The Best Budgeting Methods for Your Business

The Best Budgeting Methods for Your Business

From software developers to capital investors, most business professionals understand that budgeting is vital for sustainable growth. But few understand that a company’s budgeting methodology can make the difference between financial success and ruin.   

 In this article, we discuss four traditional types of budgeting. Then, we offer insight into driver-based budgeting – an innovative and flexible technique that allows companies to focus on factors that directly influence future success. 

Contents

What Are the Traditional Types of Budgeting?

The Problem With Conventional Budgeting Methods

How Driver-Based Budgeting Works

Why Savvy Business Owners Opt For Driver-Based Budgeting

Why Your Company Needs Driver-Based Budgeting Software 

What Are the Traditional Types of Budgeting?

Many companies follow traditional budgeting approaches, including: 

  • Incremental budgeting 
  • Activity-based budgeting
  • Zero-based budgeting
  • Value proposition budgeting

Each methodology has unique advantages as well as downfalls.   

Incremental Budgeting

This popular budgeting technique involves using the current budget as a starting point for next year’s budget. From there, you can adjust specific line items.   

 A cost of living raise may equate to a 2.5% increase in personnel spending, for example. Or, a merger may lead to a 4% reduction in production costs. 

Though incremental budgeting provides funding stability, it can also contribute to unnecessary spending. 

Pros

  • Straight-forward and easy to understand; no complex calculations are required
  • Budgets remain consistent over time
  • Less internal conflict; departments know what to expect from year to year

Cons

  • May lead to unnecessary spending; departments feel compelled to spend all the money in their budget
  • Doesn’t account for unforeseen or external factors
  • Leaves little room for innovation or creativity 

Activity-Based Budgeting

Activity-based budgeting is a top-down approach. Companies start with a key business objective and then ask, “What must we do to accomplish this goal?” Resources are allocated thusly.   

For example, if the goal is to generate $6 million in revenue from a new product line, an organization may decide to increase its personnel budget to hire more sales representatives.    

Though activity-based budgeting helps companies make goal-centric decisions, it can be tedious and time-consuming. 

Pros

  • Allows companies to focus on factors that influence the bottom line 
  • Company leadership is more likely to identify budget inefficiencies
  • Affords flexibility; changes can be made in response to internal and external events

Cons 

  • Time-consuming and expensive
  • Can lead to short-term thinking in pursuit of annual goals
  • May be difficult for younger companies to implement

Zero-Based Budgeting

Zero-based budgeting starts with a blank slate. Every year, department heads must create a budget from scratch, justifying each line item without reference to the prior year’s numbers.    

This budgeting approach is an excellent way to eliminate wasteful spending as it allows company leaders to aggressively cut fat while prioritizing key activities. 

However, zero-based budgeting is very time-consuming. 

Pros

  • Streamlines inflated budgets
  • Holds department heads responsible for costs 
  • Helpful during restructuring   

Cons

  • Incredibly time-consuming and frustrating for department heads
  • May reward short-sighted decision-making rather than big-picture thinking

Value Proposition Budgeting

Value proposition budgeting is a happy medium between incremental budgeting (which, some argue, is too blasé) and zero-based budgeting (which, some argue, is too scrupulous).   

 

The approach involves evaluating each line item by asking:  

  • Why are we spending this money?
  • What value does this provide to our stakeholders, customers, and employees?
  • Does the value outweigh the cost?

Though value proposition budgeting is useful for cutting wasteful spending, it can be difficult to operationalize “value” (i.e. what’s valuable to one person may not be valuable to another).   

Pros

  • Allows leaders to identify expenses that bring little to no value to the organization
  • Keeps companies customer-centered
  • Great for cutting wasteful spending 

Cons

  • “Value” is hard to operationalize 
  • Perceived value may change based on cultural, social, economic, or technological influences beyond the company’s control  

The Problem With Conventional Budgeting Methods 

While each traditional budgeting type has clear advantages, these methods are rigid, making it challenging for companies to pivot in response to a rapidly shifting economy.     

By contrast, driver-based planning is innovative and flexible. This type of forecasting allows companies to focus models on key drivers that directly influence financial success.   

Simply put, this top-down approach helps businesses focus on the metrics that actually matter.   

How Driver-Based Budgeting Works

Implementing a driver-based model involves four high-level steps.

Step 1: Identify Qualitative Goals

As with all budgeting, driver-based planning begins with an overarching goal. Your company may, for example, aim to drive revenue growth or increase profitability. 

Step 2: Isolate Quantitative KPIs

After determining a qualitative goal, your team should work to identify key performance indicators (KPIs). These quantitative metrics can be used to gauge progress. 

Step 3: Define Key Drivers

Now, your business must define the key drivers that have the most significant impact on its KPIs. Examples include website traffic, product price, and call volume.

Step 4: Create Your Model

Finally, you need to develop a mathematical model that investigates the relationship between the key drivers and your overarching goal.  

 This model should allow you to survey different scenarios. For example, you may want to explore how net profits will change in the wake of a 2% product price increase.

What Key Drivers To Select for Your Model

Key drivers vary from business to business. However, they generally fall into one of five categories:

  • Cash
  • People
  • Profit
  • Growth
  • Assets 

Typically, key drivers are controllable. They are inputs that companies can easily manipulate, such as the number of sales personnel. 

Why Savvy Business Owners Opt For Driver-Based Budgeting

Most traditional budgeting techniques force company leadership to slog through unnecessary information. But with driver-based budgeting, executives can break through the noise – concentrating on the key drivers that affect the bottom line.  

Efficiency and Effectiveness 

With driver-based planning, your business can focus on the variables that impact organizational success.

Flexibility 

Using a driver-based model, teams can quickly assess how different scenarios may affect financial outcomes. 

Operational Alignment

A driver-based approach encourages collaborative thinking across departments. 

Data Integrity

A driver-based model allows companies to collect a smaller amount of more accurate and valid data. 

Why Your Company Needs Driver-Based Budgeting Software

Driver-based models help companies explore the causal relationships between key drivers and financial outputs. These models also afford visibility, allowing businesses to run different scenarios and explore what may happen in the wake of future changes.   

However, building a driver-based model in a spreadsheet can be very time-consuming. Large spreadsheets also struggle to handle the macros and equations needed for these models. 

Fortunately, there’s a better way. Driver-based financial planning and analysis (FP&A) software can provide the state-of-the-art budgeting and forecasting solutions you need to catalyze your business. 

Lavoie CPA and Jirav Software Solutions

At Lavoie CPA, our goal is to deliver cutting-edge financial support so that clients can focus on soaring to greatness. With this in mind, we have partnered with Jirav, a driver-based financial planning tool.  

“Jirav affords the flexibility and visibility required to scale, focus, and grow a business.”

— Sharai Lavoie, CEO of Lavoie CPA

As our preferred FP&A software, Jirav gives companies the confidence to navigate complex business challenges. With forecasting, budgeting, reporting, and analytics, this all-in-one tool has everything you need to make your next big move. 

Contact Lavoie’s financial experts to see if Jirav is the right software solution for your business.

The 3 Financial Strategies You Want To Remember in 2021

The 3 Financial Strategies You Want To Remember in 2021

An organization’s financial strategy is critical to the health and success of the business. A well-crafted financial strategy enables an organization to optimize operations and can present additional opportunities for growth. In contrast, a poor financial plan can hinder an organization’s operations and drive even a profitable company out of business.

Despite the importance of financial planning, the process of building a robust financial plan does not have to be complicated. By following a few simple strategies, an organization can avoid many of the common pitfalls that result in a flawed financial plan and hamper the growth of the business.

Three Important Financial Strategies for 2021

1. Remember That Cash Is Still King

It is vital to remember that a company’s money (revenue) is not the same as the money that a company has been paid (cash inflow).  While an organization may be profitable on paper, it could be broke in reality based upon the ratio of revenue to expenses.

Bills can only be paid with the money that a company actually has on-hand, making cash management an essential component of an organization’s financial strategy.

This includes setting the terms of contracts to ensure that they are paid promptly and taking advantage of opportunities to minimize expenses, such as the use of automation to reduce payroll expenses.

2.Keep It Simple

Overcomplicating its financial strategy is a common mistake that businesses make.  To optimize its operations, an organization may break expenses into many buckets and independently monitor and analyze each.

While this is intended to increase visibility and optimize expenditures, it can end up costing an organization more money in the long term.  Additional complexity and analysis require additional headcount to complete.  Since payroll is typically one of a company’s largest expenses, up to 70% of the total, the potential gains made due to increased visibility and optimization are likely to be overwhelmed by the corresponding analysis cost.

A better approach to expense management is to apply the Pareto Principle: 80% of consequences come from 20% of causes.  Identify those few things that make up 80% of your expenses (likely payroll, marketing, and rent) and focus optimization efforts on those for maximum impact.

Financial analysis can also be simplified and optimized by the use of automation.  By transitioning manual accounting processes to automated ones, an organization can achieve the same level of analysis while minimizing the associated costs.

3. Bring Management Together & Make It Meaningful

One of the most common mistakes made by founders and entrepreneurs is maintaining too tight of control over a business’s operations.  By trying to do everything themselves, these leaders end up spending more time working “in” their company (day-to-day tasks, putting out fires, etc.) rather than working on their company (strategic planning, long-term goals, etc.).  As a result, the company can stagnate and fail because it lacks a clear path forward.

This also applies to an organization’s financial planning.  A crucial part of building a successful business is hiring competent people and handing over control of the tasks they are more fit to manage.

When developing a financial strategy, an organization’s management likely has a better view of the current state of the parts of the company under its direct control than the CEO.  Asking them about their departments’ current state, their needs, and potential opportunities to decrease expenses without sacrificing revenue can provide invaluable data for crafting an organization’s financial strategy.

Preparing Your Financial Strategy for 2021

The most effective financial strategies are based upon experience.  Optimizing cash flow requires knowledge of how to manage contracts best.  Simplifying financial analysis requires an understanding of what is and isn’t important.  Reducing expenses via automation requires the ability to select platforms that provide a tangible benefit and return on investment.  Crafting a strong financial strategy requires knowing the right questions to ask subordinates and take the right actions based on their answers. 

A good starting point for acquiring some of this knowledge is reading Lavoie’s Guide to Strategic Financial Planning.

This ebook provides best practices and tips for developing an effective financial strategy.

However, in many cases, there is no substitute for experience.  Lavoie CPA has over 25 years of financial planning experience and can manage your accounting for you, allowing you to focus on running and building your business.

The Most Common Financial Mistakes CEOs Make

The Most Common Financial Mistakes CEOs Make

Many CEOs don’t have a background in financial planning yet are expected to develop strategies and make decisions that dramatically impact an organization’s financial health. As a result, CEOs make several common mistakes that can dramatically impact their company’s financial health and success.

 Where CEOs Go Wrong

Getting too comfortable with “how you do things.”

Past performance is not indicative of future results.  While an organization’s strategies may have worked in the past, situations can evolve, forcing changes to “how you do things.”  CEOs must be ready and willing to adapt, not stuck in a rut.

Denying that every decision a business makes has some financial implication

Every decision that a business makes impacts its finances.  Everything that a company does affects its ability to operate in terms of additional or lost revenue, productivity, expenses, etc.  If nothing else, making the decision to do one thing means that the organization likely lacks the resources to do something else.  All business decisions should take into account the associated financial implications.

Making every decision in a vacuum

As the CEO, you will be called to the carpet for every choice you make, financial or otherwise, so it is vital that you justify the decisions you make.  Decisions should be made based upon the best data available and incorporate the input of all stakeholders and subject matter experts.  Making decisions in a vacuum increases the probability that a poor decision will be made based upon incorrect data or assumptions.

Forecasting based on what is in the bank account at that time

An organization’s current bank balance is a snapshot in time.  It can change rapidly and in unexpected ways.  For example, something as simple as a vendor depositing a check earlier or later than usual can result in a significant discrepancy between what an organization’s current bank balance is and what it “should” be.

For this reason, an organization’s financial strategies should not be based on projections based on a current bank balance.  A range of different factors could affect this and render any projections based on it erroneous and unusable.

No visibility into what you are owed and what you have to payout

Visibility into an organization’s liabilities and receivables is essential for a CEO.  For example, do you have more liabilities than what you are expecting in your receivables? You could have 600k in receivables but 800k in liability.

If this is the case, then a CEO needs to develop a strategy to decrease expenses and liability relative to receivables.  However, without visibility into the current state of liabilities and receivables, a CEO is unaware of the need to change.

Ignoring investments that don’t show up on the P&L

An organization’s profit and loss (P&L) statement summarizes its revenue, costs, and expenses during a specific period.  However, it is not necessarily comprehensive and should not be treated as such.

Investments that do not show up on an organization’s P&L statement should still be incorporated into its financial strategy.  While they may not impact long-term revenue and expenses, they will show up in cash flow.  Failing to account for them could leave an organization looking financially healthy on paper but broke in reality.

Not considering seasonality

Many businesses have seasonal ebbs and flows. Such as an increase in work for construction workers in summer and increased e-commerce sales in the months approaching Christmas.

For others, the reasons may be less obvious (such as having more sales in summer because customers have more money), but these cyclic changes will still occur and should be incorporated into a CEO’s financial strategy.  For example, building up cash reserves going into a dry season may be necessary to cover expenses while waiting for sales to trend upward again.

Planning once and refusing to iterate as things change

A business’s profitability is determined by a number of internal and external factors.  While the COVID-19 pandemic and its economic impacts are a high-visibility example, businesses experience smaller changes much more frequently.

Adaptability is a critical component of an organization’s financial strategy.  While the company may have certain goals and plans in place, if internal or external factors demand a change, it is essential to adapt rather than insisting on continuing with a course that isn’t working.

 

Avoiding Common Financial Mistakes

 Understanding how financial planning can go wrong doesn’t tell you how to develop a financial strategy correctly.  To learn more about this, check out Lavoie’s CEO’s Guide to Strategic Financial Planning.

Strategic Financial Planning In 2 Questions

Strategic Financial Planning In 2 Questions

Developing a strategic financial plan can seem daunting; however, it can be boiled down into two questions: what are you doing now and where do you want to be? This article walks you through the process of answering these two questions, providing a foundation for developing a financial strategy for your organization.

Question 1: What Are You Doing Now?

Every journey has a starting point and an ending point. Before you can implement a plan to achieve your financial goals, it is important to consider where you are now.

Current State of the Numbers

The current state of your organization’s numbers are a good starting point when determining your organization’s capability to meet its financial goals.  Some important questions to ask include:

  • Are you in a position of stability? Financial stability is vital to reaching “stretch” goals.  If the organization is not currently financially stable, it is important to identify this fact and develop a strategy for achieving stability as a first step in the planning process.
  • What is actually coming in/out the door? Knowing the size of the company’s cash reserves is not enough for financial planning.  How much revenue is coming into the organization and how much is going out again as expenses?
  • What is fueling the majority of your expenses? While increasing sales is one way of improving the organization’s financial footing, the ability to do so depends on the market and potential customers.  Identifying and minimizing expenses increases profits as well but is less impacted by external factors.

Culture

Achieving financial goals requires the support of the entire organization.  Take a moment to consider your organization’s culture and if the company has the maturity and ability to meet its goals.

  • Do your decisions match your vision and mission? An organization’s goals and procedures are important, but actions are even more so.  Are your decisions, both recent and historical, helping to move the organization towards its goals?
  • Would your employees agree? Employees throughout the organization can have different perspectives, insights, and recommendations.  Ask those “down in the weeds” how well the company is following its vision and mission and how they believe things could do better.

Question 2: Where Do You Want To Be?

The effectiveness of a strategic plan can only be effectively measured if there are usable metrics.  Before starting to build a plan to improve the organization’s financial position, it is necessary to define success and failure.

Targets

The first step in defining “success” for a financial strategy is defining concrete targets.  From there, the next question to ask is what do you need to achieve your targets?

  • Human Capital.  Does your organization have the human capital necessary to achieve its goals?  This not only includes headcount but access to the specific skill sets required now and in the future.
  • Acquisitions. Does your organization have the capabilities that it requires?  Are there areas of your business where things could be done more effectively or efficiently?
  • IT Investments. The IT landscape is evolving rapidly, and new solutions have the potential to dramatically improve operational efficiency and effectiveness.  Are there any IT investments that the organization should make that would help in reaching its targets?

Expenses

A failure to properly monitor and manage expenses is one of the most common ways that businesses fail to achieve their financial goals.  Gaining visibility into past, present, and future expenditures is an essential part of financial planning.

  • How can you gain more visibility into your expenditures? Visibility into expenditures is essential to identifying opportunities for optimizations and cost cutting.  How can you achieve a higher level of visibility into business operations?
  • Do you have an idea of your cash flow on a daily, weekly, and monthly basis? What level of visibility do you currently have into your organization’s cash flows?  Examining cash flows at the daily, weekly, and monthly level can help to identify potential inefficiencies and opportunities.

Beginning Your Strategic Financial Plan

Answering the questions that were asked in this article enables you to lay the groundwork for developing your organization’s financial strategy.  To learn about the next steps in your financial planning process, download the CEO’s Guide to Strategic Financial Planning.

Sage Intacct’s 6 Key Performance Metrics For Subscription Businesses [INFOGRAPHIC]

Sage Intacct’s 6 Key Performance Metrics For Subscription Businesses [INFOGRAPHIC]

How Healthy Is Your SaaS Business? These 6 Metrics Will Help You Figure That Out

As a Sage Intacct certified accounting and implementation firm, Lavoie CPA is excited to share the latest findings for SaaS businesses to become successful in 2021.

From startups to organizations ready to scale each one of these indicators is an invaluable piece of information to evaluate your company’s overall health — not to mention prep you for that looming board meeting in the near future.

In this infographic we will dive into why each of these metrics is the difference between getting your next round of funding, scaling year over year, or hitting the wall.

Get the infographic and learn why you should care, how to calculate, and an interesting fact about the following KPIs:

  • CARR (Committed Annual Recurring Revenue)
  • CAC (Customer Acquisition Cost)
  • CLTV (Customer Lifetime Value)
  • Churn
  • Free Cash Flow
  • CCS (Cash Conversion Score)

Lavoie CEO Named Goldman Sachs NC Hill Week Captain

Lavoie CEO Named Goldman Sachs NC Hill Week Captain

As the election season draws closer and the concerns of small businesses continue to grow in the wake of the pandemic, SMB’s are joining forces to make sure their voices are heard in congress. According to a Goldman Sachs survey released on September 8, 88% of small business owners have exhausted their PPP loan funding; with 43% of Black small business owners depleting their cash reserves by the end of the year. 

To help amplify US small business needs, Goldman Sachs is using its 10,000 Small Businesses (10KSB) Initiative to serve as a policy platform and community resource center. However, prior to the COVID-19 crisis, the 10KSB alumni collectively represented $12 billion in revenues and employed 175,000 people. More notably, 44% of these businesses are family-owned and 66% are minority and women-owned businesses.

“The 10,000 Small Businesses Voices initiative is designed to help small business owners in the United States advocate for policy changes that will help their businesses, their employees, and their communities,” according to Goldmansachs.com. “We provide the 10,000 Small Businesses Voices community with the tools, resources, and training needed to make their voices heard and drive tangible impact against real issues.”

Among the many tools to assist small businesses, the program includes surveys, open letters to congress, and ongoing virtual events to help guide owners through ongoing challenges and the most recent policy changes.

One of these events was the Virtual Capitol Hill Day held on June 9th -11th. Over three days, 2,100 small business owners connected with Members of Congress through 434 online meetings across all 50 states, Washington D.C. and Puerto Rico. Lavoie CEO, Sharai Lavoie, was named a NC Hill Week Captain and lead discussions with congressional leaders and small businesses across the state.

Lavoie led three discussions one of which was with Congresswoman Alma Adams, representing North Carolina’s 12th District. Discussion topics included:

“I was thrilled to participate in this initiative,” says Lavoie CEO, Sharai Lavoie. “It’s programs like these that will give SMBs a fighting chance and help promote policies that positively impact the everyday American business owner.” 

To learn more about the 10,000 Small Business Voice initiative, check out the website to access resources or participate in the many surveys to inform congress of US business owners’ ongoing needs.