Why planning your annual Budget is so important

Why It’s Crucial to Work on a Budget for the Coming Year

A budget is far more than just a financial plan—it’s a critical tool that translates your company’s strategic vision into a practical and actionable roadmap for the future.

A strong budgeting process incorporates both top-down and bottom-up methodologies to ensure alignment with overall company goals while being grounded in the realities of each department's needs.

The Bottom-Up Approach

The bottom-up approach focuses on granular details by analyzing each department's specific expenses. This includes categories like software, travel, and personnel-related costs. By reviewing actual expenditures from the previous year, you gain a realistic picture of what’s needed for the upcoming year, adjusted based on planned projects and company-wide initiatives.

Each expense type should be forecasted using a mechanism suited to its nature. For example:

• Travel expenses might be calculated based on airfare to key destinations, per diem rates per country, and the anticipated number of trips.

• Software costs would be projected using current contract values, anticipated usage, and potential additional licenses or upgrades.

This bottom-up planning allows you to allocate resources more accurately and identify areas where costs can be trimmed or scaled up depending on the company’s strategic focus.

The Top-Down Approach

In contrast, the top-down approach is rooted in your company’s broader financial goals and Key Performance Indicators (KPIs). For SaaS companies, these might include ARR (Annual Recurring Revenue), NRR (Net Revenue Retention), or GRR (Gross Revenue Retention), among others. Department-specific KPIs—like the number of enhancement requests planned in R&D or feature adoption rates—are also taken into account, helping you determine the necessary resources to meet these targets.

The top-down method allows you to see the bigger picture by aggregating expenses across all departments into the overall profit and loss (P&L) statement. This ensures that planned expenses align with the company’s targeted gross margins and profitability goals.

The Budgeting Process: A Collaborative Effort

To start, each department is provided with its actual expenses from the prior year. Department leaders then sit down with their teams, using the company’s defined strategy and KPIs to map out their budgets. These discussions are based on actual spending, forecasted needs, and industry best practices.

Once department-level budgets are drafted, they meet with the FP&A (Financial Planning & Analysis) team. This step is crucial as it allows for review and refinement, ensuring that individual plans align with the company’s overall financial goals. The FP&A team provides guidance on how each department’s plan fits into the larger organizational picture and may suggest adjustments based on the overall bottom-line results.

Finally, the management team reviews the budget in its entirety, making decisions on where to increase or reduce spending as necessary before presenting the finalized plan to the Board of Directors.

Human Capital (HC) Planning

One critical element of the budgeting process is human capital (HC) planning, which is done in collaboration with the HR team. This involves determining how many new hires are expected, estimating turnover, and accounting for salary adjustments, bonuses, and employee reviews. Factors such as exchange rates and other compensation-related changes are also factored in to ensure accurate personnel cost planning.

The Importance of Flexibility

While the budget provides a structured financial plan, it’s important to recognize that it will likely need to be adjusted throughout the year. Unforeseen events, whether external (e.g., economic changes) or internal (e.g., new business opportunities), can impact the budget. This is why many companies update their budget with rolling forecasts to ensure they remain agile and responsive to new developments.