The vast majority of businesses create a budget for the year and then never look at it again (until the end of the year when they’re creating the budget for the following year). Sound familiar? We thought so.
Because so few business owners actually take the time to review their budget over the course of the year, doing so may give you a huge leg up on your competitors. Imagine two lemonade stands: Lulu’s and Larry’s. Both developed a budget for the summer, but only Lulu did a midsummer review. She realized that her cost of goods sold was higher than she had budgeted. When she dug in, she realized that cost of lemons at her local grocery store had slowly increased over the past few weeks without her even noticing.
Lulu’s $100/week in profit turned into $90/week. The good news is that noticing the problem gave her options: raise prices, play with her recipe to incorporate other types of fruits, overhaul the lemonade and replace it with orange juice. Meanwhile, Larry didn’t notice the increase in lemon price and continued to produce his lemonade as before. Who do you think is better prepared to hit their end-of-summer goals? And will have more to invest in next summer’s business venture?
Obviously, this example is incredibly simple, but things happen every day to alter the cost of ingredients, change consumer preferences and priorities, and push and pull a myriad of other business levers.
By making it a priority to do a mid-year budget review (or even better, a quarterly review) you are setting yourself and your business up for success. (For a step-by-step guide on the process of updating your financial model budget, read last week’s post, Financial Model vs. Budget: The Showdown.)
How to review your budget
1. Validate (or invalidate) existing assumptions
Typically owners evaluate success by simply reviewing revenue performance. Let’s say your six-month revenue was $25,000 less than planned, this alone only tells you that you didn’t meet your revenue plan, and your initial response will be to push your sales team harder to meet that revenue goal. But this method is lacking insight and doesn’t get at the ‘why’ behind the underperforming revenue. A better place to start your budget review is to recreate the assumptions from your financial model and see if they hold true in your actual financials.
Let’s break this down. In our financial model, say we made the following basic assumptions:
- Assumption 1: We will add 10 new clients every month
- Assumption 2: Revenue per client will be $100 per month
- Assumption 3: 2 clients will churn per month
Now we look to our actual financials for the last six months and ask:
- Did we actually bring in 10 new clients per month?
- Did those new clients actually spend $100 per month?
- How many clients churned?
- How much was our total six-month revenue?
If your assumptions align with what actually happened with your business, congratulations! You know your business well! If things didn’t turn out as you expected, you are not alone. This represents a fantastic opportunity to learn what differed from your expectations and why. So, we dig in:
Let’s assume your six-month revenue ended up $25,000 under what you originally forecasted. Having gone through and compared your actuals to your assumptions, you can now ask (and answer) these more insightful questions:
- Were you off because you didn’t hit your new client acquisition goals?
- Because clients spent less on your services than you thought?
- Or because you had more clients leave than expected?
Depending on what you find, you may need to re-motivate your sales team, increase cross-and up-selling, or take a good hard look at your customer experience because churn was higher than expected. The idea is not just to see what happened, but do something about it!
The example above focused on revenue, but you’ll have to do the same review of your expenses. By doing this exercise for both revenues and expenses, you are evaluating whether how you thought about your business six months ago held true so you can use the new information to make an updated, smarter model for the next six months. This, in turn, will help you make better and better assumptions and decisions for your business.
2. Look for anomalies in the data
An anomaly is any data point from your actual financials that differs substantially from your budget. For example:
Advertising spend for 6 months (budget): $10,000
Advertising spend for 6 months (actual): $20,000
So many questions:
- Was this planned?
- Did priorities shift and you take spend from another bucket to cover this increase?
- What was not accounted for?
- Was something allocated to the wrong expense category?
For example, the discrepancy may have been expected but just not reflected in the financial model. Say your two biggest industry conferences–your highest marketing spend for the year given the booths assets, marketing collateral, and swag needed–were in February and June, that would explain why marketing spend was much higher in Q1 and Q2 (if in your budget you divided out marketing expenses equally over the course of the year).
Rather than continue to divide out the expenses equally, use this opportunity to update lazy budgeting and account for seasonal spend. If you know you will spend more on something early or late in the year, include that in your budget! Failing to do so may cause you to misunderstand your cash position and lead to financial stress down the road; for example, a smaller business might need to take out a short-term loan to cover this level of additional expense.
There are many other anomalies you may notice as you review your budget. Some of these may be do to unexpected expenses like a piece of equipment or server breaking, others may just be due to changing priorities over the course of the year.
The point of searching for these anomalies is to check for things that are out of the ordinary from a financial statement standpoint and learn from them.
3. Review your cash position
The final component of a basic mid-year budget review is to evaluate your cash position:
- How much cash do you have on hand?
- Do you have more or less than you expected?
- Do you have enough dollars in the bank to cover business operations?
- Are you solvent? What will it take to get solvent?
- Do you need to raise money or get a loan to deal with cash flow issues?
The answers to these questions may cause you to shift priorities over the coming months, so make sure to think them through thoroughly and understand the implications to your business of too little (or too much!) cash.
How much time will it take to review my budget?
Probably not the answer you want to hear, but it totally depends… on the complexity of your business, on how deep into the data you want to dive, on how clean and easy it is to access your data.
If your business involves multiple product or service lines and different P&Ls by region, it’s going to take you longer to review all your financial data. If you sell one product or one service and are interested only in high-level insights, it may only take you a few focused hours.
A few concluding words of wisdom
You don’t need to do or learn it all the first time around. Start with high-level insights and work up to deeper and deeper insights over time. If you feel totally overwhelmed the first time, chances are you’ll never approach it again and that’s exactly what we don’t want.
Don’t be hard on yourself if your actuals aren’t lining up to your projections. This is a learning opportunity and there is nothing better than knowing what’s happening with your business, even if it’s not what you thought would happen.
You and your team are all in this together. This is not the time to place blame on one part of the organization or another if things aren’t going as planned. It’s a time to iterate and figure out how to improve over the next three to six months based on your learnings. It’s also not the time to hang back and relax if you’re doing better than expected. Keep pushing and use the insights to grow more thoughtfully and quickly! And don’t forget to celebrate even the smallest of wins!