If you would rather watch than read, click here to watch the full video from Heath Advisory before diving in. We often hear service-hour businesses say budgets don't work for them. However, the budget process does work. The problem is they're not using it correctly. They either set the budget at the beginning of the year and never look at it again, or they let it change whenever they feel there's a justifiable need.
A budget should really be viewed as a static document – a benchmark against which a business can measure its financial performance throughout the year. Once you establish your goal for the year, you don't change it. You might crush it, or you might miss it, but the goal does not change. The budget's job is to drive a monthly conversation. What happened? Why did it happen? And what do we need to do differently? That conversation is where the budget's value actually lives.
Why Every Business Can Benefit From a Budget
When an owner tells us their business moves too fast for a budget, we respond that every company can benefit from one. If you crush your budget, great. Let's look at what's working and how you can keep doing it to make more and more money. And if you miss your budget, well, now you have new information you didn't have before. Either outcome tells you something, which is more than you get from having no benchmark at all.
Budgeting rigor is also something that lenders and investors like to see. They like to see businesses with a history of budgeting and meeting it, because, if nothing else, it signals financial maturity.
What Separates a Real Budget From a Checkbox Exercise
There's a big difference between a budget prepared as a checkbox exercise and one used as a real planning tool. A "check the box" budget is one where you create the budget, you say hey, yay, we've got a budget, and you put it in the drawer, and you're finished with it. The naysayers are right; there's not much value in this checkbox-type approach.
A budget used as a planning tool is reviewed each month, compared against your year-to-date performance, and then used to drive real conversations about what's working and what isn't. Same document, completely different value.
When to Start Building Next Year's Budget
A good budget starts with what you know is repeatable in your historical performance, and is then adjusted for whatever growth requires. Most of our financially healthy clients begin building next year's budget in October.
That timing matters because the key decisions from the process need time to take effect. If you wait until the new year to begin budgeting, you'll be planning for a year that's already in motion, and you're going to lose a lot of the value of the exercise.
The Three Things Most Service Business Budgets Miss
Every service business needs to budget for headcount changes and comp adjustments, and timing matters as much as the amount. When do you expect to make these hires, and when are you going to make these comp adjustments? Understanding the timing allows you to have a more meaningful monthly budget.
You also need to budget for client concentration and client losses. We all know clients eventually leave, so it's important to account for some level of attrition.
And then you need to budget for collection timing. Which clients have you agreed to accept 60-day payment terms with, as opposed to the ones that typically pay you within 10 days of the invoice date? Payment timing affects your cash budget, which you need to watch closely.
Top-Down vs. Bottom-Up Budgeting for Agencies
There are different approaches to budgeting. The top-down approach typically starts with a goal, such as a revenue goal set by senior leadership. The bottom-up approach starts with what you know. What is the cost of your team? What's the cost of your other overhead? What does your pipeline look like?
Our preferred approach is a hybrid between the two. We have all leaders across the organization create budgets for their individual teams. Then we have senior leadership budget the revenue goal and the EBITDA goal, compare the two and continue working through it until we land on a budget that everybody agrees is within reach. That level of involvement from your senior managers and ultimate buy-in is what makes people actually use it.
How to Build the Revenue Side of a Service Business Budget
Building a revenue budget for a client service business begins by bucketing your expected revenue into categories. You have known/contracted revenue, and probable or likely revenue, and aspirational revenue. Then you need to factor in some level of attrition.
It helps to picture what sits in each bucket. Known and contracted revenue is the signed retainer running through next year and the statement of work that a client has already approved. Probable or likely revenue is the annual campaign a client has run with you for four years running, but hasn't signed yet, or the phase two everybody expects to follow the project you're wrapping up now. Aspirational revenue is the RFP you've been shortlisted for and the prospect who says their budget should come through next year. Aspirational revenue can also be the gap amount from where the first two add up and where you really want that number to be at the end of the year. That's the amount you have to go out and find, the "go get."
Apply a probability factor to each bucket you've established. You don't need to hire an actuary here; a simple percentage will do. You should have a good sense of how likely these deals are to close. Maybe you give a likely deal a 90% probability, and a less likely deal, a 75% probability. Once you apply these factors and add up the output, you'll likely have a solid budget number to move forward with.
What to Do When Actuals Diverge From Budget
When actuals diverge significantly from your budget, take action now. To the extent that revenue is way below budget, you need to adjust your expenses today so that you can hit your EBITDA goal by the end of the year.
This isn't about one particular month on the calendar. Every month you postpone the adjustment is a month of savings you never get back, and there are fewer months left in the year to make up the difference. The longer you wait, the smaller the chance you will finish where you planned to.
How to Build Your First Business Budget
For business owners building their first budget, the simplest approach is to take your current year's actual results and adjust for any known changes, whether it's a big hire you're going to make, a lease renewal, or any other known change. Take those things into account, and then you're off to the races.
A simple model like this is much better than no model at all, and once you start to exercise that muscle, you'll get into the habit and become much better at budgeting over time.
Heath Advisory works with agencies and professional services firms to build budgets that hold up, run the monthly review that turns them into decisions, and start the planning process for next year while there's still time for it to matter. Reach out for a free consultation if your budget has been sitting in a drawer since you built it.
