Budgeting and forecasting are two of the most important tasks a small business owner can perform for their business. Let's explore the difference between the two and help they can help improve your profits!
What is Budgeting
A budget outlines the planned transactions you expect to occur during a given time period (most commonly a year). This budget will outline expected revenues, expenses and the financial position of the company. In small businesses the owner is usually the creator of this report, but may include the sales team and operations in the budgeting process. Companies often create static budgets, but the ones who are serious about their profits update this report on a regular basis. Why Should You Use A Budget
Sophisticated business managers use their budget as a tool to help analyze the performance of an organization. Actual financial results are compared to budgeted amounts, and variances are analyzed. If expenses in a certain area are higher than budgeted, then a company should determine if the overage is tied to additional business or just overspending. By looking at the root cause of variances, a business owner can either adjust the budget or adjust cash outflows to maintain sufficient margins.
When developing a budget, here are a few things to consider:
Use cash flow forecasts to help estimate revenue. It is always better to err on the conservative side when estimating future income.
Break down your expenses between fixed and variable costs. Fixed costs are expenses like utilities, rent and insurance. Variable costs are expenses associated with direct labor and material costs.
Add any loan and equipment payments your business has to give a true picture of cash outflows.
Take 10% of your yearly revenue estimate and exclude it from the budget. This will ensure you have at least a 10% profit margin come year end.
What is Forecasting
Forecasting is the process of analyzing past data and current trends to make predictions for how the business will perform in the near future. These forecasts take into consideration current market events and how operations have performed up to that point in time. Changes that will impact the outcome of financial operations should be incorporated into forecasts on a fairly regular basis to ensure the forecast remains as relevant and accurate as possible. Forecasts aren’t used as comparisons to performance like budgets are. This means forecasts should remain fluid while taking recent events into consideration to provide insight into the company’s expected position in the near future.
When creating forecasts, here are a few things to consider:
Prepare more than one forecast. We typically like to see three types prepared: optimistic forecast, pessimistic forecast and a most likely outcome scenario.
Keep these forecasts updated. The business environment is constantly changing. Stay on your toes!
Involve adequate staff when preparing these forecasts. Typically sales, operations or marketing managers have a clear picture of the real environment you are operating in. Get their opinion on future expectations.
How Are The Two Connected?
Budgets and forecasts are interconnected in the way they are used. A sound forecast can help in the preparation of a budget and a budget from previous years can help forecast future events! By utilizing both of these tools in the management of a company, your business will have the desired financial results you're looking for!
Comments