Like a project’s financials, company financials shouldn’t be a surprise or require major revisions at the end of the year. When a company budget is not created, used, or updated, it is often due to uncertainties from inaccurate data for revenue projections, lack of understanding and questions about spending, missing the necessary data structure to codify and track costs, and even not knowing how to plan.
Effective company budgets and budgeting processes that are tracked and adjusted with learning and feedback can result in higher and more predictable profitability. This article outlines the process for developing financial forecasting; policy and process for cost allocations and distribution; the baseline budget and departmental responsibility; lead indicators that give early signs of budget variance; and a process for dynamic, rolling budget reviews and how to update it during the year.
Assessing the Current State
Assessing the current state of your budgeting process helps you create a plan and timeline for where you’re headed. To get the full picture, it’s critical to recognize that it takes information from the accounting, estimating, and field databases shown in Exhibit 1. Consider your answers to the following:
- Are you planning to increase revenue, increase profitability, invest in growth/stability, or supplement income to keep your crew/staff?
- Do you know where your work-in-progress (WIP) stands?
- Do you have a handle on your project pipeline and backlog?
- Do you know how your chart of accounts is split up between direct costs and overhead (and the percentages of each)?
- Do you have some type of budget in place today?
- Do you have defined roles/people responsible and accountable for the items in the budget? And how do you define responsible and accountable?
- How frequently do you review the budget? What happens if the actuals differ from the budget?
- Are your financial reviews passive or active (are you documenting what happened as well as pivoting to future projections and plans)?
- What do you do when something unforeseen happens?
Depending on the answers, your next steps may vary.
The Framework to Move Forward
There are two sources of data that can be used for your financial forecasting. The first is market data, which indicates what work is available.
The second is your company’s pipeline and backlog tracking that can be used to plan based on current pursuits. The CFO can then develop scenarios to back into the budget based on the desired net profit for the year. Exhibit 2 shows a sample of market data by category, available nationally, per state, and per county.1
Additional information is available for health care, warehouse, transportation (air), lighting retrofit, power, industrial maintenance, and data centers. Depending on your hit ratio and appetite in category, this market size trend gives you the ultimate limiting factor of top-line planning.
The sample shown in Exhibit 3 is based on estimating input and real-time field-driven burn against the backlog, which is an example of a company’s pipeline and backlog tracking. In this case, the company starts its budgeting process with a plan for $1.7 million in revenue in 2022, which can also be planned by PM, geography, customer, and type of work. This allows the company to dynamically consider the impact of the budget, showing what work (backlog) has been approved (and therefore needs to be planned for with labor and material spend).
It’s important to recognize and prepare for what work is being bid (pipeline) as well, recognizing that the potential for adjustment of your budget is needed more frequently than annually.
Many companies build their budgets top down, taking revenue and subtracting the costs (based on last year’s budget) to get a planned net profit.
Instead, try backing into a structure by setting the net profit and then fixing/calculating the variables of revenue, direct and indirect costs, and overhead.
It’s important to understand the state of both the market and your company. Consider such questions as:
- How is the market in your area?
- Which areas are growing, and which have experienced some slowdown?
- Are there large projects coming to the area?
- How is that impacting the jobs available to you?
- Are you gaining or losing ground?
It’s equally important to define if and how you’re planning to grow, stabilize in certain areas, and/or increase profitability. You must understand both the business around you as well as the state of your company’s current pipeline and backlog to prepare the foundation to create or use your budget.