“We moved the launch up two weeks to align with marketing.”

You’re in the exec meeting when it drops. Everyone turns to you.

You know what they’re thinking: What does it do to revenue? Cash? Can we still afford expansion?

You start doing the math in your head.

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Missed the mark

“Yes, but which one is the ACTUAL F-ING BUDGET, young man?”

Ouch.

I felt humiliated, patronized, and useless all in one go.

It was my first experience in front of a VP of Operations. A veteran of the industry. He was the classic grizzled old operator. Ten years older than my Dad. Veins popping out of his head. Booming voice.

Here I was explaining his budget problem to him.

And I was doing a sh*t job of it.

I’d done what I thought was a good piece of work. There was a gap between the bottom up budget build and the top down expectations.

I’d broken both down so we could compare at a line item level to see where the gap was. Printed on a big piece of ledger paper.

But I’d confused him with the idea of ‘two budgets.’

The right analysis, but the wrong output, using the wrong language, and most of all… the wrong audience.

I learned three valuable lessons in that moment:

1. It doesn’t matter how good the background work is if the output isn’t good.

2. I'd better get multi-lingual and quick. Not everyone speaks business school, bullsh*t finance lingo.

3. Budgets are about engaging non-finance stakeholders. It’s a business process facilitated by finance. Not a finance process.

Budget like a boss

Welcome to part 3 of this 9 week series covering FP&A:

• In week 1, we set out the core FP&A cycle

• And last week, we broke down the Long Range Plan (LRP) process

Financial plans are all about alignment… especially budgets.

So this week, we’ll dive into budgets and how to get your stakeholders in line.

Let’s start with the basics.

What is a budget?

A budget is a detailed financial plan for the year ahead.

How is it different from an LRP?

Last week, we talked about the Long Range Plan, which is the big brother of the budget. So let’s start by understanding the differences between the two:

What is the budget used for?

The budget is a tool used to drive behavior towards better financial performance.

A good budget acts as the gravitational center of your business performance. When you're drowning in red ink, it's your lighthouse cutting through the fog.

And when you're crushing targets? It’s your launchpad. The baseline that creates the platform for your next move up.

That’s the principle, but what are the practical uses? Endless:

• Align stakeholders on an operating plan

• Provide a reference point for cost control

• Performance manage department/business heads

• Ensure KPI targets tie to a financial plan

• Basis for annual bonus plan

• Anchor for variance analysis

• Guidance for external stakeholders

Who owns the budget process?

Finance are the custodians of the process, but it is a business process, not a finance process. Many budget processes I’ve seen fail on this premise alone.

Think of a budget as having 3 accountability areas:

• Inputs: owned by the department head responsible for the input + a finance business partner

• Modeling: owned by finance

• Outputs: collectively owned by everyone

To share an example of a simple budget model:

When is the budget built?

Typically, the budget process starts immediately after the long range plan wraps (more on that relationship shortly).

So the process typically starts 2-4 months before the start of the new year. It will typically take all of that time, and often even runs into the first weeks of the new year.

What is the output from the budget process?

I like to think of the budget as a ‘product’ that finance owns. And the business as the customer.

So the output you need to produce from a budget should depend on the ‘problem’ your ‘customer’ needs to solve using your ‘product.’

But at a minimum, most budgets will need the following:

• A detailed financial budget loaded into the system by cost center and account code (crucial for measurement)

• A summary of the annual operating plan that tells the story of the 12 months ahead (crucial for engagement)

• A budget information pack for distribution to the business so personal objectives can be set accordingly (crucial for accountability)

We’ll explore the mechanics of how budget targets flow into executive and team incentive structures in a later part of the series.

What are the steps in a budget process?

I approach my budget processes with 6 distinct phases:

1. Set top down expectations

2. Build a bottom up budget

3. Identify and resolve the budget gap

4. Wedding vows moment

5. Analyze and approve

6. Lock & load

Let’s dive into each:

Step 1: Set Top Down Expectations

Writing a budget is a lot easier if you know what the answer should be before you start.

‘Top down budgeting’ is the napkin math that gives you that answer. It’s the north star for the budget. Not for all of the financial statements, just the crucial metrics: Revenue, EBIT, Capex, Free Cash Generation, (or whatever is fit for your business).

It is also helpful to break this down into the operating units. The level at which the budget gets reviewed. This is a good way of making sure each operating unit is working to metrics that give you the answer you need in total.

So, how do you get to what those numbers should be?

Remember, the Long Range Plan (LRP) we talked about last week?

Year 1 of that LRP is the start point for the top down budget. They do not have to be the same, but it is the starting point.

So the key questions here are:

• Are there any reasons the top down budget should be (materially) different from the long range plan?

• Specifically, is there any new information that has emerged since the LRP plan concluded?

Let’s use an example.

A group with 3 business units plus a corporate center:

One business unit (in this case, C) has underperformed since the LRP was set.

As a result, revenue expectations for next year are now down $300m. This puts a hole in the budget, meaning that EBIT in that BU will now be $100m lower next year.

The top down budget process allows you to reset assumptions to cover this gap. This could mean changing the shape of the top down budget to solve for a particular metric. Or it could mean changing expectations altogether and accepting that the LRP Year 1 assumptions are no longer valid. It depends on the circumstances.

In this example, the business priority is to solve back to the LRP Free Cash Flow Target for the group. But this is just an example, and it that could be revenue, EBIT, etc depending on what is most important to your investors and your business.

So, how do we solve the $100m gap created by EBIT performance in Business Unit C? It’s a big gap, so no one thing solves it. It’ll need A & B to push their own performance harder. And everyone has to take some pain on discretionary spending.

In this case, you can use the ‘top down budget’ to make sure BU A & BU B are working towards tougher targets to compensate for the issue in BU C.

Should BU C be expected to self-medicate? Ideally, yes. But it’s no use kidding yourself if that just isn’t possible.

This process can be emotive, and may need the Group CEO & CFO to mandate a position. I have seen a BU president fired who refused to sign up to a target stretch that the Group CEO felt was reasonable.

As CFO, your role is to make sure that any gaps are transparent and everyone is clear on what is needed. And the advanced mode is to be the facilitator who resolves (and often negotiates) these gaps.

This is a good time to check in with your board. If they disagree with how you have recut your top down plan, it’s better to know now. Because you are about to kick off a ton of work in the business.

Remember, what you have isn’t ‘the budget’, but the signpost for what the budget should be.

Step 2: Build the Bottom Up Budget

You might argue, if you already know the answer, what’s the point in doing anything else?

Well, you do have the answer, but only for a small number of metrics, and at a high level. And you don’t necessarily have ‘the answer,’ just what you think (and hope) the answer will be.

Now is the time for the real work: building the ‘bottom up budget.’ This is when the assumptions come up through the business, to see if they add up to that top-down expectation.

The output of this part of the process is useful. But it’s the process itself that is most valuable.

It’s the time when the team pauses to determine what the hell the plan is for next year:

• Grow sales or protect margin?

• Invest capacity before demand growth or vice versa?

• Increase maintenance spend, or take replacement asset cost risk?

And then there is the question of ‘when,’ i.e. which month (or even week) will all this happen? This will dictate the shape of the budget.

There will be a long list of questions which were too detailed for the LRP, but must be tackled now.

A bottom-up budget process has a large number of stakeholders. It needs real discipline to keep the process together. And a great project manager.

Good budget discipline matters because it forces every business lead to own their assumptions in public, under pressure, with cross-functional challenges. The CFO needs that visible tension to surface issues and negotiate the final plan with the CEO and board.

Sales or capacity first?

Having a robust activity plan is at the heart of your bottom up budget. How many widgets do you plan to sell? How many widgets can you make? How do you reconcile one to the other? And if it’s not widgets, it could be hours (professional services), or stores (retail), or the size of your sales team, or engineering velocity (growth technology business).

Managing the circularity of sales aspiration and operational capacity is the difference between a smooth budget and chaos. And you, as the CFO, could be trapped between a CRO and a COO who can’t agree on the answer.

In these situations, identify which factor is the most heavily constrained. Is it sales volume compressed by a weak market, or an operations function limited by a capacity issue?

Then focus on that constrained variable, and challenge the hell out of it. If this is the biggest constraint on growth right now, then leave no stone unturned. Figure out what would be needed to take the brakes off, and then figure out how you make it happen.

A passive CFO would settle for that hard constraint flowing into the budget model. Instead, figure out how to unlock that constraint and what else would need to change in the budget to make it happen. Do this well, and you probably just paid for yourself 10x over.

I find that if you deal with the most difficult constraint early, oftentimes a lot falls into place downstream.

Once you have a full, first credible draft of a bottom up budget, it’s time to move to the next step.

Step 3: Identify and Resolve Budget Gap

You will have a gap between the top down and bottom up budgets on the first attempt. And almost certainly your bottom up will be lower thank your top down.

This is where ‘compound prudency’ becomes the CFO’s core challenge. Across layers of the business, each manager adds a small safety buffer, and those buffers multiply up into a material gap.

Your job as CFO is not to eliminate prudency. But it is to cut through the noise, force a realistic trade-off, and protect the investments and contingencies that matter.

Whatever happens, the gap you have must be resolved. Ultimately, there can only be one budget, and that is the bottom up budget. The top down can help you identify where the biggest expectation gaps are.

Much like the LRP, resolving these gaps could need several iterations. It’s crucial to maintain a ‘budget audit trail’ so you can track different versions of the bottom up budget. You may find you need to retrace your steps.

During this part of the process, the focus is on the big year-on-year drivers:

1. Risks: Things that will worsen profit year-on-year

2. Initiatives: Things that can be done to improve profit

3. Investments: Discretionary investments that will worsen profit in a year, but will improve the long term health of the business

4. Tasks: An unidentified / non-specific initiative

5. Contingency: To allow for one or more assumptions/components to miss

A strong CFO here will focus on protecting discretionary investments and contingency. They are the easiest thing to chop out to deliver a profit gap. A lazy finance team will always take this route. Don’t be lazy.

Investments and contingency are muscle. Surplus cost and slack targets are fat. You need to cut fat, not muscle.

And showing you want to protect investments motivates stakeholders. It gives you leverage to trade to the outcome you need: “Hey, this $5m marketing investment is super important to help us grow sales next year as we planned. But we can only afford it if you can find another 2% growth in category A. Can you help me?”

A great FP&A cycle is all about making sure you hand off from one part of the process to the next. Now we have gone from a 5-year, high-level LRP to a detailed annual operating plan and resolved all the gaps along the way. Making sure your individual operating targets add back to the financial plan you need in total.

And remember… CFOs must not just balance P&L targets but also rigorously test the implied cashflow, liquidity, covenant headroom, and working capital demands. A budget that clears EBIT but blows cash is no good to anyone. You are also making critical capital allocation decisions here, too.

Many of the frameworks outlined in the recent series on capital expenditure apply here.

Step 4: Wedding Vows Moment

We covered this last week, but the ‘wedding vows moment’ is just as important in the budget as it is in the LRP. Make sure the execs individually own their assumptions and collectively own the output.

Step 5: Analyze and Approve

Now that you have a budget the business is aligned with, it’s time to take it back into finance and finish it off.

First thing is to convert the bottom up budget into a full calendarized Income Statement, Balance Sheet, and Cashflow. Then you can start analyzing it. A death by waterfall chart (but what a wonderful way to die). We’ll cover more on bridging and waterfalls in week 7 of this series.

Once you are happy with the budget in all its glory, you should take it through the exec and board approval process (like the LRP last week). This part often sucks, but you can make it easier by making sure you have involved them at the right touch points throughout the process. A budget process can be 3-4 months long, so that likely means multiple conversations with the board.

Think about your budget decisions as being either a one way door or two way door. Two way doors are easy to reverse. One way doors are not. If you have a one way door decision, and it’s material and/or strategic, you should find a way to check in with your board before too much time passes.

There is a fine balance between giving the board too much room to interfere and making sure they are with you on the journey to avoid an unwelcome surprise at the end.

Step 6: Lock & Load

Once you have a board-approved budget, it’s time to lock and load.

That means loading it into the systems and reporting at the appropriate level. Feeding it into KPIs and incentive schemes. Being ready to report against it in the new financial year.

Making sure you communicate the final budget in the right format to all stakeholders is vital. You want no ambiguity on what each individual has to do to deliver their part of the budget.

Practical Challenges

That’s the theory… anyway. Of course, it never quite goes that way. Like Iron Mike said, “Everyone has a plan until they get punched in the face.”

Here are some practical issues that always seem to pop up every year:

Phasing/Calendarization: Make sure key metrics look sensible on a quarterly basis, not just an annual basis. Avoid any nasty investor surprises, or at least see them coming.

In flight changes: When you start the budget, you might be working off an 8+4 forecast base and a period 8 balance sheet. But 4 months is a long time. You need a way to fast pivot the budget if something changes in the business.

Actualizing the final balance sheet: ALWAYS rebase the budget for the final year-end balance sheet. This helps ensure you have a fresh cashflow budget to report against from P1 of the new year.

Tasks & Hockey Sticks: Avoid the temptation to default to loading unallocated tasks into the second half of the year. While the outcomes might be backweighted, the actions should not be.

Wraparound. Checking that the opening weeks of the new year in the budget look reasonable, in the context of actual performance at the end of the old year. If the business blows out its budget in the first couple of months, everyone looks at finance for setting a stupid budget.

LRP Rebasement: Finally, I like to ‘rebase’ the LRP to reflect what is discovered during the budget early in the next year. This is a good way of making sure you aren’t waiting another 8 or 9 months to get an LRP that connects to your cycle.

Net-net

The CFO is not a neutral referee in the budget process.

It’s the CFO’s job to force realism, surface uncomfortable trade-offs, and ensure the final plan earns external and internal buy-in.

In the rest of this series, we’ll focus on how you operationalize the budget and avoid performance drift. And also what to do once the budget becomes stale.

That starts next week when we talk about monthly performance reporting.

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