Small Business Budgeting & Forecasting 101

Thoughtware Alert Published: Sep 09, 2020
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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 defined traditionally as a documented estimate of revenue and expenses over a future period. Put simply, 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 multibillion-dollar corporation. Most small business needs for budgeting and planning usually fall somewhere in between. In this article, we will describe 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 a plan ahead of time? Would you buy a house without establishing a range for the purchase price?

Budgets and forecasts serve several purposes:

  1. Most importantly, they assist owners, managers, department heads, and any other stakeholders in making decisions based on capital needs
  2. They serve as a performance benchmark for investors and other equity holders
  3. They help drive “this or that” planning
  4. They provide goals for sales personnel
  5. They provide spending guidance and limits
  6. They 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 on your individual business scenario.

Whom 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 approves information submitted by its subordinates.

How? It’s All About Drivers

All budgeting and forecasting should start with identifying 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 all be considered 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 nonfinancial metrics drive your various revenue and expenses, and list them out.

Next, calculate your organization’s key performance indicators (KPI) based on 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? What costs are associated with hiring? A flowchart 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 also is 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 (like these) has enabled real-time direct collaboration, revisions, version tracking, and what-if planning scenarios.

Final Tips

The budget process can be high-level and basic or extremely complex and granular. It’s important to understand that your drivers are an accurate link to the business’s financial performance. 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.

Need help with budgeting and identifying drivers and KPIs? Contact Us to speak with a BKD Trusted Advisor™ or visit our outsourced accounting services page to learn the details about how we can assist you with budgeting and forecasting and a suite of other services.

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