How To Use Budgeting and Forecasting Effectively

With the end of the financial year fast approaching, many will take the opportunity to reflect and wonder how they can better plan for the next year. Budgeting gives us the opportunity to step back and take a strategic view of where we want our business to go and be able to quantify the impact in terms of performance, business strength and liquidity. It is also a time to plan to do things better. As a small business this should be especially true and you should be asking if you could be making savings or how you are going to improve cashflow. Your goals can be a struggle if you don’t budget effectively.

Be clear about why you are budgeting, don’t just spend hours working on something to pop in the drawer and forget about. Instead, use it as an opportunity to create a roadmap for the following year(s) that you can compare your actual performance against.

Use past performance to assist but understand that it has limitations. Past performance will allow you to find a base level of revenue and cost that you can adjust up or down based on up to date information. It will also allow you to identify trends such as seasonal variations of income and costs. It will not, however, provide the best measure of future performance, it cannot be taken in isolation. Ensure that past inefficiencies do not become the norm by just accepting what happened in a prior year. Question everything.

Aim for an overview, not perfection. 

Do not expect to have perfect information. A budget is a best estimate and it will never be 100% accurate. However, it can provide a good baseline measurement of performance to work against and highlight areas for further investigation/questioning.

Be realistic, it can be easy to create a budget that shows what we want to see rather than one that is reasonable. Do not get sucked into overestimating your revenue and underestimating your costs just so your budget looks good. It must reflect reality as much as possible. It will assist with emotional stress later on, as you won’t be worrying why your performance is falling short of your budget.

Cash is King – The P&L is not the be all and end all. Go a step further and create a cashflow forecast that is derived from the budget P&L as it will show you the impact on cash flow of a number of factors such as:

• Payment terms of both suppliers and customers;
• Non P&L payments such as loans, leases and Capex;
• It will adjust for non-cash items in the P&L such as depreciation of capital purchases where the cash left the business in a previous financial year.

When creating your objectives and budget, give them a deadline to give you something to work towards but be realistic. Don’t set yourself up to fail.

Calendar your progress: put time in your calendar each week/month, whatever works for you and measure your success. Be sure to do this regularly enough that you can take steps to improve performance in good time.