What can we do to project the success of our business?
What is Budgeting and Forecasting? This seems like a simple question on the surface. Budgeting and Forecasting is traditionally defined as a documented estimate of revenue and expenses over a future period. On the simple side, budgets are used to plan and fund a project, or can be as advanced as a multi-scenario five-year cash flow projection of a multi-billion-dollar corporation. Most small business needs for budgeting and planning usually fall somewhere in-between. In this article we will discuss how to get started.
Why are we doing this?
Have you ever heard the adage “Failing to plan is planning to fail”? Would you go on a vacation without forming some sort of plan ahead of time? Would you buy a house without having a range on the purchase price in mind?
Budgets and forecasts serve several purposes:
- Most importantly, they can help owners, managers, department heads, and any other stakeholders make decisions based upon capital needs
- Serve as a performance benchmark for investors and other equity holders
- Help drive this or that planning
- Provide goals for sales personnel
- Provide spending guidance and limits
- Serve as an objective criterion for staff bonuses
When will we go through this process?
Budgeting and Forecasting can take place at any point preceding a financial period or can even happen in the period itself. Budgets should be considered a tool and not written in stone. Keep in mind that the more recent actual results data you have in hand, the more accurate your plan becomes. Balance accuracy with proactivity based upon your individual business scenario.
Who should we include?
There is better buy-in to budgets and forecasts when the metrics are considered reasonable by those responsible for the budget. Representatives from the finance department should suggest, maintain, and approve budget metrics, but successful plans include input from department managers, sales people, and other staff who have influence on actual results of the organization. The budgeting process is exactly that: a process. Schedule multiple follow-ups to initial meetings. Make sure management is privy to staff suggestions and approve information submitted by their subordinates.
How: It’s all about Drivers
All budgeting and forecasting should start with the identification of Drivers. Drivers are the key metrics that allow for revenue and expense expectations. The definition of a Driver may be better served with a few examples: total members, new members, and account cancellations would be Drivers in a subscription-based business. Number of tickets would be a Driver in a restaurant. Employee headcount might be a driver for a professional services firm. Break down what non-financial metrics drive your various revenue and expenses and list them.
Next, calculate your organization’s key performance indicators (KPIs) based upon past actual results. Some KPIs can be derived by simply dividing revenue and expense line items by corresponding Drivers of those lines. Other KPIs such as Cost of Sales might be a ratio of an expense line to a corresponding revenue line.
Once Drivers and KPIs have been identified, use historical data, current or future pricing, geopolitical factors, and expansion or retraction plans to determine the budget period calculations. Are material costs rising because of supply chain issues? Will you pass those costs along to your customers? These are examples of considerations for calculation adjustments.
Consider which Drivers influence other Drivers. If you plan for a major influx of customers, will employee headcount need to increase? And what costs are associated with hiring? A flow chart or map can be useful in determining which Drivers influence one another.
Finally, list all contractual obligations and be sure to include recurring or contract minimum revenue and expenses in your plan. This is also a good time to evaluate the need of recurring expenses.
Use a spreadsheet or budgeting application to link all the data together and ultimately produce Pro Forma financial statements. Version tracking was a troublesome part of the process in the past, but the rise of internet-based applications has enabled real-time direct collaboration, revisions, version tracking, and what-if planning scenarios.
Some final tips
The budget process can be high-level and basic or extremely complex and granular. The key is that your Drivers are an accurate link to the financial performance of the business. Don’t waste time on complex calculations if what is being calculated is not a relevant line item for your business.
If new information comes about or there is a change in the business environment (global pandemic, anyone?), don’t be afraid to pivot. The budget process is ultimately in place to help manage the business, and a business cannot be well managed without an accurate plan.
This article is a selected piece from By the Books: FORVIS' Complete Guide to Small Business Accounting & Finance, which we are excited to release in April 2023. Subscribe to our Small Business list to get future updates and articles and be the first to receive the full guide.