No matter the size of your business, budgeting and forecasting are essential practices to help you succeed long-term. Whether your organisation is in a period of growth, transition or maintenance, budgeting and forecasting can help map out the path to achieving your financial goals.
Despite the importance of budgeting and forecasting, many small businesses don’t prepare budgets, and larger companies don’t always follow best practice. What factors make up a successful budget or forecast, and what does the process look like in action?
The importance of budgeting and forecasting
A well-planned and implemented budget is important regardless of business size, type or industry. Most commonly, budgets help to estimate revenue, expenses and cash flow based on a careful analysis and understanding of what drives the business. Ultimately, these estimates can be compared to the actual numbers to help businesses identify any gaps in operations, improve and grow.
Forecasting, on the other hand, enables a business to adjust their future settings based on different scenarios, combined with an assessment of the current state and past performance.
Used together, these two tools are a powerful way for organisations to determine how they should allocate their resources and future budgets.
Budgeting and forecasting are also important to:
- Create tangible business goals
- Provide a roadmap for leaders and managers
- Increase cash flow
- Enable better accountability
- Expose areas for improvement and gaps
- Prepare contingency plans
- Make informed commercial decisions.
Budgeting and forecasting best practice
When it comes time to start setting goals and crunching numbers, there are several best practices to keep in mind as you build your financial literacy around these concepts. Here are a few key reminders to ensure you get the most out of your business budget and forecasting:
Make sure you understand your drivers
Identifying your key drivers ensures you’re focusing on the factors most crucial to your business: What are the internal and external factors that have the most influence on your business’ success? Pinpointing your Key Performance Indicators (KPIs) can provide valuable insight as to your drivers, while also helping to track revenue, profits and outcomes. Understanding how your business cycle works can help to fine tune the way the business is operated.
Be flexible, but maintain consistency
A common mistake made by business leaders is changing the budget each month. While it may seem harmless to alter your budget along the way, doing this can make it difficult to track profit and loss or predict cash flow throughout the year. However, you don’t want to keep your budget so rigid that unattainable metrics are held in place. The key is to establish a baseline budget that reflects your company’s needs and goals, whilst staying flexible to allow for the unexpected. If budget updates are required – then make sure the baseline budget is still available to enable you to track variances. This approach enables you to factor in the impact of important decisions made during the year, whilst still being able to compare the revised budget against your original intentions.
Track your data and put it to use
When it comes to budgeting and forecasting, even data that seems minor can be important in the future. Tracking all relevant data helps you adapt quickly, make changes when necessary and enables your business to fund its future growth. Think about your data sources – such as customer relationship management systems, social media, operations, and HR systems – that can provide you with non-financial indicators which are important drivers for your budget. Identifying these key data sets will help to develop a more accurate financial model of your business.
Know your profit and cash flow numbers
It’s obvious, but true — profit is a critical metric to your business, even more than revenue. However, in times of uncertainty and economic change, keeping an eye on your cash position is crucial. Being constantly aware of your profit and cash flow goals and current metrics will keep your business from missing crucial financial goals and help set attainable cash flow goals in the future.
Get outside perspectives and expertise
One constant of business is that the market is always changing. Working with an adviser can help business leaders keep up with this shifting landscape, challenge their assumptions, remain agile and support business growth. Access to the business networks of these external advisers can be an invaluable asset when you’re looking to diversify or expand.
Key steps to create a budget:
- Start from the bottom up: Don't assume anything - seek to understand all aspects of the business
- Understand your business cycle and how this can be quantified: Are you a seasonal or cyclical business? Do you have boom times and / or quiet times during the year? Do you have customers who are slow to pay?
- Review and quantify your income streams: What drives your revenue? Is it the sale of widgets or of hours? Do you charge fixed prices, or are they variable?
- Review and quantify your direct costs and your operating expenses: Understand variable costs which fluctuate with your revenue vs fixed costs or overheads which are more consistent, regardless of the sales for the month. What are the factors that determine the value of your costs?
- Set realistic targets to account for change: Ensure that your budget is achievable but ‘stretchy’. At the end of the day, this will help your team to buy into the budget and take accountability for it.
Proactive, not reactive: Start budgeting and forecasting
The final, and most important, best practice tip for budgeting and forecasting is to be proactive, not reactive. Don’t wait to seek financial help when you’re already in the thick of a crisis. It’s best to be proactive with budgeting and forecasting so that if a challenging situation occurs, you’re well prepared.
Original content provided by BDO Australia.