Here are 5 common budget mistakes that can easily be avoided by checking a few metrics –
- Your Revenue Growth is unreasonable– Revenue is the key to any business and understanding how it changes year over year gives you insight into growth. So the first thing to check in your budget is Year over Year Revenue growth as a Percentage.
YoY Reveune Growth Calculation = The difference from last years actual revenue and next years forecasted revenue divided by last years actual revenue.
Check = The average growth rate for companies with over $1M in annual revenue is between 40% and 50%. Only a third of companies have growth rates over 100%, so if your model is showing a really high growth rate to get a hockey stick forecast you may want to double check your assumptions to make sure they are believable.
2. You forecast growth without Marketing Costs – It is really hard to get growth without investing in it, so it is good to check your Sales and Marketing as a Percentage of Revenue.
S&M % Calculation = Total Sales and Marketing Costs divided by Total Revenue
Check = As you spend more in sales and marketing your growth rate should go up or if your forecast Percentage is lower than last year, it is probably underestimated. It does not make sense to have your revenue skyrocketing and your marketing spend is flat. An average Sales and Marketing % is 25 – 35%. One approach is to calculate cost to acquire a customer and that can be the driver of your new customers, which drives revenue.
- You forecast revenue growth without Cost of Goods Sold growth
Gross Margin Percentage Calculation = (Revenue minus Cost of Goods Sold) divided by Revenue.
Check = This is a good metric to make sure your model is accurately scaling your COGS with your revenue. Typically the Gross Margin % should stay pretty constant year over year unless there are major initiatives to drive efficiencies or reduce costs. Every year with scale and focused growth on the most profitable areas of the business you would expect gross margin % to improve slightly. The gross margin % is typically 50% to 75%.
- You forecast revenue growth without Employee Cost growth – The 2 most common metrics are revenue per employee or Operating Expenses as a Percentage of Revenue. I recommend looking at all areas of OpEx as a Percentage, although employee cost is generally the most important for startups.
OpEx as a Percentage of Revenue Calculation = Total Annual Operating Expenses divided by total revenue
Check – like most of the other metrics you want it to be pretty consistent with prior years performance. I find it particularly useful when looking at all line items so that you can check all areas of your forecast. Here is an example where you can see that employee costs and marketing costs may need a closer look since the % of revene is not in line with previous years, which causes total OpEx % to be low.
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- Your budget does not consider cash impacts – It is easy to focus on Net Income of the Profit and Loss statement, but the most important thing in your business is cash. Your forecast should show your bank balance each month and help you identify any months when cash will be tight, which is typically when there is a big investment in marketing or hiring new employees, but can also be for 1 time annual things like taxes or employee bonuses. If your business is not cash flow positive then it is super important to track your cash burn and your progress towards breakeven.