The IT services playbook for annual planning, budgeting and forecasting

Why do businesses fail?

It comes down to strategy and execution.

We know. It’s not rocket science. Yet you would be surprised at the number of businesses that don’t have a defined strategy or operating plan in place. Some of them are even quite successful…at first.

However, as the number of employees and complexity of a business grows, having a well-documented, simple-to-understand plan that everyone in the organization can drive towards becomes increasingly important. Especially for a people-based services firm. An annual strategic plan and budget acts as a map for how to grow and guide the business over the coming year. Without that map, people may not know the destination or the most efficient way to get there. They’re left to find their own path–or worse, they become immobile because they’re afraid of making the wrong turn.

Think of the annual strategic plan and budget as a map for how to grow and guide the business over the coming year. Without that map, people may not know the destination or the most efficient way to get there.

Effectively managing the annual planning and budgeting process can be overwhelming for busy leaders and founders who are being pulled in a million different directions.

  • How do they find the time to pull the right stakeholders in the business together to define the plan?
  • Which framework should they use?
  • Do they set the plan and push it down, or do they collaborate with the team to set the plan?
  • How do they develop (and vet) a budget that’s realistic and drives the right behavior?

If you are asking yourself these questions, you aren’t alone. That’s why we developed a playbook and toolkit for our portfolio companies to specifically address these questions. For those who are struggling with these questions outside our portfolio, here are a few of the highlights.

The who, what and when of annual planning

The annual planning process starts with understanding where you are as a company and giving your team enough time to gather input and data on what the objectives should be in the coming year. This is why most companies begin their annual planning process in the fourth quarter of their fiscal year. Larger companies and those with more constituents to involve may begin in Q3. The key is having enough visibility for where the current fiscal year will end. If you’re great at forecasting (a topic we’ll cover in a bit), you can start earlier.

The CEO and executive leadership team are typically responsible for setting the company-wide objectives, while the functional leaders are responsible for defining the “how” or methods that will be used to successfully deliver on the plan. The CFO is typically the one driving the budget process, which marries the top-down financial objectives with the bottom-up plan of how to get there. Compensation and hiring plans are a big piece of this, as is the sales and marketing plan to drive the demand required for growth, so those leaders must also be involved.

The CEO and executive leadership team are typically responsible for setting the company-wide objectives, while the functional leaders are responsible for defining the “how” or methods that will be used to successfully deliver on the plan.

It can also help to collaborate with your independent software vendor (ISV) partners and board of directors early in the process to understand what they are guiding toward and their expectations before you dive into the details.

There are many types of frameworks that can be used here, but the three we see most frequently are Objectives and Key Results (OKR), Objectives, Methods, Metrics (OMM), and Vision, Values, Methods, Obstacles, and Measures (V2MOM). The essence of these frameworks is to lay out the objectives your organization is looking to achieve, the plan for how you will get there, and what success looks like. The framework you use doesn’t honestly matter as long as those components are included. It’s how you use it to align and manage your teams that matters most.

The framework you use doesn’t honestly matter as long as those components are included. It’s how you use it to align and manage your teams that matters most.

Focus is critical, so don’t pick seven objectives. The magic number is three to five. If this is your first year building an annual strategic plan, we’d advise starting with three. Ideally, these objectives map to your business’s core. For cloud services businesses, fundamental drivers include talent, sales, and delivery.

Regardless of the goals your organization selects, the measures or metrics you define to gauge success must be objective and quantifiable. For example, if “Delivery Excellence” was one of your objectives, the metrics might include:

  • Goodwill less than X%
  • Utilization higher than X%
  • CSAT or NPS higher than X%
  • No more than X red accounts

Better budgeting

Your annual budget serves several purposes:

  • It objectively aligns priorities: The budget aligns with a company’s annual strategic plan and prioritizes resources and spending to achieve its goals, and it provides an objective view of company-wide financial performance.​
  • It specifies the areas of investment: Cash is a finite resource, and the budget helps to ensure the organization has adequate resources to meet its objectives.
  • It holds leaders accountable: In addition to allocating spend, it allows the CFO and functional leaders to keep spending to the appropriate level for the plan and to ultimately measure the return on investment​.
  • It identifies risks early in the process: The budget provides a roadmap for the year if everything goes according to plan. Variances from the plan indicate where pivots may be required throughout the year.

The budget should include a detailed financial model (income statement, balance sheet, and cash flow statement) that outlines expected revenues and expenditures annually. The annual budgeting process usually begins in parallel with, or as a fast follower to, the completion of the annual strategic planning process. Because the budget impacts hiring plans, program spend and more, it’s critical for the budget to be locked before the end of the fiscal year.

Similar to the annual strategic planning process, it’s important to include functional leaders. For example:

  • The sales team should provide an account-level build of bookings and the cost required (base + commission) to achieve those bookings​.
  • Finance and delivery should provide how these bookings translate into revenue and the anticipated headcount required to deliver this revenue.
  • Other functional areas should be consulted to understand the investment (people, technology, marketing investments, events, etc.) required to support the company’s revenue and profitability targets.

When it comes to defining the top-down financial targets, the Rule of 40 can be a good starting place for growth and profitability. The Rule of 40 is measured by adding your company’s annual revenue growth rate plus your EBITDA margin or profit margin. The sum of these two metrics should meet or exceed 40%.

If you’re a growing cloud services business that is also closely tied to a particular ISV, we guide leaders that revenue growth should exceed the ISV’s forecasted revenue growth. If you’re growing slower, that means your competitors are likely taking share.

Budget vs. forecast guidance

Financial stability requires more than just a fixed budget; you also need to implement a rolling forecast that remains adaptive to year-to-date actuals and real-time data.

This forecast, distinct from the budget, enables your company to navigate uncertainties like shifting market conditions or new bookings, and allows for more informed decision-making throughout the year. If the annual budget is your printed map, the forecast would be Google Maps providing alternative routes to the destination.

If the annual budget is your printed map, the forecast would be Google Maps providing alternative routes to the destination.

A forecast is especially important in the IT services sector, which often relies on project-based revenue that results in poor revenue visibility. To properly forecast this choppy revenue, firms should be analyzing backlog (signed contracts that are yet to be worked on) and pipeline (potential future business, not yet signed). Looking at these two together will help you estimate where revenue might land.

This estimation is the foundation for determining whether you need to adjust delivery decisions and overall costs. Ultimately it leads to a clearer understanding of cash flow—a critical element in effective risk management.

There are various formats and methods for forecasting revenue, but walking you through those is better done via spreadsheets than a blog. So we’ll leave you with a few practical rules of thumb we’ve commonly seen for forecasting:

Book-to-Bill Ratio: Over the last twelve months, this is the ratio of new contracts booked divided by recognized revenue. A ratio above one indicates business growth, while a ratio below one suggests an eventual decline in revenue. This forward-looking metric provides valuable insights into the financial trajectory of the business.

Pipeline Coverage: Pipeline coverage compares the total value of opportunities in your sales pipeline to what you still need to close to hit your target number for a given period. This is often referred to as a “go-get” number. It’s your revenue target minus the revenue already booked. If your go-get is higher than what you know you can realistically achieve given your typical close rates are and how long deals take to close, you may need to adjust plans.

By having a clear separation between the budget and forecast, companies gain two valuable tools. The budget serves as a benchmark for self-assessment, while the forecast becomes instrumental in making real-time adjustments. This dual approach facilitates strategic decision-making, especially when unforeseen circumstances demand quick pivots.

By having a clear separation between the budget and forecast, companies gain two valuable tools. The budget serves as a benchmark for self-assessment, while the forecast becomes instrumental in making real-time adjustments.

As Jim Collins so elegantly writes in Good to Great, “You can change your plans through the year, but you never change what you measure yourself against. You are rigorous at the end of the year, adhering exactly to what you said was going to happen. You don’t get a chance to editorialize. You don’t get a chance to adjust and finagle, and decide that you really didn’t intend to do that anyway, and readjust your objectives to make yourself look better. You never just focus on what you’ve accomplished for the year; you focus on what you’ve accomplished relative to exactly what you said you were going to accomplish—no matter how tough the measure.”

Don’t go it alone

Planning, budgeting and forecasting are distinct yet interconnected workstreams. Mastering these processes takes time and engagement from across the businesses, but those who put the time and energy in to do it right will be rewarded.

If you’re an IT services founder looking for a capital partner that can help you with topics like these while helping your firm gracefully navigate the plateaus of growth, we’d love to connect with you!

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