Most of us have by now experienced budgeting in an economic crisis. Think about the financial crisis, now over a decade ago, or the more recent covid epidemic. Preparing a budget or a forecast was a best guess that hopefully led to robust discussions on action planning. No one dared to predict the future with confidence. Those were hard times for the finance team. But, I might argue that budgeting in times of financial uncertainty is even harder than it is in a crisis. Will inflation normalize to the Fed’s target? Is a recession looming? Are we already in a recession? Expectations for budget accuracy are high and the macroeconomic environment for the next 18 months is unclear. So now what? Here are a few tricks that I’ve used. They don’t fix the uncertainty, but they will make your budget defensible and help your executive team understand the key risks.
1. Be Conservative – Now is not the time to go out on a limb. Be conservative with your revenue estimates and aggressive with your cost control. Most often, it is easier to add back expenses if sales take off than it is to labor through a year with lousy, or negative, margins because your expense base is too high.
2. Use Run Rates for Expenses – One thing we do know is that inflation has been driving up costs. These increases sometimes take a long time to trickle down to expense line items on your P&L. This makes year-over-year comparisons of limited value. After considering any seasonality, look at recent monthly history for a good predictor of the future. Simply annualize the last three months’ results as a sanity check.
3. Productivity – This is going to be a new one for anyone who has never operated in an inflationary environment. Year-over-year variances for costs aren’t going to be useful. Inflation made that calculation deceiving. You must calculate productivity, which is simply the change in costs normalized for inflation, and potentially volume. This accuracy is particularly important in headcount discussions.
4. Check Pricing – When customers have slowed their buying, the last thing your sales team wants to hear about is a price increase. Assume that the increases in labor and material costs are permanent. Make sure that you provide analysis and have pricing conversations about every single product and service with your leadership team. Be strategic about passing on cost increases to customers. Keep in mind that it will be harder to increase prices later as the economy improves.
5. Run Scenarios and Sensitivities – The day you finish your budget, you can be certain that it is wrong - the landscape changes and your business evolves. Yet, most forecasts have a handful of variables that make a significant impact on the bottom line. Run multiple sensitivities on those factors in isolation and perhaps in combination. Providing your leadership team with a view of risk and volatility in the budget will spark discussion on contingency planning. Scenarios support your plan’s credibility over the long run by demonstrating that there is a range of possible answers.
In short, this year will be a challenge for finance teams. Hopefully, at least one of these tips will make your task easier. And as always, our team is here should you need help. Feel free to reach out.