The Art of Startup Finance: Financial Budgeting – Your Operating Budget

Kauffman Founders School, Bill Reichert, TheArt of Startup Finance, Financial Budgeting: Your Operating Budget>> Now for the hard part, we're going to talk about budgeting and forecasting.

This is frequentlythe toughest thing for startup entrepreneurs because we're asking them to predict the future.

Hitting your budget may be the difference between success and failure.

And I'll tellyou, the most frequent reason that venture capital investors fire founders and CEOs isbecause they miss their budgets.

You want to be the CEO that hits his or her budgetevery time.

So let's see if we can offer some approaches to make the budgeting and forecastingprocess a little bit easier for you.

Now don't worry, we know it's not going to be right.

That's a given.

But at least it frames out your thinking so you know if things don'twork out the way you expect, you know exactly which way they worked and which way they didn't.

So let's start with the operating budget.

The operating budget is the detailed planof how you're going to spend money and hopefully earn revenues over the next year.

When youdo your operating budget you start by figuring out what are the key drivers for my expensesand for my revenues going forward.

What are the things that are going to cause me to spendmoney and enable me to make money? Think those through.

Most entrepreneurs, they make themistake of finding some template, some Excel template out there.

And then trying to plugtheir numbers into somebody else's framework.

I would urge you instead, start by figuringout the design of your business and the key drivers of your business.

So the key driversof expenses, generally those are going to be related to people; the people you firefor different tasks in the company.

Your revenues are a function of your customer contact.

Soin order to have customer contact you have to have those marketing and sales programsin place in order to generate those revenues.

When you're putting together your operatingbudget you want to put it together using frames of reference that are going to make senseto your whole team on the inside as well as to your board of directors and investors onthe outside.

And that's more likely going to be an around your milestones rather thanthe traditional accounting categories.

So a term you might hear is a term called milestone‑basedbudgeting.

And this is a really powerful concept for developing your operating budget.

Insteadof designing your budget around just the plain old accounting terms that your accountantmight use, instead frame your operating budget around the key milestones that you need tohit.

So for this budget period, one of your key milestones may be we need to build andship a product.

So you're going to organize your expenses around that process, that milestoneof building and shipping your product.

Unfortunately, I got to tell you, once you've put togetheryour operating budget, your work has only just begun.

As I mentioned, it's almost certainlygoing to be wrong.

So you're going to have to iterate.

How often should you iterate?Probably you're going to have to make adjustments every quarter, certainly every six months.

Prepare your investors for that.

Prepare your board for that.

It's going to be a continuousprocess, especially during the early years.

But once you get the processes down for puttingtogether your operating budget, it will yield enormous results for you in helping you manageyour company more effectively.

So entrepreneurs ask well how long shouldwe do an operating budget for.

What I would recommend, you do a 12‑month, monthly operatingbudget.

And then do the two following quarters just to get some sense of visibility intothe period beyond.

How much detail should I put into my operating budget? Well, that'sgoing to change over time.

In the early days of your company, you're not going to havea lot of data on which to base a very, very detailed operating budget.

As you have moreexperience with your company, as you go through different years of operating budgets you'regoing to be able to fill in more and more detail.

Get this question all the time from entrepreneurs.

Entrepreneurs are wondering, so how much cushionshould I build in to my operating budget.

Because, you know, entrepreneurs know if theymiss their budget it's a really bad thing.

I encourage you to put a little bit of cushionaround each of the elements of your operating budget.

But do not do what we've seen someentrepreneurs do, which is they put a big plug number at the bottom that says this isour cushion number.

And that doesn't help you.

Investors are just going to look at thatand they're going to say this guy doesn't really know how to budget.

Instead try toincorporate as best you can, your best guesses with a little bit of cushion around each ofthe elements of your operating budget.

And hopefully you'll come in under budget on termsof your expenses and over budget in terms of your revenues.

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