As an outsourced CFO, it’s sometimes my responsibility to deliver bad news — such as telling functional department leaders they need to restart the budgeting process because the company has wildly diverged from its roadmap.
One mechanism to do that rework is a 3+6, 6+6 or 9+3 budget exercise. The most common in my practice is a 6+6 budget; that is, create a new budget that shows six months of actuals and six months of forecasts. If expectations built into the budget aren’t materializing, then it’s time to recalibrate. With 6 months of actual numbers we’re in a much stronger position to accurately forecast the remainder of the year.
Mid-fiscal-year budget recompilations are a burden for not just business leaders but finance staff. That’s true even when you’re rebudgeting because sales are significantly higher than expected. In those cases, you’re not greeted like an angel of doom, and needn’t worry about morale and attrition. But still, you’re asking for a lot of unplanned work.
There are two ways to approach a situation where actuals and budgets diverge significantly.
Scenario 1 — tactical reforecasting: The board-approved budget remains untouched. The CFO tells departments, “Okay, we're investing more into our key strategic areas to continue supporting and pushing sales. If you require an increase of, say, 5% or less, let us know what you’re doing, but you don't need approval. For more than 5%, you will need executive approval.”
Scenario 2 — strategic rebudgeting: If there’s a large swing from expected sales, say up 100% or down 30%, the CFO rebudgets because something has strategically changed. It’s no longer just investing more in the same areas, but an actual deep dive into where the highest ROIs are now coming from. When sales are positive, there’s excitement. On the other hand, when sales disappoint and cash problems arise, expenses will need to be cut. This causes a lot of concern up and down the organization and can eventually lead to turnover.
Which path is best depends on whether you need to reset not just near-term targets (Scenario 1) but your three-to-five year goals (Scenario 2).
OK, so we’ve established that rebudgeting is always a big deal, for several reasons. So why do it?
It's sometimes abundantly clear that your budget-versus-actual roadmap has diverged so much from your original plan that it doesn’t provide actionable guidance anymore. It’s useless going forward, and targets need to be reset. When sales have significantly disappointed, big, strategic cuts may need to be made, and that requires deep thought. You need everybody to buy in, including the board.
Note that I never advise rebudgeting downward unless goals really are unobtainable, and asking people to strive to make those unrealistic targets will damage morale. If you rebudget lower when you could and should have pushed harder, you risk giving everyone permission to be mediocre.
A reach-goal encourages hard workers to say, “Okay, we're really gonna do it in the second half of the year.” That’s instead of, “Okay, phew, now we can just keep going at the same [unimpressive] rate.”
If you’re doing a 6+6 right, stakeholders across the organization will question all assumptions. It’s very hands on, to the point of being invasive. Watch out for superficial efforts and back-channel complaints. These will need to be managed if the rebudgeting effort is to be successful.
A material event has occurred: The pandemic is a perfect example. I never encourage companies to proactively slash budgets without first understanding detailed scenarios — we saw businesses cut too aggressively without supporting data, and it hurt their long-term growth. But when variances become too large, it's time to act.
The budget was not created correctly: I’ve had to support companies in a rebudgeting process when they’re off by only 5% or 10%, while others might see larger variances but are able to tweak within the existing framework. It’s something of an art to know when to go back to the drawing board.
Ask: Will needed changes impact all departments? Was the initial budget not well-formed?
Your business model assumptions are flawed: This doesn’t always result in negative consequences. We can be pleasantly surprised that, for example, although our budget was built based on B2B demand, our secondary B2C channels have outperformed beyond all expectations.
The worst case is worse: Companies go into budget exercises hoping for the best and planning for the worst. If numbers are coming in below your worst-case scenario and you’ve smoothed out seasonality and other temporary factors, then it’s time for a 6+6.
Cash flow liquidity has deteriorated: Maybe the budget looks, on paper, more or less accurate. But if your cash on hand continues to decline, then you need to reevaluate all your assumptions. Continuously reviewing numbers makes you nimbler.
The finance team leads the effort to create the new budget and works intimately with the cross-functional department team heads. The CFO will take the first draft and go back and forth with the CEO until a final draft is agreed upon. This gets moved to the finance committee for approval before being presented to the board for final sign-off. Expect lots of Q&As and drafts flowing up and down among all stakeholders. This is definitely an all-hands-on-deck process.
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Budget setting and financial forecasting have unique purposes, but they work best together. While a budget details expected future results, a forecast focuses on probable future events to inform whether a company will hit the targets set in a budget.
Economic volatility has put the shortcomings of traditional budgeting methodologies on full display. The smart money is moving toward rolling forecasts as a better way to predict business performance — and get finance in line with sales, marketing and production.
Without a financial forecast, as a business leader you’ll have a hard time gaining funding and essentially be navigating without a compass.
I like the saying, “All’s well that begins well.” When I am in a CFO advisory role and a budget review comes up, I first make sure we’re working with up-to-date numbers. Your finance team should close within 10 days of the end of the month, never more than 15 days. The quicker the better.
Now, I look at five buckets of data and ensure we’re up to date:
Only with all this information in hand do I have confidence that the numbers I’m taking into the rebudgeting exercise are correct.
Remember, a budget has three main functions: Prevent overspending. Set goals for employees around revenue generation and cost containment. And help you get additional funding if you need it. When your budget bears little resemblance to reality, it won’t support any of those, and it’s time to regroup.
James Vanreusel is CEO of Vanreusel Ventures. His 20-year finance career has taken him halfway around the world, from Belgium to the UK to Rice University Business School in Texas for an MBA in Finance & Marketing.
Vanreusel has experience as a VP with Banc Of America Securities, selling IPOs to a client base of Wall Street investors. In 2008, he moved into a consultancy role, specializing in private equity and asset management with BlueOrchard Finance, before moving into the corporate world. In 2014, he relocated to San Francisco and set up Vanreusel Ventures, a team of CFO consultants and financial analysts, working with for-profit and nonprofit clients headquartered in the US with extensive international operations. He is a member of CFO Leadership Council’s San Francisco Chapter.