How a fractional CFO can help with budgeting and forecasting

When it comes to managing your company's finances, budgeting and forecasting are two essential tools that will prove necessary time and again. 

On the one hand, budgeting creates financial stability for your company, anticipating your business’s financial needs and ensuring that they are provided for

On the other hand, forecasting is a powerful strategic tool that helps leaders choose between different scenarios, identify opportunities they might have missed, and size the different risks lurking on the horizon. 

And if you don’t have the internal time and resources to handle your  budgeting and forecasting needs, then a fractional CFO might be your most cost effective solution.

At what business size do budgeting and forecasting become important? 

When asked, Michael Eitler, a CFO with decades of experience, had this to say:

“Well, I think I'm one of those that thinks budgeting and scheduling is essential at any size. If you're a sole proprietor, a landscaper for instance, and you own one pickup truck and two lawnmowers, I think you should be budgeting so you know you're informed about decisions that you need to make.”

The point is that regardless of the size of your business, you need to always have a budget in place, and you might want to perform a couple of forecasts every quarter. This will give you plenty of visibility on how your business operates and make it easier to make tough decisions based on numbers rather than just gut feelings. 

Why some small businesses are reluctant to budget and forecast?

For many small businesses, the issue is that they are concerned that any budget or forecast they do will be inaccurate given the volatile nature of their operations and the difficulty of predicting what the next quarter will hold in store for them.

Nevertheless, both exercises are still critical even if they aren’t giving you the most accurate results right now. For one thing, as your company grows and its revenue becomes more predictable, your budgeting and forecasting will improve, and the results will become more and more accurate over time. 

The other point to bear in mind is that the value of budgeting and forecasting is in the process of creating them just as much as it is in the results.  In other words, when you create a budget or try to forecast what the next quarter will look like, you are forced to think about the minutiae of your business, and this exercise is very valuable in and of itself. 

Budgeting and forecasting are so critical that, at some point, it might make sense for you to enlist outside help, such as a fractional CFO.    

At what size does it make sense to bring in outside help?

When it comes to the right time to bring on a fractional CFO to help with budgeting and forecasting, Eitler, our CFO from earlier, shared the following:

“I think at any point you lack the ability to do either budgeting or forecasting yourself reasonably well and on a timely basis, then you need help. 

So that could be when your business hits two or five million dollars a year, or it could be a higher number. But the minute you can't or won't do them for yourself at least every quarter, then I think you need to go get somebody to do it for you.”

How can a fractional CFO help with budgeting and forecasting?

One of the main benefits of fractional CFOs is that they have worked with multiple companies, so they have ample experience and have seen different situations. 

Consequently, they can walk into your company and start identifying the possible problem areas based on your industry, company size, and business model. Identifying these potential issues is more reliant on business acumen honed over the years as opposed to just pure financial knowledge. 

For instance, a CFO with experience will understand the operational differences between service- and product-based businesses. They will have ample experience with how each type of business reports its numbers to outside stakeholders, including creditors and investors. 

Moreover, depending on the age and maturity of your company, a seasoned CFO knows how to budget and forecast based on where your company is right now while also considering your company’s possible future needs based on its growth and progress. 

If anything, one of the main prerequisites to becoming a good CFO is garnering that experience and developing that acumen. 

While that understanding helps a fractional CFO identify the needs of your company, it also has a few other critical benefits:

• It enables fractional CFOs to understand the story your numbers are telling
• It better equips them to perform variance analysis
• It lets them help business owners avoid common pitfalls 
• It makes it easier for fractional CFOs to act as cross-functional leaders

Let’s look at each of these points individually.

A fractional CFO understands the story your numbers are telling

All the financial numbers rattling around your company are telling a story, and it is the responsibility of a CFO, be it full-time or fractional, to take these numbers, analyze them, and understand the story they are trying to tell. 

To do this, it takes the aforementioned business acumen of a seasoned professional coupled with having a solid accounting and financial understanding. 

For instance, if the profit margins on a specific product are slimmer this quarter than the previous one, a fractional CFO should be able to explain why and whether this is a good or bad thing. After all, slimmer margins aren’t always a result of a company’s missteps:

• Perhaps, the product is becoming more mature and the market more saturated.
• Alternatively, the company may have lowered its prices because it initially followed a pricing skimming strategy. Put differently, the margins were inevitably going to shrink.
• Another option is that the lower margins can be attributed to a new customer who was quoted a lower price because the incremental revenue justified the sale. After all, a company’s value is a multiple of its EBITDA, not its profit margin. 

It will usually be the CFO’s responsibility to figure out which option, if any, is correct, and this will be reflected in their budgets and forecasts.

Moreover, stakeholders, both inside and outside the company, will want answers, and your fractional hire will be the one to provide them. For instance, your creditors might be concerned that the shrinking margins are a canary in the coal mine, and they want to know the story behind that. 

As you can tell, part of translating the story told by numbers is understanding the business’s strategy and its potential impact on the company's future. 

And the forecasting kicks in when the CFO makes sure that the story they are seeing matches the CEO’s vision and where they intend to take the company. 

In short, a CFO can connect the finances to the business strategy to the CEO’s vision, explaining what is happening today as well as what the possible future scenarios might look like. 

Fractional CFOs are better equipped to perform variance analysis

It is very rarely the case that the budgeted and forecasted numbers align perfectly with what happens on the ground. Nevertheless, when the planned numbers diverge from the actual ones, someone has to dive in and figure out where the discrepancy came from, which is called variance analysis.

Understanding why the company failed to meet the projected numbers

First off, when trying to understand why your company undershot some of the planned numbers, your fractional CFO will look in one of three places:

1. The strategy
2. The strategy fit
3. The execution

The company’s strategy is based on its read of the market. If the top executives aren’t interpreting the marketing dynamics correctly or are misjudging where the market might be headed, then the strategy they put in place will also be flawed. 

And even if the executives have a keen understanding of the market, they must put in place a strategy that fits the company’s core competencies. Countless companies have floundered because the strategies they put in place were detached from their actual capabilities.

Finally, even with the best strategy that perfectly matches a company’s capabilities, execution can make or break the result. 

Figuring out which of these three elements led to the underperformance relative to expectations is a challenging task, which is why an experienced fractional CFO can add so much value here.

Not all negative variances are bad

Remember, everything in business is about context, and no one understands that better than your fractional CFO. 

For instance, let’s say your company has taken on a client who’s paying you far below your target margins. Is that always a bad thing?

Not necessarily. Maybe they are a strategic client who will open for you a new market. Or, perhaps they have just bought your loss leader, and you expect to upsell them later. A third possibility is that taking them on might improve the margins on all of your other clients because of the economies of scale and lower inventory costs. 

Figuring out whether failing to meet the targets is a good or bad thing is up to a seasoned professional like your CFO.

It is just as important to look at areas where the company exceeded expectations

Now, a mistake many professionals make when performing variance analysis is only looking at the areas where the company underperformed compared to expectations but failing to analyze areas where the company exceeded expectations. 

A great CFO will spend some time on positive variances, trying to figure out why things went better than expected. They will ask themselves whether whatever worked is replicable across different departments and activities throughout the company. 

The more frequently you budget and forecast, the smaller the variances will become

Variance analysis is an exercise to see whether things are going according to plan.

Even though nothing ever truly goes according to plan, you can minimize the gap between the planned and actual numbers by frequently budgeting and forecasting, e.g. monthly rather than quarterly. 

The benefit of such a rigorous exercise is that you will spot problems early on, and almost any problem is a lot easier to solve when it is still a small one. 

Based on their experience, the fractional CFO can also help you avoid common pitfalls

According to Eitler, our CFO from earlier, one of the biggest mistakes many entrepreneurs and non-CFOs make is assuming that all revenue is created equal.

Here are his thoughts on the matter:

“A lot of entrepreneurs and non-CFO types think the next incremental dollar is as good as some other incremental dollar. But dollars are not all built the same because behind some dollars there might be a gateway to additional economic benefits or benefits to the business.

The cash flows that follow those may behave very differently. 

So I think a CFO needs the ability to kind of peel the onion back and just say, why should we invest our next million dollars in this project rather than that one?

I think an experienced CFO is good at asking a bunch of layered questions that make an owner or a controller go, “Well, that's a good point. We hadn't thought it all the way through like that.””

A fractional CFO acts as a cross-functional leader, engaging with other departments

For the budget and forecasts to have any legitimacy, you need your different departments to weigh in on them. You want them to break down their expenses, explain the required costs to achieve their targets, and highlight any other nuances affecting your company’s bottom line. 

Fortunately, a solid CFO should be able to speak the different languages of each department. In fact, part of the coaching of a CFO includes having them interact and even work directly with other departments. This holistic training makes them much better cross-functional leaders, understanding the needs of these departments and knowing the right questions to ask them.

So, what would typically happen is that your fractional CFO would approach each department leader and work with them on the budgets for their respective departments. Afterward, the CFO will take all of those budgets and start working on a master budget for the entire company, one where they incorporate other fine points such as the company’s tax strategy. 

Moreover, based on these budgets, the fractional CFO will be able to build solid 90-day forecasts, keeping a keen eye for any dangers that might be lurking in the future. Additionally, if the executive team wants to explore different strategic possibilities, they will have enough material to forecast these options' impact on the company.

How startups can benefit from a fractional CFO managing their budgeting and forecasting

So far, we have been talking about budgeting and forecasting in the context of running a company.

However, startups also rely on budgets and forecasts when fundraising, another area where a fractional CFO can add value.

What are a startup’s main issues when it comes to budgeting and forecasting?

To begin with, startups have a similar problem to small businesses: their revenue can be unpredictable. If anything, startups suffer from this problem because while many small businesses operate in established markets- think marketing agencies, many startups are creating their own markets from scratch.

This is why startups tend to have a high failure rate, usually around 90%, but small businesses tend to have a smaller overall failure rate of 65%. For most startups, the biggest reason for failure is a lack of product-market fit. 

However,  aside from the inaccuracy of the budgets, most startups have to contend with the skepticism of investors. After all, if you are creating a new market, every investor will have their own set of questions about why your idea should work.

And this skepticism will even be more apparent when they look at your budgets and forecasts. After all, not only are they aware of their inaccuracy, but they also realize that a lot of founders and entrepreneurs might use generous assumptions to make their numbers look more attractive than they actually are. 

Consequently, investors will scrutinize every assumption and be critical of every decision made in the budget and forecast.

How a fractional CFO can help?

A better question yet is how can entrepreneurs solve the catch-22 they find themselves in:

They need to create solid budgets and forecasts to raise funds, yet nobody will believe those numbers no matter how good they are.

The answer is to realize that investors aren’t too concerned about the budget and forecasts per se, but they care about the thought that went into them. They are looking for the following things:

• The assumptions used to generate these documents and how you came to them. In other words, why do these budgets and forecasts make sense to you? Can you have an in-depth discussion about them?
• Your level of maturity. For instance, how will you react if someone challenges your assumptions?
• Your understanding of the business world. After all, every business is supposed to make money and offer investors a healthy return on investment. So, investors need to see that you have thought about how you will make them money and that your vision toward profitability makes sense and is reasonable. 

For experienced entrepreneurs, understanding these points is pretty straightforward. 

The first-time founder might struggle a bit here, and this is where a fractional CFO can help.

Owing to their experience, a fractional CFO can help the entrepreneur create budgets and forecasts that tick all the above boxes. What’s more, a well-thought-out budget and forecast give investors confidence in the entrepreneur’s abilities and business acumen. (Notice that we mentioned that the budgets and forecasts need to be well-thought-out but not accurate)

In short, if a founder has yet to experience dealing with investors, then it makes sense to ask for help from a seasoned CFO, one who has ample experience dealing with and raising funds from investors.

Also, it is worth bearing in mind that when it comes to startups, investors put their money behind the management team first then the idea second. So, the more you can offer them a favorable view of yourself, the higher the likelihood they will be interested in what you are selling.

A fractional CFO will lead your company’s budgeting and forecasting processes, but the rest of your finance team is critical to their success

For the budgeting and forecasting processes to be meaningful, the company needs to have a solid accounting foundation. If the accounting processes aren’t working well, e.g. there is a problem in how the information is collected, not only will the budgets and forecasts be off, but the company will also struggle with variance analysis afterward. 

Consequently, it is critical to have a financial professional, be it a fractional CFO or a controller, ensure that all the numbers within the company are assembled correctly and in a timely fashion. This is why it is critical to have strong internal controls that ensure all historical information is collected and assembled properly. 

If you take anything from this article, then let it be this piece of wisdom shared by Mike Eitler:

“Not every company that is good at accounting is also good at budgeting or forecasting.

But every company that is bad at accounting will also be bad at budgeting and forecasting.”

Putting it all together…

One of the biggest assets a fractional CFO brings to your company is the wealth of their experience. This lets them better appreciate your company’s current and future needs. Moreover, it lets them have a nuanced understanding of what is going on in your company, an understanding that goes beyond the numbers and looks at the story behind them. This acumen is also critical when performing variance analysis, and it allows the fractional CFO to be an exemplary leader to you and the rest of your company.

All that said, you might still have questions or remain uncertain about how a fractional CFO can help or help with your budgeting and forecasting. In that case, please do not hesitate to reach out to us for a free consultation. We would love to help you answer these questions and to assist you in any way we can.