Q: How should a business create a budget?

Rodney Davis: There’s two ways people look at budgeting. Some people like to do zero-based budgeting, which assumes that you’re starting from zero and what would happen from there. I think there are circumstances where that makes sense. I’m not a big proponent of zero-based budgeting in isolation. There are elements of your budget that you can take a zero-based approach but if you’re an existing business that has a track record and history, it’s incumbent upon you to look at the budget as a progression of your business. A business like a person has a life, a lifespan and a life cycle. 

When you’re budgeting, if you take into consideration your history, you have a better chance of understanding where you’re likely to go. But if you’re a brand-new business without a history, then you have to consider what you’re trying to achieve, who you’re trying to reach, and what things make it a viable business. Then break them down and try to get an idea of where you’re likely to end up. 

I often say to businesspeople who really struggle with this, it’s your best guess. There’s nothing wrong with guessing and being wrong, as long as you’ve put the right amount of thought into it. You’re going to be better for it, no matter what the outcome is.

Q: Why is planning and benchmarking important?

Rodney Davis: I don’t advocate flying by the seat of the pants. I get that sometimes it’s a time crunch. I get that sometimes you can’t do the exhaustive process. The challenge I have with some people who resist planning is the all-or-nothing approach. I either do this incredibly elaborate, super detailed plan, or I don’t do a plan at all. There’s always a balance and there’s always time for planning.

There’s a conversation theme that comes up time and again. And that’s benchmarking. On the question of marketing, or on the question of how much I should spend on any other attributes of my business. If you’re not looking at the whole, it’s very hard to answer that question because the business where the product cost is 50% should probably spend less on marketing than a business whose product cost is 10%. However, what comprises the remaining 50% will dictate what they have available to spend on marketing and still make a profit. And likewise for the company that only has a 10% product cost. The effectiveness of your marketing is equally important when you’re determining how much you should be spending, If you’re spending 15% of your budget on ineffective marketing versus spending 15% of your budget on effective marketing, that’s a very different outcome. So it can’t be looked at in isolation. 

The marketing budget is a good example for measuring how effective you are at budgeting. If you said, if I spend 15% of my marketing budget, I should be able to attract a certain number of clients with a certain amount of spend. When you finish the period and you look at how many people purchased and you look at what their average spend was, you can compare whether or not that was the right amount. Or if I had spent a little bit more, I may have gotten more out of it, or if I spent a little bit less, would I have gotten the same result? 

It’s a journey and it’s an iterative process. You shouldn’t assume you’re going to get it right the first time.

Q: How do you measure the success of a budget?

Rodney Davis: Getting a good budget is understanding the drivers of your business. So if you’re a service business that has a client base that’s easily identifiable, you should say, do I need 50 customers to spend $50 to get to my revenue number of $2,500? Or could I do that with 10 customers spending $250?

If you know the drivers, you’re in a much better position to budget. Budgeting isn’t about top-line. Executives might give you a top line number, “We did $10 this year. We’re going to do $15 next year.” But do you know what gave you the $10? If you’re going to approach budgeting with an intent to get budgeting right, you should know what drives my costs, what drives my revenues.