps to secure additional funding quicker, or be ready quicker, explore cost-saving measures, or pivot their strategies to maintain a healthy cash runway. This proactive approach to financial planning is crucial for startup survival and growth.
Having a VCFO to help make the budgeting process smooth is a big help. Talk to us about our virtual CFO service and how we can help you with budgeting for your startup here