Dec 23 2019

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:

  1. Take the constrained number that you created and reduce it by 10-25% to give yourself room for expansion, if necessary.
  2. Divide the budget created above in the ratios that you believe are appropriate across the team.
  3. Communicate the budgets to the team.
  4. Run your goal-setting exercise and encourage your managers to demonstrate their skill by achieving great things within their budgets.
  5. 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?