I work with a lot of Boards and management teams, and once a year I get questions about budgeting. The questions are more pointed this year because everybody is wondering how to reflect the uncertainty of the market in their forecasts.

For most of the last decade, the budgeting process was relatively easy. An ISP would know its expense structure and there wasn’t much chance of unexpected inflation. An ISP could estimate the cost of a construction project that would be good for three or four years. The hardest decisions that had to be made in creating a budget were operational, such as the timing of when the ISP might add staff or start a new construction project. I once built a budget for a client that was still pretty accurate four years later.

But the easy budgeting days are behind us. Inflation has wrecked budgets for the last two years. Nobody built enough expense into budgets. Practically everything an ISP buys that was not tied to a long-term contract saw cost increases. Construction budgets were particularly gruesome since it seemed like the prices for fiber and electronics was increasing every month. It’s been even harder to get a reliable budget for engineering and construction crews. Anybody that finances with debt has seen interest skyrocketing rates.

Sitting in January 2024, it looks like the uncertainty has calmed a bit for now. The Federal Reserve has said that it hopes to drop interest rates a bit in 2024 – but that is no guarantee. Inflation is still a little higher than pre-pandemic, but it’s impossible to know if world events will cause another spike in costs. Supply chains have largely returned to normal, but we’re finally going to see the impact of BEAD grants across the county hitting on roughly the same time frame. The labor shortage didn’t materialize to the degree predicted in 2023, but BEAD grant construction could cause problems in 2025.

The most common question I get is if forecasts should be conservative or optimistic – and that is not an easy question to answer. Management teams always opt for conservative budgets. They want to be able to beat expectations with owners or Boards, and the easiest way to do that is to hedge the forecast to be conservative. That means predicting slower sales, higher expenses, and higher construction costs than expected. It probably means using the highest interest rate that they think the Board will accept in the forecasts. But Boards often have a different goal. Boards often want to know how well the business might perform, which means looking at realistic or even optimistic forecasts.

In the past there was not as much difference between the two scenarios. In the past, the primary topic of conjecture for ISPs that were growing was the likely customer penetration rates a year into the future. Management budgets were made a little conservative to provide wiggle room to account for unexpected events.

One of the dangers of creating an optimistic forecast is that human nature tends to accept and remember the rosiest scenario and not a more conservative one. Management’s biggest nightmare is to be faulted for not meeting an optimistic scenario due to factors outside its control. There is nothing to be done about interest rates that come in higher than hoped or another round of increased material or labor costs from vendors.

I think Boards need to have a discussion about this topic this year. Boards should be the ones to decide the degree to which they want conservative or optimistic forecasts, or both. Boards should have a discussion at the start of the year about how they will feel if actual performance is better than the conservative forecast but not as good as the optimistic one.

I know Boards that only want to see conservative forecasts. They want to be sure that the wheels don’t come off the business and that there will be sufficient cash to operate even with a conservative outcome. Such Boards typically expect management to beat the conservative forecast, but they don’t usually choose a specific earnings target.

But I’ve also worked with Boards who want an optimistic forecast and who then put pressure on management to meet it. I caution such Boards that putting unrealistic pressure on management in an uncertain environment is unhealthy for the business – but there are many companies that operate under this philosophy.

A Board should be making an open and conscious decision of what it wants to see and how it expects management to perform. Too many Boards don’t convey their expectations to management – and that is not a formula for success.