Mastering business budgeting and forecasting

Sally Preston

Toward the end of financial year is the time of year to start looking ahead to the next financial year and working on your business budget.

When setting a budget, it is not often as simple as rolling forward last year's data and adding 5%.

Let’s first clarify two different terms:

• Budget – this outlines your planned revenue and expenses, allowing you to allocate funds and set financial targets over a defined period, typically quarterly or annually.

• Forecast – this involves predicting future financial trends based on historical datas, providing a more realistic view of your business’ financial performance. Cash flow forecasting, in particular, is crucial to managing bills and demonstrating financial stability to lenders.

So why budget?

1.       It provides goals and direction - Budgets enable businesses to set realistic financial goals and benchmarks, providing a roadmap for measuring success and progress.

2.       It helps you make better business decisions - Armed with a well-defined budget, managers can make informed decisions regarding investments, expansions, and cost-saving measures.

3.       Can provide accountability - Budgets serve as a yardstick for evaluating performance. By comparing actual results against budgeted figures, businesses can identify variances and take corrective actions promptly.

4.       It is also important if you need or use external sources of finance in your business.

Some examples of business outcomes that may arise when you don’t have a budget:

• A customer asks for a new service – you do up a quote based on the known direct costs, plus the profit margin you would like. If you don’t understand the variable business overheads, then overall this job may actually produce a loss. So why quote at all?

• The business owner sees cash in the bank. Amazing to see such a healthy balance. However, without considering what is planned for that cash, things can quickly slip, spending increases or a capital asset is acquired with the cash and before you know it, there is not enough cashflow to pay the bills.

• The head of a division may approach you and request a new employee or piece of equipment. Without a budget, how can you understand the impact of that on your profitability by the end of the financial year?

A budget can also help eliminate wasteful spending. When you don’t have a budget in place, you might overspend on things such as:

• Discretionary spending. This includes things such as:

                             o   Professional development that doesn’t directly link to probability.

                             o   Travel and accommodation costs (where a Teams meeting may have sufficed)

• Salary and wages, particularly when there isn’t a current business need for the number of staff or level of experience

• IT systems that are above what the business needs – particularly where you are anticipating more growth than what is realistic

• When developing a new asset or product, often people don’t plan how they will fund the idea and profit from it. This can lead to severe financial consequences for the business where this hasn’t been considered, including:

So how would you start with budgeting and forecasting?

1.       Understand your drivers – what has the most influence on your business. For example, a transportation business may be impacted by fuel prices, award wages, availability of skilled staff.

2.       Understand the cashflow nature of the business – do customers pay within 30 days; every month on a subscription basis; whenever the feel like it? How do you pay? What other bills are due to come in and when? Is there capital expenditure planned and how does this fit in? Are there cycles in a business year?

3.       Be flexible and continuously monitor– always keep the set budget as baseline but adjust as the business changes. It may be that the budget was exceeded in one aspect two months in a row, so maybe it is time to review where the spending needs to be cut back and communicate the new budget with the team. It is good to have the original budget still there to compare against.

4.       Start with good numbers – with the right technology and people at the helm of your financial data, your file should be up to date on a daily or weekly basis.

5.       Communicate– collaborate with your team on setting the budget as they may have different insights into upcoming expenditure; expected payroll changes; client and customer attitudes etc. Communicating and collaborating can also get the team to take more accountability for the budget.

How to create your budget

Profit and loss

In your accounting file – print your year-to-date P&L. If you are using Excel then maybe it is time to automate.

1.       Review the revenue – what revenue is recurring and what was one-off. Maybe you have long-term contracts and you know roughly (or exactly what you will bill on those in the future). Maybe you do a lot of bespoke work, so you may have more trouble forward predicting the revenue for the next year. Historical data can give us good insights into both. Use this data to form a view of the revenue budget for the year. You may even look back an extra year to compare what happened in that year and reflect on any changes in the trading conditions, market etc.

2.       Review your expenses – look at the year-to-date spend. Consider including the recurring expenditure and fixed costs such as rent, phone, internet. Often there is not much change in these. But don’t set and forget – is your provider giving you good value for service? Is it time to shop around? Then record a budget for sundry costs – the small things that just happen. Include a detailed review of payroll, debt repayments and capital expenditure.

              a.       Consider how you are financed (if at all) and see if this is the best rate given the ever-changing interest rates.

              b.       For payroll, you may need to look at a few benchmarks for the industry you are in to determine whether your payroll is in line with your market. If not, then why?

              c.       For capital expenditure, review the equipment and capital needs of the business. Is there equipment that is increasing the need for maintenance or even replacement? This needs to be budgeted for. Even though it is not a cash number, reserving cash that represents the depreciation on equipment will provide you with a cash reserve when the equipment does need replacing.

3.       Review the outcome – more expenses than predicted income is a real problem. It is better to know that now so you can review how to turn this around. More revenue, cost cutting?

Balance Sheet

Often in budgeting, the balance sheet is overlooked. It is much easier to focus on profitability but arguably the balance sheet can cause you more issues if left unattended.

This is what decides a business that is thriving or dying. If you owe more than you own, then you may have some serious issues. Why? Because in a downturn in profitability, where you own more than you owe you have options – sell assets, sell a business that is worth something. But otherwise, a downturn in profitability gives you almost no options – your business may not be worth much and if it is it may only just clear the debts.

So, don’t forget to review the liabilities – including longer-term ones and consider the actual value of the assets – are they worth what they are recorded at?

Now what?

You may have started with a high-level view of the organization wide budget, but for a larger business you may need to take the above approach on a divisional or operational basis as well.

For example:

If you have a lot of employees and set a payroll component to the budget, what does this look like for each division or per person? Consider reviewing head count – if this needs to increase for operational reasons then what impact would this have on the budget? This budget may also be used to determine payrises and the total available for increased remuneration for the coming year.

As another example:

In a transport business, there may be a budget for replacements, repairs, new vehicles. This will help that department allocate the funding based on needs. Is this what you expected though? Did you think you would be able to afford new workshop equipment? Well maybe the overarching budget needs to be reviewed again.

Forecasting and cashflow

The P&L budget, and the current balance sheet, can be used to create three-way forecast. This is a cashflow, P&L and balance sheet forecast that can tell you where you will stand in the future should the assumptions come true. This modelling can also be used for “what if” scenarios. So, what happens if revenue is up by 10%; or even down. What if the overall payrise for staff is 4% rather than 2%. What if you hire a CFO to take all this hassle away – did that just eat up all your profit? However, it is not that easy to prepare without the right tools and people.

The main reason why this is so important is to predict cashflow. The revenue and expenses are just that, they do not always represent cash in and out of the bank at the same time. Plus, any capital expenditure, is not included in revenue and expenses, but can have a huge impact on cash.

Cashflow forecasting will enable you to predict what is in the bank at any given time. This is where the understanding of cash timing for your business is important. Review your debtors days – this is the average time for your clients or customer to pay. This can be used to determine when your revenue turns into cash. The same for your creditors days – when should the bills be paid. For many this is fortnightly or monthly – note, model when they should be paid to get into the best practice of paying on time. Using your creditors as a bank is not best practice!

Then apply some parameters to the model – such as, what if a large customer is lost, or you need to change a supplier and the input price goes up. Then see the impact on your cashflow. That way you can start to plan for scenarios if they are likely and occur.

What is the saying? Failing to plan is planning to fail? This is true for your business finances.

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The main message is, if you don’t have a budget, do one and start now so it’s ready to go on 1 July.

Then move this into a 3-way forecast that you can adjust to predict what lies ahead based on the factors that can impact on your business performance and profitability.