December 14, 2020

The First Step You Should Take When Building Your Budget

Mandy Leavell
Director of Marketing

Building a budget for your organization can be one of the most foundational things you do. However, looking at all the numbers for the entire year ahead can leave you unsure of where to go, or even scrambling for a start.  I spoke with Jen Happ, our Head of Client Services, who helps our customers design their own budgets every day. She shared a simple, yet effective way to begin thinking about your budget that is backed by data, matches your company’s real goals, and accounts for any gaps.

How to create your new budget

At a glance:

  1. Analyze your previous metrics and your projected end-of-year revenue
  2. Factor this is with your retention rate
  3. Set a realistic revenue goal
  4. Analyze based on your customer segments
  5. Find your new sales goals and total revenue goal
  6. Find an appropriate revenue goal for each segment
  7. Use your discoveries to make educated decisions about your budget (headcount, etc.)

Where to begin your budget

Ultimately, setting up a budget is not just about picking a goal, throwing a dart at it, and hoping everything else adds up. Conversely, you want to make sure you’re not plugging in different amounts that add up to a goal that is frankly  achievable.

Rather, the first thing you want to do is look at where you’ve been. Take a look at your dashboard; at what revenue number are you projected to close the year? (Don’t have a dashboard? We’ve got you.)

Next, take a look at your retention rate. You’ll want to look at the last 12, 6, and 4 months to make sure you get the most relevant number. Combining this with your revenue should show you what you’re projected to make next year with no additional sales. This is a crucial step to calculating an appropriate goal, which allows everything else to fall into place. Let’s say you’re ARR in 2020 was $1 million with a retention rate of 95%. For your budget, you know to expect to earn $950,000 next year with no additional sales.

Setting a realistic revenue goal

Great, now you know what you’re projected to make next year without any additional sales. Time to set your revenue goal for next year. Maybe you were initially thinking of setting your goal at $3 million. That leaves $2,050,000 you’ll need to earn in new sales. Is this realistic for your business? Maybe it makes more sense to set your goal at $2 million. This would make your new sales goal $1,050,000 (remember, you’re expecting $950,000 from retained business!) Knowing whether your goal is attainable depends on your sales team and other variables.

Analyze based on your segments

Let’s put this method into practice and break it down by product or customer segment. When setting up a real budget you’ll need to segment your customer base. Knowing how many new contracts you can sell is going to look very different between products, or, for example, SMB and Enterprise. The effort, sales cycles, and ability to attempt new sales does not and should not look the same for your different segments. The level of detail will help your budget be more accurate and overall just make more sense. Performing a cohort analysis to segment your customers is also overall a best practice for your business.

Each segment you’ll want to analyze according to the steps above to get an accurate read on retention. Let’s say you’ve decided $190,000 is an attainable total revenue goal for 2021. Since retention will look different across segments, we’ll pretend Segment 1 has a Net Revenue retention of 95%, and Segment 2 is 105%. (Retention over 100% meaning you were able to upsell services to your retained customers in that segment). Of course, your numbers will likely look very different. The numbers here are (hopefully) simple to better illustrate the scenario.

Here’s what we know. Time to fill in the gaps.
Here’s what we know. Time to fill in the gaps.

It’s important to segment because, as you can see, different products/segments will have different retention rates and therefore bring you more (or less) revenue next year! Let not focus on the new sales goal quite yet. Take a look at the “Retained ARR” section above. Based on the retention for both segments, we can expect $90,000 in revenue from, again, no additional sales. Once you’ve calculated your retention, you can see that between Segment 1 and 2, you’ll need to earn $100,000 in new sales.  

Here comes the fun part: Finding both your new sales goal and total revenue goal will involve a bit of problem solving, creativity, and playing with numbers. If X+Y= $100,000, you’ve got quite a bit of options for what X and Y may be!

Finding an appropriate revenue goal for each segment

How many new deals do you think you can close next year for each segment? These might be 2 different products, or it could be that Segment 1 is SMB and Segment 2 is Enterprise. Either way, knowing the segment will allow you to realistically estimate what your goal is. Assuming there’s no price changes (but hey, that could be another variable!) You can adjust the number of new sales per segment until you meet your new sales goal/total revenue goal. Once you recognize your new Sales goal needs to be $100,000, you consider one scenario: selling 45 new Segment 1 contracts and 11 in Segment 2.

Scenario One: You acquire 50 new logos in Segment 1 and 11 new logos in Segment 2. Think your team can swing it?
Scenario One: You acquire 50 new logos in Segment 1 and 11 new logos in Segment 2. Think your team can swing it?

Your team takes a look- 11 new contracts for segment 2 doesn’t seem realistic at all. (Look at your previous year’s numbers, look like you sold 4 + some extras. Could you really sell almost triple of your more expensive segment?) Let’s adjust to 8. That means Segment 2 will earn $40,000 in new sales, leaving $60,000 up to Segment 1. Can your business realistically get 60 new logos in Segment 1?

That’s more like it!
That’s more like it!

You decide this seems attainable. Now you can move onto using this information to inform more of your budget! Simply put, you’ll need to adjust your new contracts for each segment and your total new sales and see how they affect each other.

The way we’ve described above is useful if you’ve got a good idea of what you’d like your total revenue goal to be. If you’re at a loss, maybe consider first looking at the number of new logos per segment you’re confident you’ll be able to acquire, adding that total to your expected retained revenue to find your total revenue goal. Most likely, you’ll need to take both approaches: adjusting both your revenue goal and new logo goals back and forth until you arrive at an attainable and appropriate goal. Take a look at what this will look like when complete:

Looking good!
Looking good!

Moving forward with your budget

Now that you’ve set your revenue goals and know how much you need to earn in new sales, you can begin to assess other aspects of your budget. In the example above, you’ll need to sell 8 new contacts for Segment 2. Look at your metrics from your sales teams; how many new contracts can each of your sales heads sell? If the average per year is 2 logos in Segment 2, and you have only 3 people on your sales team, you’ll likely need to plan for hiring a new sales employee and include that in your budget. Your historical data will inform how much you’ll need to spend in sales, marketing, and other costs based on previous performance, in order to meet your now well-established revenue goals.

Why build your budget this way?

The reason why it’s important to begin to set your budget according to your new revenue goals is simple: while it’s obviously less expensive to retain a customer than find a new one, your retention rate is actually pretty difficult to adjust. While it’s always valuable to always work to improve retention, you have a lot more control and ability to affect the number of deals you close. Your efforts are much better spent improving the metrics around new customer acquisition.

Additionally, beginning your budgeting process with the revenue goal is a great way to ensure transparency and justify your spend, headcount, etc. You’re building from an informed, strategic foundation, instead of setting an arbitrary number and filling in variables as best you can to somehow reach it. This way, your goals and numbers are built off of data you already have, your past behavior and successes, and within the scale of your specific company.

Taking the time to strategically begin your budget up front will save you the hassle of spending hours cobbling together numbers just for them to not serve you. We’ve given you some examples here, but if you’re looking for a way to go through this with someone else, we do this all the time and would be happy to run scenarios with you. Set up a time to chat with us here.

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