Budgeting and forecasting
Budgeting and forecasting are fundamental financial practices for any business. Together they assist you in managing cashflow, acquiring and maintaining equipment, paying creditors and staff, reinvesting earnings and covering operational costs. Creating a budget and generating forecasts is essential for a financially healthy business.
What is budgeting?
A budget is essentially a prediction of expenses, revenue and overall financial position, usually over a period of a year (though some businesses create quarterly budgets or biannual budgets). A detailed budget will cover items like rent, utilities, staff salaries, taxes, equipment maintenance and all other payments required to keep the business running. These will be balanced against predicted revenues to ensure that the financial obligations of the business can be met. If a budget is created properly and stuck to (and the predicted revenue comes through), the business will end the year in a healthy financial position.
In larger companies or businesses with a large variation in yearly income, budgets may be adjusted over time to reflect the actual revenues coming in, which may necessitate cutting certain non-essential expenses or reinvesting extra earnings (whichever the case may be).
What is forecasting?
Forecasting is related to budgeting, but takes a higher-level view. Forecasts typically look at key revenue streams and the overall expenses, along with predicted outcomes of business development elements (such as the introduction of new products, ongoing staff development and business growth).
A long term forecast looks out over a period of several years. These are essential for creating business development plans and strategic business plans. A forecast will look at the current profit of a business and the return on its invested profits to determine how much profit it will make in the future and how much those profits will generate in return. In addition, a forecast may look at the development timeline and costs associated with creating new products, and the predicted revenues once that product is introduced. Forecasts are an essential part of 5-year plans and exit plans.
Short term forecasts have more of an operational benefit, as they are typically more certain and less susceptible to changing circumstances. These forecasts allow businesses to plan future growth and asset acquisition, as well as assisting businesses in seeking financing from banks and private investors.
Forecasts are also necessary for managing employees and keeping the number of staff sustainable. Positive forecasts may allow for the hiring of new staff which further increase productivity, while a negative forecast may necessitate a hiring freeze or even lay-offs.
New businesses often conduct more forecasts than established businesses - sometimes as regularly as fortnightly or weekly. This is also common practice during rapid growth or times of business uncertainty. Stable, established businesses are more likely to conduct their forecasts quarterly or yearly.
What is the relationship between budgets and forecasts?
While the two serve different functions, they are not wholly separate. Developing a realistic, achievable budget is dependant on accurate forecasting. Additionally, forecasts and budgets need to be constantly compared as the business continues operations, to test assumptions and adjust as necessary. As the market environment changes, so too will the forecast and subsequently the budget.
In small businesses, the owner often handles both budgeting and forecasting, but the process can be complicated and doing it incorrectly can lead to insolvency or even bankruptcy. For this reason, most business owners use bookkeepers, accountants and financial advisors to ensure that they are making accurate predictions and realistic budgets. These professionals also assist businesses in sticking to their budgets, making the most of windfalls and mitigating the impact of shortfalls.