Many of us lack any vision when it comes to renovating a house. The people on TV make it look easy but when we try, the result is just a slightly different version of the same house we’re already living in. The same principle can be applied to budget setting.
Establishing a budget for next year is just good business management. Yet, we come across many owners who struggle with it. Most take an incremental approach – they take last year’s budget. They tweak it a little and cut back a little here and there and then say “that’ll do”. A better approach is to take the “Grand Designs” version of house renovation. We need to envision a different type of business and not just what we want next year but a different type of business over a three to five-year time horizon.
THE REAL QUESTION IS NOT HOW MUCH ARE YOU SPENDING NEXT YEAR, IT’S HOW MUCH ARE YOU INVESTING NEXT YEAR?
If we apply this thinking to your current budget setting, yes, it’s useful to look at what BAU (business as usual) requires in terms of funds. But, when you go through that exercise, we recommend doing it from the perspective of what return am I getting from that current expenditure. And am I getting a return on investment in the right places?
You’ll find that some of your expenses this year have been about keeping the lights on, producing today’s products and services and selling to today’s customers. No doubt you’ll also have some expenditure which relates to things that you’re doing to generate tomorrow’s customers. However, you should separate these groups and ask yourself:
ARE YOU GETTING THE RIGHT RETURN ON INVESTMENT OR IS YOUR RETURN ON INVESTMENT MEETING YOUR EXPECTATIONS?
At Board Associates, we start the conversion by looking at what your future vision is and what it is that you’re trying to accomplish over a three to five-year time horizon, what the potential of the business is and what investments are required to get there.
To give you an example, we recently spoke with the inventor of a motorcycle company here in Australia. This company produces some of the most innovative electric vehicles you’ll find anywhere in the world. These motorcycles have significant market potential as well as social benefit. The thing that’s holding them back is investment. And so the question we posed to the founder was:
“if you have that much passion for getting your vehicles into the hands of as many people as you can, and creating this environmental and social benefit, why would you put the brakes on that by taking an incremental approach to growth and only investing internally? Why not take a more ambitious approach so that your company can live up to its full potential?”
We believe that this is the approach that you should take on all budget lines when planning next year’s budget.
3 STEPS TO BETTER BUDGET PLANNING
Step 1: Split your current years’ actual figures into two groups
Group 1: expenses which are about delivering on business as usual, and;
Group 2: the money that you’re spending on investing and preparing for your new customers.
Step 2: Analyse and adjust your current return on investment.
For both of these groups, you should be clear about what your return on investment expectations are and measure them.
For Group One, ask yourself if you’re generating a commercial rate of return. If not, this should guide how you adjust your BAU budget.
For Group Two, ask yourself how attractive your return on investment will be and again use this to guide decisions about investing more, investing less or changing the balance between BAU and incremental investments (group two). Importantly, get rid of those pet projects if they’re unlikely to generate a sufficient return.
Step 3: Take a fundamental return on investment approach
Ask yourself: what investment would you make in the business now to create the next version of the business and to secure a better return on investment over 10 years?
This step is more like developing a business case for investment than setting a budget but of course the answers to these questions then drive where you allocate funds next year and importantly whether that investment is coming from internal vs external sources.
SO HOW CAN BOARD ASSOCIATES HELP?
The team at Board Associates have a significant amount of expertise not only in CFO and financial management services, but also in new venture assessment, investment management and strategic planning. If you’d like some assistance in analysing your current allocation of funds, the return on investment that you’re getting versus industry benchmarks and how you might fuel your future potential, reach out to us and we’d be happy to schedule an initial chat to discuss how we might be able to help.
Graduate of the Australian Institute of Company Directors and Chairman of a number of family and private enterprises, Matthew is the founder of Board Associates and specialises in innovation and strategic marketing.