As the venture capital market becomes more challenging, some experienced startup executives are turning to an aggressive approach to managing their company’s finances - zero-based budgeting.
This is an approach that can help a company reduce burn rate and push out the cash-out date.
As a firm that provides outsourced financial modeling help to our accounting clients, we’d like to share some information on this particular financial projections process.
What is Zero-Based Budgeting?
Zero-based budgeting is a method of budgeting in which all expenses must be justified for each new period. This means that, unlike traditional budgeting, where budgets are based on past spending levels, zero-based budgeting starts from a “zero base” and every function within an organization is analyzed for its needs and costs.
The goal of zero-based budgeting is to ensure that all activities and expenses are necessary and beneficial to the organization, and to allocate resources in the most effective and efficient manner. This can help startups to reduce waste and increase accountability for spending.
How to create a zero-based budget / run a zero-based budgeting process
budgeting process includes these steps:
- Identify the organization’s objectives and goals
- Just like with any budgeting exercise, the first step in zero-based budgeting is to clearly define the organization’s objectives and goals. This will provide a framework for the rest of the budgeting process and help to ensure that all activities and expenses align with the organization’s overall strategic direction. For VC backed startups, this is typically to reach a point where another round of financing is possible, or to achieve cash-flow breakeven (or in many cases in today’s economic environment, make it through a year long possible recession where it will be hard to raise capital at attractive terms.)
- Identify all activities and expenses
- The next step is to identify all of the activities and expenses that are necessary to achieve the organization’s objectives. This may involve conducting a thorough review of the organization’s operations and consulting with relevant stakeholders. This is where an experienced accounting firm like Kruze can be helpful; our bookkeepers can produce a download of all GL expenses.
- Assess the value of each activity and expense
- Once all of the necessary activities and expenses have been identified, the next step is to assess the value of each one. This will involve evaluating how well each activity or expense contributes to the startup’s objectives, and determining whether it is worth the cost. A sub-component of this step is to understand how you can cancel or modify your relationship with the vendor; for many of our clients who are involved in year-long subscriptions, it’s not necessarily easy to stop an expense. In this case, we recommend keeping the expense in the budget until you can cancel it - and also setting reminders so you don’t forget to cancel the service or subscription when the contract allows!
- Find a financial model template
- If your startup doesn’t already have a financial model template, find a free one. Kruze has several free financial model templates available for download on our site. Don’t waste time recreating an excel file - manipulating spreadsheet formulas are not value-add for most startup founders, especially ones who need to focus on cutting costs and hitting difficult targets. Either use one of our free templates, or find another one that you like better.
- Add your historical results into the template
- The best budgets have a basis in reality, so the first step is to drop in your historical actual results into the budget template. While we don’t generally recommend having a ‘break’ or big jump in between historical results and the first month of projections, zero-based budgeting is the exception. Seeing a big difference from the previous month to the projected month is a sign that the budget discovery process is working, and is identifying opportunities to reduce burn rate
- Develop a budget
- Based on the assessment of the value of each activity and expense, a budget can be developed that allocates resources in the most effective and efficient manner. This budget should include all necessary activities and expenses, and should be designed to help the startup achieve its goals and objectives.
- Monitor and review the budget
- The final step in building these types of projections is to monitor and review the budget on an ongoing basis. This will involve tracking actual spending against the budget, and making any necessary adjustments to ensure that the organization remains on track to achieve its goals. We strongly recommend doing budget vs actuals on a monthly basis if you are tightly managing your cash flow.
Financial model template Historical results
All startups should have projections, but startups facing a difficult economic situation definitely need one!
A roadmap for controlling burn and getting back on track
Financial projections provide a roadmap for the startup’s future financial performance, and they can help to identify potential risks and opportunities. By regularly updating and reviewing the projections, the startup can assess its progress and make adjustments to control cash burn.
In addition, financial projections can be an important tool for communicating with investors and other stakeholders. By providing a clear and detailed picture of the startup’s financial performance, the projections can help to build confidence and trust, and they can provide a basis for discussions about investment and collaboration. This is very important when a company is struggling, as investors will be watching closely to see how the management team responds and manages the company’s finances.
Overall, having a detailed set of financial projections is an essential part of running a successful startup, and it can help to manage through turbulent times.
Other budgeting advice for startups in a downturn / facing difficult times
We’ve written about what startups can do when entering a recession, and many of those lessons apply to today’s startups as they navigate a difficult funding environment. Here is a summary of our advice:
- Focus on what you can control.
- Quality revenue growth makes up for a lot of problems.
- Have a legit cash flow model.
- Set up spending milestones.
- Have a targeted burn rate (our burn rate calculator can help).
- Outsource what you can.
- Keep a firm hand on what your employees spend on systems, food, etc.
- Focus on efficient operations.
- Raise capital when you can, not when you need to.
- If you have to cut, cut deeply enough so that you don’t have to do it again.
Zero-based budgeting is a solid process to use when your startup is facing difficult times. But remember to use it wisely - your employees and executives won’t love the process of rejustifying all of your expenses repeatedly. And don’t forget the human aspect of cutting expenses!