Changing How You Think About Budgets

I received plenty of useful feedback on my rant Budgets – There Has To Be A Better Way.

Two of the links that I found particularly helpful were:

Robert Howell points to a longer term view than one year with his suggestion around rolling plans. He also emphasizes a focus on economic value – specifically future cash flows – rather than accounting earnings. Simply – focus on cash, rather than non-cash calculations. He ends with a great paragraph on eliminating the word “budget” and reorienting it around your specific goal (e.g. “profit plan”, or “break-even plan”, or “maximum monthly investment of $500k plan.”)

Ben Horowitz describes how his budgeting process almost bankrupted his company LoudCloud, and how he now suggests a different approach based on constraints. It’s especially relevant for fast-growing companies. His approach is summarized below.

Run rate increase – Note that I say “run rate increase” and not “spend increase”. You should set a limit on the amount by which you are willing to increase what you are spending in the last month of the coming year vs. the previous year.Earnings/Loss – If you have revenue, another great constraint is your targeted earnings or loss for the year.Engineering growth rate – Unless you are making an acquisition and running it separately or sub-dividing engineering in some novel way, you should strive not to more than double a monolithic engineering organization in a 12-month period.Ratio of engineering to other functions – Once you have constrained engineering, then you can set ratios between engineering and other functions to constrain them as well.

Then:

Take the constrained number that you created and reduce it by 10-25% to give yourself room for expansion, if necessary.Divide the budget created above in the ratios that you believe are appropriate across the team.Communicate the budgets to the team.Run your goal-setting exercise and encourage your managers to demonstrate their skill by achieving great things within their budgets.If you believe that more can legitimately be achieved in a group with more money, then allocate that manager extra budget out of the slush fund you created with the 10-25%.

I love the theory of constraints as an operating principle for many things, and Ben applies it really well in his post.

Both articles are worth a detailed read – they are each short, but full of goodness.

I wonder if it means anything that each of the author’s last names starts with the letter H?

Original author: Brad Feld