Many years ago, I did my first Merger and Acquisition (M&A) project. In the due diligence report, we came up with five-year financial projections primarily using a model. We assumed 5% revenue growth, 3.5% compensation growth, and 2% OpEx growth, along with synergies and integration costs, and we could show how we were going to make it an accretive acquisition. When you do M&A, you’re required to make 1+1=3 to justify the acquisition.

A couple of months after I did another M&A project, and I was asked to do a regional budget. I asked for advice on how to do the budget. The advice was to just roll up the business’s ground-up assessment and see what you get. That was 1+1=2 thinking. I took the advice and waited for my team to give me a budget from the ground-up. When I got the results, I realised that if I were doing M&A, I would be selling this business as opposed to buying it. Where do we go from here?

When you work for a big company, the final budget needs to get approved by the board. The board is responsible for ensuring they are signing off on a sound financial plan. So, the submitted aggregate plan needs to give the board confidence. Of course, the budget also needs to be realistic so we can hit it. Missing budgets can happen, but it is better to have a good story to explain if we miss! The budget is just a plan. Like with any plan, we obviously need to make adjustments as we progress throughout the year. The trick is that adjustments are not to the budget itself but to the decisions we make to attempt to achieve financial goals measured by our annual budget.

Here are some useful learnings from my experience:

1. Set Targets that Inspire Action

Start by asking your management team about what targets are realistic for next year, and what strategies they are using to accomplish them. Just like with an M&A plan, we need to know the financial metrics we aspire to, so we can measure them. Set your revenue and EBITDA targets. In a big company like mine, we realise that corporate goals may be different than regional goals, and it’s our job to bridge the variances. Maybe something like this: we think we can drive 5% revenue growth with 7% bottom-line growth. Corporate vision wants 10% growth with 12% to the bottom line. How do we bridge this difference? Why is there a difference in the first place? Asking these questions is essential, so management can have meaningful financial discussions on strategies.

2. Keep It Simple, not Complicated

Keep the numbers simple and in metric form to drive a narrative instead of focusing on precise moving sums. Nothing damages credibility more than moving target numbers without explanations as to why they are moving. You can get buy-in with simple metrics like the following: revenue growth is 7%, driven by $50 million in new business, leading to a 0.5% margin improvement and 10% bottom-line growth. Here’s what we know before we do any budget: revenue growth won’t be precisely 7%, and bottom-line growth won’t be precisely 10%. If we start talking about the precise ingredients to hit these numbers, we will confuse the business, and it will counter by telling us that the budget is wrong. The budget is a financial target — it can’t be wrong by definition. However, we do need to be able to explain why we picked the targets we picked so we can learn something when the results are a little different! As we prepare the budget, we will update the numbers to our targets monthly as monthly results come in, trying to lock in the targets but not the final end product.

3. Ensure Meaningful Ground-Up Work

Know the purpose when you're doing your ground-up work. It would be great if we could just wish for the big-picture numbers and if we could achieve them just by talking about them. However, that's not how life works. We do need to take a ground-up assessment of our budget and compare it to our goals to identify gaps between where we want to be and where we are. By analysing those gaps, we can come up with game plans to address them and get the whole team on board to address them in unity!

4. Apply the Pareto Principle

Master the law of the few. It seems everyone knows the Pareto principle, where 20% of the effort drives 80% of the results. However, when we do budgets, we tend to forget that the budget will be done on the averages, hiding our outperformers and minimising our underperformers. The averages can result in a minimalist mindset, creating a lowest common denominator mindset. Here's a question: if everyone pushes to hit the average, and some miss the average, what will happen to the average? Obviously, it goes down. We need to push our people above the average to do better, just like we push those below the average to come up. Ask ourselves if our financial plan inspires excellence?

5. Align Structure, Incentives and Resources

The hardest part about the budget is that it should drive some tough decisions, resulting in confidence that we are taking actions that will give us financial success. Here are some things to think about when driving the crucial conversations necessary to make tough calls:

• Do we have an organisational structure that allows us to achieve the budget? Results will be driven by the leaders of our business, and we need to make sure they are set up to lead effectively and buy into the budget numbers. Could adjusting team structures allow us to achieve the budget goals more effectively?
• Are our people incentivised to hit the budget? We all need to be aware of incentives and if incentives are aligned with budget objectives. Furthermore, knowledge of the budget narrative can help drive motivation. People are motivated by both hard and soft incentives. The hard incentives are the measurable metrics. The soft incentives are more intrinsic. A soldier will fight long and hard for a badge of courage. It also helps to feel like you're part of a team that has its own value. If we set the budget up correctly, we will have money set aside to reward our people if we are successful. Getting buy-in from our leaders to get incentives set up correctly is crucial to balance resource allocation between return on investment and reinvestment in the business.
• Do we have optimised resource allocation to hit our budget? Is our structure set up to scale? "StrengthsFinder 2.0," a business self-help book by Tom Rath, encourages the reader to pinpoint things they are good at and focus on developing those qualities rather than spending time and energy trying to improve weaknesses or fixing wrong things. Similarly, in the budget, we can focus on things that are wrong, such as over-allocating resources to our problems instead of investing in our strengths and maybe even divesting or outsourcing weaknesses. We should review resource allocation for each annual budget and understand what we are changing from the prior year to raise the bar.

Conclusion

While many people treat budgeting as an accounting exercise, they are missing an opportunity to create value from budgeting by using it as a strategic advisory tool to measure strategy. If used correctly, the annual budget can help us achieve better organisational structures, aligned incentives, superior resource allocation, and overall better financial performance.