'Tis the Budget Season

December 14, 2011

Most companies are now preparing their 2012 budgets and going through the approval process. To say the least, few people enjoy the budget process. It is often long and drawn out to the point where many managers involved in the process are just relieved that it is over, regardless of whether they agree with the numbers.

Most companies follow a bottoms up/top down annual budgeting approach. In other words, the Finance Department sends a budget package to each department head asking them to fill out a detailed survey of line-item expenses for the coming year. Each department head asks their line managers to submit budget requests for headcount and resources, and the department heads compile the requests and come up with a total expense request for their department. Meanwhile, Sales is asked for both an expense request, as well as bottoms up calculation of how much they can grow revenue in the coming year.

At a recent CFO conference, the CFO of Netsuite, Ron Gill, made the comment that CFOs now really control the forecast, which has always been the purview of sales. It took a while for this concept to really sink in and was sort of shocking for many of the conference attendees. The reality is that in a recurring revenue world, with complex waterfall analyses involving contracted recurring revenues, new customer additions, upsell revenue streams, as well as churn rates, Sales no longer is in control of the forecast, because for an established SaaS company, the recurring revenue makes up the vast bulk of the revenue forecast.

Getting back to the budget process, all these inputs come back to Finance where they are compiled, compared to the topline revenue projections, then Finance either presents the draft budget and revenue targets to the management team or directly to the CEO. The next stage of the budget process involves negotiations between the members of the management team, the CEO and within certain departments to get all the numbers to the point where the CEO is comfortable finalizing the process (and presenting to the Board). This may include a lot of back and forth reviews of the numbers, heated discussions about the resources required to achieve the targets, and some horse trading. Eventually, everyone has their numbers, whether they agree with them or not, and the budget is presented to the board, which may or may not approve it on first pass, in which case, some of the back and forthing within departments has to be repeated in order to bring everything in line with the board’s

One of our benchmarking clients, Jim LeJeal, CFO of Rally Software, tried a new approach last year. His Finance group sent out the standard departmental survey of expense requirements to each department of the company, but he also sent each departmental head detailed expense benchmarks for companies with the same revenues, business model and revenue growth rates as Rally. He asked each department head to develop their budget estimates and be able to explain any major deviations from the benchmarks. Each department head had to be able to explain why their budget request and targets were either above or below the benchmark and supported the company’s business model and strategy. He said the budget process last year was incredibly efficient, productive and collegial:

“We carried out a parallel process whereby we collected inputs from the executive team for each departmental budget. We circulated a presentation with benchmarks for comparable companies and business models to each department head, 80% of which came from OPEXEngine and 20% of which came from public company data for other market leaders that we follow. We reflected as a team on the benchmarks and how our internal plan related to those benchmarks. We then used the benchmarking data to adjust the plans from the executive team as appropriate. The team said this was one of the most friction-free and productive planning cycles they had ever experienced—primarily because it was data-driven.”

“In the same way, we moved through a systematic process to get budget approval from our board by giving them supporting data for our plans. We circulated the benchmarking presentation to each member of the board in advance of the board meeting to approve the budget. Our goal was to start the board meeting with board approval of the budget and we did exactly that. In the past, we have spent 30 to 60 minutes of the board meeting discussing the budget. This time, we started the meeting with approval from the board first off and spent the rest of the board meeting talking about how to move forward with the plan.”

This kind of data-driven decision making has been proven to improve productivity and profitability among firms. Prof. Erik Brynjolfsson at MIT/Sloan has been doing work with very large firms showing that a one standard-deviation increase toward data and analytics correlates with a 5-6 percent improvement in productivity and a slightly larger increase in profitability in those same firms. After benchmarking hundreds of fast growth software firms over the past 5 years, I would venture to suggest that with smaller companies, an even stronger result can be seen. By the nature of our business (offering benchmarking services), we tend to work with data-driven companies. We tend to see the highest results in terms of revenue growth and profitability among the firms that are on top of their numbers, and hungry for outside data to compare to their internal numbers. These companies see benchmarking as a way to minimize risk and as an aid to making faster course corrections along the path to growth.

Rally found that by using peer benchmarks, it could speed up the process of developing next year’s budget and make it more productive for all involved. In the end, department heads could spend more time executing, rather than spending too much precious time at the end of the fiscal year being worn down in a frustrating budget process.

And department heads were committed to achieving the next year’s numbers – and that commitment is what is required in order to achieve those numbers. That’s another reason why having good, 3rd party data to help drive the budget decision-making process is essential.