Reforecasting your budget: the 6×6 exercise
As an outsourced CFO, it’s sometimes my responsibility to deliver bad news — such as telling functional department leaders they need to restart the budgeting process because the company has wildly diverged from its roadmap.
One mechanism to do that is a 3+6, 6+6 or 9+3 budget exercise. The most common in my practice is a 6+6 budget that shows six months of actuals and six months of forecasts. As the year progresses, forecasts should become more accurate. When they don’t, it’s time for a conversation.
Mid-fiscal-year budget recompilations are a burden for not just business leaders but finance staff. That’s true even when you’re rebudgeting because sales are significantly higher than expected. In those cases, you’re not greeted like an angel of doom and have to worry about morale and attrition. But still, you’re asking for a lot of unplanned work.
Scenario 1 – tactical reforecasting: The budget remains untouched. The CFO tells departments, “Okay, we’re investing more into our key strategic areas to continue supporting and pushing sales. If you require an increase of, say, 5% or less, let us know what you’re doing but you don’t need approval. For more than 5%, you will need executive approval.”
Scenario 2 – strategic rebudgeting: If sales are up 100% or more and are coming from products or channels you did not foresee being so lucrative, the CFO rebudgets because something has strategically changed. It’s no longer just investing more in the same areas, but an actual deep dive into where the highest ROIs are now coming from.
Which path is best depends on whether you need to reset not just near-term targets (Scenario 1) but your three-to-five year goals (Scenario 2).
On the other hand, when sales disappoint and cash problems arise, expenses will need to be cut. This causes a lot of concern up and down the organization and can eventually lead to turnover. Rebudgeting is always a big deal, for several reasons. So why do it?
It’s sometimes abundantly clear that your budget-versus-actual roadmap has diverged so much from your original plan that it doesn’t provide any useful information anymore. It’s useless going forward and targets need to be reset. When sales have significantly disappointed, big, strategic cuts may need to be made, and that requires deep thought. You need everybody to buy in, including the board.
Note that I never advise rebudgeting downward unless goals really are unobtainable. Asking people to strive to make those unrealistic targets will be damaging to morale. However, if you rebudget lower when you could and should have pushed harder, you risk giving everyone permission to be mediocre.
A reach-goal encourages hard workers to say, “Okay, we’re really gonna do it in the second half of the year.” Instead of just saying, “Okay, phew, now we can keep going at the same [unimpressive] rate.”
If you’re doing a 6+6 right, stakeholders up and down the stack will question all assumptions. It’s very hands on, to the point of being invasive. Watch out for superficial efforts and back-channel complaints. These will need to be managed if the rebudgeting effort is to be successful.
5 Signs You Need a 6+6
A material event has occurred: The pandemic is a perfect example. I never encourage companies to proactively slash budgets without first understanding detailed scenarios — we saw businesses cut too aggressively without supporting data, and it hurt their long-term growth. But when variances become too large it’s time to act.
The budget was not created correctly: I’ve had to support companies rebudget when only off by 5% or 10%, while others might see larger variances but are able to tweak within the existing framework. In these situations, it’s something of an art to know when to go back to the drawing board. Ask: Will needed changes impact all departments? Was the initial budget not well-formed?
Your business model assumptions are flawed: This doesn’t always result in negative consequences. We can be pleasantly surprised that although our budget was built based on B2B demand, our minor B2C channels have outperformed beyond all expectations.
The worst case is worse: Companies go into budget exercises hoping for the best and planning for the worst. If numbers are coming in below your worst-case scenario and you’ve smoothed out seasonality and other temporary factors, then it’s time for a 6+6.
Cash flow liquidity has deteriorated: Maybe the budget looks, on paper, more or less accurate. But your cash on hand continues to decline then you need to reevaluate all your assumptions. Continuously reviewing numbers makes you nimbler.
The Process
The finance team leads the effort to create the new budget and works intimately with the cross-functional department team heads. The CFO will take the first draft and go back and forth with the CEO until a final draft is agreed upon. This gets presented to the finance committee for approval to be moved to the board for final sign-off. During this process there will be lots of Q&A and drafts flowing up and down between all stakeholders in a defined process until a final budget is approved.
I like the saying ‘All’s well that begins well’ and when I am in a CFO advisory role, and a budget review comes up, I first make sure we’re working with up-to-date numbers. Your finance team should close within 10 days of the end of the month, never more than 15 days. The quicker the better.
I look at five buckets of data and ensure we’re up to date:
Previous 12-month of financials statements
A rolling 12-month model of projected data
BvA: Detailed year to date budget versus actuals with explanations for variances.
Weekly cash flow projections looking forward 16 weeks including cash position, receivables, payables and working capital requirements
Profitability KPIs, such as gross profit and net profit margin, product profitability, etc.
Only now do I have the confidence the numbers going into the rebudgeting exercise are correct.
Rules to live by:
1. No surprises! Ever.
2. Constantly stay on top of your assumptions
3. Calculate your project ROIs to effectively allocate capital
4. Review your goals daily
5. Daily ask ‘where’s the risk’…’what can go wrong