Financial Forecast Consulting Service

Budgeting has three main purposes no matter the size of business or method implemented. First, it should be used as a planning tool to determine resources needed and allocate them accordingly. There are a handful of small businesses that do this somewhat well, but they generally miss the second purpose. The second purpose of budgeting is to be able to compare budgeting to actual performance on a recurring basis (monthly, quarterly). This process is not meant to scold underperformers, rather, it should be used to identify issues and unforeseen strengths. Lastly, budgeting should be a process where the organization comes together to discuss strategy. It should be looked at as a time where all functional units can share knowledge and help each other grow.

Budgeting should be a financial reflection and analysis of a company’s strategy. No matter how big or small, every successful business should have a strategy. I won’t get too deep into strategy, but your company’s purpose and values should be the driver. Many companies have a strategy and start to execute on it before ever determining if that strategy is profitable. Budgeting forces you to research and estimate certain assumptions. This process is what makes budgeting so valuable.

While I said earlier there are three main purposes of budgeting, there is actually one more purpose for you as a business owner. It allows owners to run a larger organization. Let’s face it, you only have so much time in a day. While today your company might be small enough that you can get your arms around it, your hope is that tomorrow it is not. Eventually, you will have department heads or people in charge of certain functions of your organization. In a decentralized organization, one that can shift and make decisions quickly, it is essential that the owner not be a bottleneck.

In 2016, I had a client who had seen very encouraging growth, but unexpectedly came upon some struggles. While the initial success was great, the lack of processes led to bad decision making and an organization that lacked alignment.

Tactile Surgical
Tactile Surgical markets leading surgical and non-invasive body shaping products utilizing ultrasound technology. Tactile Surgical’s SculpTrim system uses ultrasound waves to selectively emulsify fatty tissue prior to extraction from the body. The technology allows physicians to perform fat extraction with less tearing of the surrounding tissues, thus reducing blood loss, pain and bruising.

The Company was founded in 2011 by founder Maggie Castro. Ms. Castro has a medical background and prior to founding the Company had an extensive background as a partner in a liposuction specialty clinic. She left that practice and shortly after invented SculpTrim. Ms. Castro quickly realized she would need capital and a management team to support her vision and dream. She worked with an outsourced CFO who connected her with various potential funding sources. The advisor helped her put together an initial round of financing for just over $2 million.

With this initial money, she put together management and sales teams. In addition, with the help of her new Chief Operating Officer, she was able to put together a supply chain for the unit to be mostly manufactured in South Korea. The unit would then be shipped to the Company’s facility in the United States and the final assembly would be done. The units sold for just over $40,000. It was a significant investment for a medical practice, but not one with which they were unfamiliar with making. The margins on the machine were very good, typically around 80%.

In the medical device industry, sales and marketing can be very labor and cost intensive. It is not unheard of for sales and marketing to account for 50% of the margin depending on the distribution model.

Five years after being founded, the Company continued to grow. In 2016, the Company had revenue of $7 million and had been slightly profitable for the past 2 years. Thanks to the second round of investment funding, the Company had ample resources to put into sales, marketing, and product development. While Ms. Castro was reasonably happy with her product, she admittingly wanted to make several updates, enhancements, and changes to it. After encouragement from a few of her investors, she decided to begin development on the SculpTrim II. The new unit would be less invasive and more efficient. It represented an opportunity to develop new intellectual property, which management believed would increase the value of the Company.

With seemingly no downside, Ms. Castro and a small R&D team went to work. Just 1 year later, they had an updated, “better” device. A small budgeting process was done with the executive team having all the input on the assumptions. The team was excited because the updated device could be sold at a higher price point than the first, which seemingly gave them the opportunity to sell a high priced, luxury device and a lower price, budget device.

Almost immediately, there were issues. The sales team, which Ms. Casto thought would be excited, had serious concerns about whether the new device would sell. It had taken them five years to build up their customer base and they felt they were just hitting their stride with the original device.

With some of the updates to the current device, the margins were somewhat less. Instead of realizing 80% margins, the new unit was closer to 72%. Further, a few of the new accessories and parts used meant the Company was required to purchase more units at a time and on-site assembly increased labor costs.

Spurred on by the success of her initial product and with the support of her management team and investors, Ms. Casto pushed ahead to market and sell the new product.

Despite a few sales of the new product to existing customers, a market for the new product was hard to find. Existing customers were satisfied with their current devices and new sales were favoring the older, lower-priced device. Additionally, the Company’s planned push into foreign markets didn’t align with the higher price point. The four foreign markets the Company had targeted all had demographics that favored a lower priced device.

It would certainly appear, at least on the surface, that if the new device was going to be successful, a new strategy must be developed. However, in order to prevent the current mistakes from happening again, Ms. Castro gathered with her COO and fractional CFO to discuss paths going forward.

Ms. Castro’s fractional CFO asked for the budget of the current fiscal year. He asked Ms. Castro how the assumptions around the new unit were projected. Ms. Castro, who left most of the budgeting to the COO, explained that they had a pretty good handle on what a second launch would entail since they already did the first version. After some discussion, it was apparent that the sales and marketing team had never been consulted. Further, the Company’s current suppliers were not consulted with until late in the design process when it was too late to make significant changes. Lastly, the Company’s overall mission of being an innovator and leader in providing safe and cost-efficient liposuction solutions was not being furthered by the new product in its current form.

After hearing this, the fractional CFO had the following strategies to move forward:

• The sales and marketing team should be brought in so that they can give feedback on not only projecting sales but on how sales of the new unit could be increased.
• The COO should go back to their suppliers to brainstorm how to bring margins up while decreasing the production of the device on site, even if it meant making some changes to the new product’s design.
• They should review their pricing strategies on the two units to more closely align the prices. While this may lower the margins on the newer unit, that would potentially be offset by the increase in margin on the older unit.

However, prior to doing any of this, the entire team would brainstorm and create a comprehensive budget detailing out the effects of the planned strategy. The executive team would integrate the head of sales and his team into the process so they could forecast sales more accurately. As their CFO told them, their budget should be more than a document with numbers, rather, it would ideally be a document that integrated with the Company’s strategy.

A Budget Process for Small Businesses
Odds are, there is no one budget process or template that fits all businesses. There are pieces that will be the same (for instance, each of the three major financial statements should be included in your budget), but inevitably there will be differences in the best process for companies. For a small business budget to be successful, there must be multiple people that are included in the process.

While I could write pages how I recommend setting up your budget, the program you use, and the process you undertake, what I really want to impart to small business owners is how important it is to include all stakeholders in the organization. This includes talking to operations, sales, marketing, and any other group that are vital to the business’ results as part of the process to create your annual budget.