Welcome back to part 4 of our 5 parts series on Annual Planning.
If you’re late to the planning party, here’s a snapshot of our syllabus:
Part I: The Kickoff
Who’s involved in annual planning?
Bottoms up vs tops Down forecasting
Guiding questions and guardrails
Part II: Building sales capacity
Modeling out rep ramp time
Pod ratios: Business Development Reps, System Engineers, and Sales Managers
Quota deployment and over assignment (shhhh!)
Part III: Designing a marketing budget
Modeling Pipeline Coverage and understanding the marketing funnel
Working with your CMO to develop a “GL pick list”
Programs vs People cost split
Part IV: Costing out the P&L (This post!)
Modeling headcount as an input, and a driver
Forecasting non-people costs
Developing a mutually exclusive list of expense types
Part V: Bringing it all together
Modeling P&L by cost type vs P&L by department
Checking your outputs: CAC Payback, ARR per head, cash runway
Five year plan tie in
This guide comes from thousands of hours on the job, designing annual plans for multi billion dollar tech companies. And it’s strongly influenced by the hundreds of hours spent with my entrepreneur friends who are building their very first budgets.
Today we’ll show you how to fully burden your P&L - a fancy way of saying “find a home for all the stuff you spend money on".
If there’s a single thing you take away from today’s jam sesh, I just want to say one word to you. Are you listening? Plastics Headcount.
Cost build ups should start and end with headcount.
Headcount as an input and a driver: Believe it or not, 75% of costs at tech companies tend to walk on two feet.
That makes nailing your headcount forecast key to budgeting success - not only is payroll the majority of your costs; it’s also a driver for the majority of indirect costs (e.g., software licenses, office expenses, rent).
So it’s less about matching the dollars in the model to people, and more about using the people to come up with the dollars in the model.
You may have an idea of where you want your cash burn (or profitability) to shake out, but to validate that you have to build up from the bottom starting with employees.
“Max” headcount figures as a backstop: From an OPEX perspective, the most crucial part of the annual planning process is coming up with “max headcount” figures by department, preferably phased by quarter.
Leaders should hire throughout the year to stay within the bounds of a “total team size”. This is where annual plans are made or broken. Full stop.
Establishing a baseline: In terms of putting numbers on paper, pick a date (like end of November) and draw a hard line in the sand. This is your starting baseline to work off of. Any headcount hired the rest of this year will be caught in a final refresh. But this is your single source of truth for the starting line to build off of.
If you didn’t have a company last year, nice! This will actually be a lot easier. Just decide what you want to pay yourself and your cofounders, and that’s the baseline.
A List of Possible Expense Types
If you’re looking for the most basic, yet comprehensive, list of expenses to include in your P&L, start with these:
Salaries & Benefits: For US based employees you can usually use a 20%-25% uplift off of salary as an estimate for benefits (health insurance, dental insurance, life insurance etc.). Some rules of thumbs for other countries can be found here. If you are hiring contractors, you don’t have to worry about the benefit portion.
Commissions: This should be reserved for the sales team and sanity checked as a % of revenue. You generally want to keep this below 15% of total revenue.
Contractors: Flex labor capacity for specialized or project based work, like design or copywriting.
Mostly advice: I often put placeholders in each department for contractor work - you often don’t know you need it until you start the project, or begin building a new product
Professional Services: Lawyers, bookkeepers, tax accountants.
Mostly advice: If you plan to raise money this coming year, reserve minimally $100K in lawyer fees just for this event. You can probably / eventually argue to put this “below the line” as a 1x expense, but it will still chew up cash and completely ruin your lawyer budget if you don’t think about it now.
Rent: You should think about allocating this out based on headcount once you surpass ~100 people. But until then you can park it in G&A as shared overhead.
Subscriptions: The cost for software tools like Salesforce, Adobe, Miro etc.
Marketing: Refer back to our third post on marketing budgeting.
Travel: Useful to break this into team (internal) vs customer / revenue generating (external) buckets
Mostly advice: Travel should always follow the person who’s doing the traveling back to their department. Booking travel for, say, a person in product who’s traveling to cover the marketing booth at a conference is a cardinal sin.
Marketing might say they’d rather expense this person’s travel now, but when they are over budget later in the year it will become a source of frustration.
Plus, it’s really hard for the accounting team to divvy out which travel hits which departments if it doesn’t follow the person.
Office Expenses: Paper, pens, coffee, food
You can budget for and embed most of these expense categories within each team, then roll them up at the company wide level to check total spend by bucket. In my opinion, this is the most basic list of GL (General Ledger) codes a software company should have.
What belongs in COGS?
Think of COGS as your cost to serve a customer on an ongoing basis. It’s what you need to spend to make sure customers are getting value out of your product after you reel them into the boat.
I tend to think of COGS in three buckets. Here are some rules of thumb in the SaaS industry:
33% people
Customer Support (Break / Fix) and Customer Success (Adoption / Upsell)
There’s a good argument to put Customer Success in Sales, not in COGS, if the people carry a quota. If they don’t carry a bag, they should burden your gross margin.
33% tools or data
Customer support tools (Ask Nicely, Zen Desk, Churnzero)
33% hosting infrastructure
AWS, GCP, Snowflake
What do costs look like at the department level?
Sales:
75% people
Payroll + Commissions
Note: if you have commissions showing up in any other department, you are doing it wrong. Commissions should be reserved specifically for sales. Any other variable comp should be classified as a management by objective (MBO) bonus.
15% tools
CRM (Salesforce, Hubspot)
Sales Efficiency (Gong, Zoominfo, Linkedin Sales Navigator)
Meeting Management (Calendly, Chilipiper, Vidyard)
Contract Management (Docusign, Linksquares)
10% travel
Revenue generating travel: Client facing meeting, conferences
Non revenue generating travel: Small hands, all hands, QBRs (quarterly business reviews)
Marketing:
50% people
This varies by company scale - you need people to deploy the marketing programs and campaigns, so at first this skews towards people (60% / 40%).
But overtime the ratio starts to slide in the direction of programs (40% / 60%) once you have people to spend it
Generally speaking though, you won’t see it move more than 70% / 30% in either direction
40% programs
This should include all of the following program costs:
Design
Online advertising
Offline advertising
Sponsorships
PR
Social Media
Channel / Partner
Events / Tradeshows
Collateral / Gifts
Incentives / Promos
Contractors
Consultants
Software / Tools
Tools you’ll commonly see pop up in your vendor report include Hubspot, Mailchimp, Marketo, Jasper.ai, SproutSocial, Podium
[Big annual conference]
10% travel (and shipping)
Lead generating travel: Conferences, and anywhere you ship that booth
Product:
70% people
25% tools
Project Management (Miro, Clickup, Asana)
Design (Figma, Fullstory, Adobe)
5% travel
Customer studies: meeting with clients first hand to understand their needs. This may include advisory committees.
Conferences: often working hand in hand with marketing to man the booth
Team meetings to work on the product roadmap
Engineering:
93% people,
5% tools,
Gitlab, Docker, Postman
Surprising tangent - a lot of dev tools are actually relatively cheap (as a CFO, I rarely ever say this. It actually hurts that I’m writing this).
Most start as free. And if you are an org that’s under 200 people, there’s a good chance that more than half the tools your engineering team is using are still free.
Very minimal travel (2%?)
If your engineering team is traveling a lot, something is very broken.
There are no customer facing opportunities for engineering teams, and Product and Marketing people should be representing the company at conferences to better communicate the story (sorry if I’ve offended any Toast Master developers)
Finance
60% people
25% tools
Money In, Money Out (ADP, Bill.com, Brex)
Finance / Accounting (Quickbooks, NetSuite, Xero)
Treasury and Procurement (Kyriba, Coupa, Ivalua)
Cap table management (Carta)
12% professional fees
Lawyers (Cooley, Fenwick, Goodwin, Wilson), Tax (BDO), Audit (Big Four)
<3% travel
HR
80% people
10% recruiting “advertising” / “program” spend
LinkedIn, BuiltWith, Indeed, Monster, Glass Door
I think of this as effectively marketing program spend but for the org’s overall brand to attract talent
7% tools
HRIS tools (Workday, Bamboo HR, Gusto)
<3% travel
“G&A” / “Exec” / “Operations”
40% People
CEO, COO, Admins, facility workers etc.
30% Tools
This is where I’m throwing shared tools (Zoom, Slack, GSuite) rather than allocating out to the departments
As you get past ~$25M in ARR you can start to allocate the larger shared costs (like rent) so G&A doesn’t look like an absolute albatross
And I’m also throwing all security and compliance tools here (Crowdstrike, Jfrog, DataDog)
20% Rent and Overhead:
Also includes utilities, office expenses, snacks, the disgusting Flavia coffee I had to drink at PwC etc.
10% exec travel
This is where you park the 150 hour NetJets card for your CEO and hope you get invited someday when you beat your revenue forecast
Building P&Ls
Creating two P&L outputs: Your goal is to construct two Profit and Loss forecasts.
One should be organized by team, and another by expense type.
They should both tie out to the same amounts, but provide different views for decision making.
But honestly, if you are under 10 people, you can get by with just one plan on a page that’s organized by expense type
But before we go, what about…
Laptops
Laptops are a cash expense which get amortized on the balance sheet over time
This is the biggest cost for new hires, so make sure you budget for one laptop for every new person
Although it might not hit your P&L right away, it’s a scary sight when CDW wallops your bank account for 20 x $1,750 in Mac Books
You can add in an assumption for hardware refresh, say 20% of current employees, per year
Annual Bonuses
For non sales people, most software companies have annual bonuses based on a percentage of an employee’s salary.
For example, a 10% annual bonus for someone making $120K is $12K paid in the next fiscal year based on the prior fiscal year’s outcome
At many tech companies these bonuses are “at board discretion” but are magically paid out in full (or else employees would revolt)
These bonuses are NOT commissions. Do not put them there.
Commissions are only for sales people. Full stop.
Put a new GL code for Bonuses
Although no cash exchanges hands during the year, the accounting team should still “accrue” this as an expense each month as if you are going to hit 100% by year end
So for the example above, the accounting team would “accrue” an expense of $1,000 for that person each month, expecting to pay it out at year end
If you suck next year and don’t get 100%, the accounting team can reverse the accrual and you can cancel that boat you pre ordered.
If you are on a classic fiscal year schedule (December year end) make sure to pay this out by March 15th payroll the following year - if you don’t, it can have a bad impact on your 409a.
Implementation Costs
If you are doing a big software install, like a new ERP, don’t forget about the 1x set up fees you’ll get smacked with
Implementation and professional services can be up to 3x higher than the first year costs for some major systems.
Examples of software with big implementation costs include NetSuite, Workday, and Salesforce. So if you are buying one of these tools, don’t forget the professional fees, and associated time to go live.
