As a startup founder, you put significant time and effort towards the end of each year mapping out your strategic plan for the year to come. And yet, many startups neglect a critical piece of their planning: the budget.
We understand that investing time in a budget can feel like wasted effort when so many things can shift quickly within a startup. Having said that, including budgeting in your annual planning is extremely important and useful for businesses of all sizes – and startups are no exception.
With the proper processes and tools, you can efficiently craft a realistic budget that will improve your startup’s performance and build good habits that will pay dividends as you scale.
In this article, we outline:
- The difference between budgets and projections
- The benefits of budgeting
- Four steps to create your budget
Budgets vs. Projections
Budgets and projections are two mission-critical tools that help businesses of any size . The two are often linked together, but they are not the same.
A budget sums up your goals for the coming year. The budget is locked in at the beginning of the year and reviewed for possible revisions on a semi-annual or quarterly cadence.
Every startup’s budget should include:
- Customer Acquisition Costs (Sales & Marketing)
- Cost of Revenue (COGS)
- A detailed hiring plan with projected new hires by department
- Overhead (G&A)
A projection, on the other hand, is a projection that is generally higher-level, can be short-term or long-term (even over several years), and reflects the conditions you expect and the course of action you assume.
The Benefits of Budgeting
Developing a budget for your startup protects you from making early financial missteps and helps you make informed decisions for your business.
A well-crafted budget helps you to:
- Align resources with company priorities
- Agree on a plan with your executive team, board, advisors, and investors
- Stay ahead of financing requirements, such as due diligence for debt and equity financing
- Quickly course-correct when actuals start to stray from your budget
Running a Budgeting Process
Your budgeting process should be integrated into the end of your overall strategic planning framework.
Once you’ve decided on your company’s strategy and goals for the coming year, you’ll run a budgeting process to allocate your company’s limited resources for the achievement of those goals.
We recommend you do this in four simple steps:
- Review last year’s spend
While established businesses lean heavily on historical financials to set the budget for the coming year, in a startup things can change quickly and dramatically from one year to the next. For this reason, we recommend you build your financial plan using the zero-based budgeting approach. Still, it’s helpful to review a breakdown of your prior year’s spend and reflect on how that spending might shift in the year to come
- Set next year’s targets and create a rough company-level financial plan
If your business has a path to meaningful and predictable revenues, you should run a revenue-driven process and kick off your budget-setting by establishing revenue targets. If your business is still working to find product market fit, a spend-driven budget starting with a runway target is the better option.
Based on that top-level target, you should be able to get a rough department-level picture of your expenses for the coming year to help guide the buildout of your detailed budget. For example, if you’re building a revenue-driven budget, aiming to add $1M in new ARR, and your CAC ratio for last year was 1, you should earmark $1M in sales & marketing expenses for the year ahead. If your historical gross margins are 75%, you should budget $250,000 for the Cost of Revenue.
- Build a hiring plan
Headcount-related expenses are by far the biggest driver of spending for most startups, so it’s worthwhile to spend time crafting a realistic hiring plan. Consult with your department heads to understand what hires they’ll need to make to support achievements of your company’s goals. Don’t forget to budget for fringe expenses (taxes, benefits, etc.) as well as compensation adjustments for current employees; we’ve built a downloadable hiring module that can help you lock down this part of your startup’s budget.
- Round out other expenses and get feedback from departments
At this point, you should have a pretty good idea of what your budget looks like for the biggest buckets of expenses. Next, you’ll want to go through department-by-department and budget for operating expenses. At an early-stage company, this exercise can be run by the company’s executive team, while a later-stage company might choose to empower department leads to propose their own budgets.
Once you’ve allocated these expenses and have a budget that aligns with your company goals, your department leads should review their departmental budgets, including OpEx and headcount, and provide insight and feedback.
We recommend you kick off this process by early December so you can share the final product with your Board and finalize ahead of your Q4 Board meeting.
Using Budgets to Course Correct
Once you have your budget in place, set up a simple process for measuring your startup’s performance against that plan. You can do this with a simple Google Sheets template or financial planning software like Trace and OnPlan.
We recommend you formally review your actual spend versus budget quarterly. By doing so, you’re able to more effectively course correct when needed. When you’re seeing consistent variances against your budget, it’s worth exploring the root cause of those variances. For example, maybe you’ve had a series of unexpected one-off expenses, or discover that it’s costing more to acquire customers than originally planned.
Now you know how budgeting fits into planning, why budgeting is important, and how to craft your own in four simple steps.
Need a little help? airCFO works with founders and management teams to streamline systems, provide financial clarity, and improve financial literacy.
We’d be delighted to have a quick conversation about how we can help you build a best-in-class back office. Book a call here to get started.
Author Note: Alex Wittenberg leads up airCFO’s Financial Advisory team and serves as fractional CFO to 6 high-growth startups, primarily in the B2B SaaS space. He has a background in management consulting, startup finance and as founder of a social enterprise startup called CoffeeQ.