Driver-Based Budgeting for High Growth Companies

When client volume is increasing rapidly, how does Finance determine appropriate budgets for Departments? What is more important to measure: efficiency or labor costs?

The old static budgeting concept that we all know of does not lend itself well to situations where uncertainty is the only thing that is certain. Departments within high growth SaaS companies need to be able to hire as needed, while still maintaining alignment with key performance metrics. A static budget might not be sufficient to allow managers to make quick decisions. How do we empower those managers to grow their departments as needed and stay aligned with company performance targets?

We can use a Flexible Budget which adjusts for volume or activity. Flexible Budgets are based on a variable rate per unit of activity instead of one fixed amount, and are able to balance efficiency and wages. It allows managers to leverage improved efficiency to offset higher wages, or vice versa.

This type of budget is best suited for departments where labor is closely related with client levels, such as Client Success, Operations, or Professional Service. Maintaining alignment of these departments to control costs and maximize efficiency can literally mean the difference between success and failure for an organization.

The rudimentary way of measuring efficiency is:

And, the rudimentary way to measure labor rates is:

I am here to teach you a better way.

How do we bring both measures together into balance? What is more important? If the department manager meets the Efficiency Ratio but falls below the labor % target, is the department over-performing or under-performing?

Flexible Budgeting in SaaS

To adequately balance the desire for efficiency and cost savings within a growth environment, we turn to a Flexible Budget. For costs that vary with volume or activity, the flexible budget will flex because the budget will include a variable rate per unit of activity instead of a single fixed amount. In short, the Flexible Budget can be a helpful tool when measuring a manager's overall effectiveness. And most importantly, it gives us a clear picture of the balance between efficiency and labor wage rates.

Using Flexible Budget techniques, we can measure the performance related to Wages and Efficiency separately, with variable targets that are relative to any volume of business . A department can be measured holistically when the two measures are combined, and can hypothetically be favorable on one metric and unfavorable on another. The sum of the 2 metrics can provide a comprehensive view of departmental performance.

Metric 1: Measuring Wages (Labor Rate Variance):

A basic labor metric takes labor as a % of revenue. Taking that concept one step further, the flexible budgeting process allows us to measure wage levels within a variable context. It is calculated as:

Example: Figure 1

Metric 2: Measuring Efficiency (Labor Efficiency Variance):

A basic efficiency metric takes client count divided by headcount. The technique can be taken one step further by converting that measure into dollars, and measuring the variance between target and actuals.

It is calculated as:

Example: Figure 2

Bringing It All Together: Total Flexible Budget Labor Variance

It is interesting to note that a key difference between this technique and other budgeting methods is that neither component of the Flex Budget utilizes revenue to calculate the desired ratios. Why? Revenue is not a business driver. Revenue is the result of a company’s underlying operations. We need to look beneath the surface, and find out what really makes our business tick. Analyzing business drivers, beyond the standard financial statements, is an important theme that you will see repeated here at SaaSFinance.io.

Since the efficiency result is converted to dollars, we can add the Labor Efficiency Variance and Labor Rate Variance to reach the total flexible budget labor variance for the department, which will give a comprehensive picture of budget performance and favorability.

It is calculated as:

Application In The Real World of Business (SaaS)

Client Success, Operations, and Professional Service departments who directly service a clients are a great candidate for this budgeting method. The targets allow Department Managers to move chess pieces on the board (metaphorically speaking) as they see fit, since it allows them to under-perform on one target and over-perform on another. They can choose to improve efficiency while increasing pay for top team members, all the while knowing their Total Flexible Budget Labor Variance can still be favorable.

A template is available here. Use this Flexible Budget template to bring alignment to your teams. In the example, client count grows exponentially. Despite rapid growth, labor expense and efficiency are balanced to create a clear picture of team performance.