An accurate budget to actual variance analysis is essential for a finance team’s ability to assess current financial performance and decide how the budget can be improved to better meet the goals of the org. This process can help unearth issues, such as inaccurate forecasting, that are acting as roadblocks to the business reaching its potential. This is especially vital in the current macro environment, where every dollar counts. In this article, I’ve outlined the steps our finance team took to lower our variance to within 5%.
6 steps we took to improve our budget-to-actual variance
#1. Ensure that you have the proper financial targets in place
It’s critical to both take the time to establish the right targets prior to making a plan and ensure that everyone has a consensus view on them. We work with the business owners at a great degree of detail to forecast accurately and help them achieve a higher level of business performance. For example, on the growth side of the business, a major driver is customer acquisition. But within customer acquisition, you need to look a level deeper at outbound efforts, paid marketing by the growth team, content, and partnerships. The executive team, as well as any other leaders who are key to actioning the plan, must be fully aligned.
Take time to especially understand the inputs and outputs
It’s important to have a deep understanding of a business’s inputs and outputs, especially the inputs. Many companies over-index on the outputs of their business plan. For example, revenue profit is a lagging indicator and doesn’t give any indication of how to actually achieve that level of revenue or profit.
#2. Check that they’re grounded in data
Next, make sure that these drivers and inputs are grounded in data, and that you’re being realistic with your quantitative analysis. One trap that we fell into at Ramp early in the company is assuming that things would always improve—we always become more productive and efficient.
But we fell into areas where this wasn’t always the case because we were not being realistic with our assumptions. Taking a top-down, bottom-up approach helped us with this issue. A top-down approach is driven by the org, often the corporate finance team. For example, in sales, you would start with the goal amount of money generated in closed won, and divide that by the amount each account executive can close in a given month.
The bottom-up approach is crafted by business-specific drivers and levers. In the above example, instead of first looking at the goal cash amount, a bottom-up approach would examine how many calls account executives can realistically field in a day to estimate how many of those will close and in turn translate to closed won.
We look at the gap between these two approaches and then work with the team to triangulate and ensure that we’re landing on appropriate goals and budget targets. Organizations, especially early on, have very aspirational goals. This approach helps us ground them more in reality.
At the moment we're focused on growth and the top line component of budgeting, which is very important for a lot of businesses, particularly for an earlier stage growth company like ourselves. It involves a thorough analysis of the soup to nuts components of our go to market strategy: number of SQLs, average deal size, closed-won conversion, and activation and retention of spend.
#3. Balance aspirational goals with reality
As I alluded to before, we often receive goals from our senior leadership that are very aspirational in nature. It’s our job as the finance team to build the plan to help us get as close as possible to that North Star goal. We backsolve to determine whether the goal is realistically
achievable in the context of our current performance, estimate the expected improvements in performance( if any), the level of investment that we want to make, and any potential ROI hurdles.
This allows us to give a realistic output based on the level of investment that we are comfortable with given our financial targets.
#4. Adjust annual planning cycles
We've always had a very data driven process ever since I've been at Ramp, but to varying degrees of sophistication and success. Previously, we had been on a quarterly planning cycle. We're now moving to an annual/biannual planning cycle this year which is a pretty natural progression for a growing organization like ours, which is moving so fast that it's very difficult to plan effectively beyond anything like a three-month cycle. As businesses stabilize and mature, that timeline can extend.
Our last two cycles are great examples where our attainment relative to goal has been in the 80% to 110% band (depending on the goal), which I think is very healthy.
If you're hitting all of your goals, then your goals aren't ambitious enough. If you're falling well short with every goal, then they're probably too ambitious.
Relative to budget, we are now within 3% across the core metric that we are optimizing against, which I think is an excellent outcome.
#5. Establish different scenarios
Establishing different scenarios can help your business prepare for every possible outcome. Here are the three types that we forecast for at Ramp.
- Goal scenario: The goal scenario is intentionally ambitious and aspirational. We set it with 50%- 60% confidence that we'd be able to hit these targets, which we make sure to communicate to the org. The idea is we want to try to push the GTM teams to do more than they think is realistically achievable because we have high standards. The budget is then what we actually think is going to happen. We don’t expect to hit all of these goals.
- Base case scenario: The base case scenario is what we expect to actually happen. We have revised down those expectations given the macro economy. So for example, we have increased our base case monthly net retention assumptions. Previously we expected to have around 102% or 103%-right now it’s around 100.2%.
- Downside scenario: The downside scenario is a cautionary exercise in which goals are largely missed due to macroeconomic headwinds leading to poor internal performance. This is intended to be viewed only by leadership and board members as a means of stress-testing and to gauge potential levers of corrective action.
#6. Recognize that ROI can differ among teams
It’s crucial to understand how ROI can differ greatly across teams. A central belief of the finance team is that no money should be spent at Ramp without a clear understanding of how we are going to measure the success of that investment ahead of time.
At Ramp, we seek to be hyper-efficient and want to have very strong payback. At the same time, we need to understand that different teams and campaigns require different ROI timelines. For example, you cannot directly measure investment into what we call paid performance campaigns. Ads that you'll see on Bing or Google are intended to drive pipeline. And so you measure success based on how much pipeline and ultimately close won business and card spend those bring in. That is a very different framework for measuring success than what we might set up for a billboard out of home (OOH) campaign. Ultimately we want it to drive and improve our customer acquisition efforts, but you cannot correlate certain leads back to that billboard.
Our future budget-to-actual variance goals
With the roll out of bottom up budgets, we will have greater insight into specific areas of managing expense budgets. From this, the vision is to create area-specific P&Ls such that budget owners are empowered, and held accountable for operating margin rather than simply top-line growth.