Budgeting and forecasting are two of the most important financial tools for small businesses.
A budget is what you’d like to happen, and a forecast is a reflection of what might actually happen. So, they’re closely linked, but they’re not the same.
Financial statements are confusing – including budgets and forecasts. So you’re certainly not alone here.
So, budget vs forecast?
What’s a budget?
A budget sums up where you’d like your company to be over a particular financial period. It’s a summary of your goals, over the next few months or even years. You’ll base your budget on your forecast of revenues and costs.
Most budgets are static and set for the company’s financial year. However, you can use the static budget as a guideline, and be flexible if business conditions change. You can adjust your spending if that’s the right business decision at the time.
How businesses use budgets
A budget is a key management tool for any small business. You can compare actual financial results with budgeted figures, to test your company’s performance. And that’s vital in the business world.
Your budget will show:
- The sales figures you’d like to achieve – a plan of action
- What you have to spend and how you plan to prioritise this. If you do this accurately, you won’t run out of money to do the things which are crucial to your business
- A point of comparison at the end of a period, so you can gauge how well you’re doing
Here are a few things to consider when creating your budget:
- Start with a realistic cash-flow projection. Your revenue forecasts will drive this in part, but they may not fully materialise. It’s better to be conservative here
- Differentiate between essential expenses like broadband and electricity, and expenses that are less essential to running your business. And prioritise your spending accordingly
- Build debt reduction into your budget, if you have any
- Try to incorporate cash reserves into your budget. This way any extra profits can serve as a cushion against a future downturn in business
Review your budget on a regular basis
Put your budget to good use – test your financial position. Are revenues and profits on track? Did the business add more revenue or lose business that was included in the budget?
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What’s a forecast?
A forecast is an estimate of what your business might achieve. In other words, it’s a projection of what might actually happen, and is generally restricted to revenue and expenses. In essence, a forecast will help you achieve your business goals.
Forecasts can be used for the long or short term. When you’re starting out in business, you may find monthly or even weekly forecasts necessary.
Your forecast will show: * Start-up costs - you may want to allow for more than you expect * Sales – and review these regularly to identify problems before they happen * Expenses – always consult industry benchmarks * Cashflow – the lifeblood of your business, so watch this closely
A longer-term forecast might span several years and feed a strategic business plan. The revenue forecast will drive adjustments to head count, production planning and stock levels for businesses that produce or distribute a physical product. A convincing forecast may also help you with getting bank loans on favourable terms.
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How businesses use forecasts
Forecasts are an important tool. Forecasting helps you make any necessary adjustments in focus or spending, as business can change over the course of a year. For example, if a major customer is reducing or adding to their volume of business with you, this will have a major impact on your operations and cash flow.
Here are a few things to consider:
- Consider using more than one forecast. One that reflects an optimistic outlook, one pessimistic and one most likely. This allows you to plan for growth but also to adjust in case some opportunities don’t materialise or happen more slowly than expected.
- Update your forecast on a regular basis. Things change, and you don’t want to be caught off-guard.
- Involve key members of your team, so you don’t miss any angles. Consult those closest to what is actually happening. Not only will this provide better data, you’ll keep key staff involved and happy.
So, let’s recap
Budgeting and forecasting perform different functions, but they’re not mutually exclusive.
Whilst the budget is a plan for where you’d like to go, your forecast shows you where it’s actually going. A good forecast feeds the development of a sound budget.
Over the course of the year, compare your most recent forecast to the budget for the rest of the year. This will help you make any necessary adjustments to meet changing business conditions.
Need more help?
Accounting software such as QuickBooks can help generate budgets and projections without much effort. And you can be confident of accuracy – all the data is automatically pulled from your accounts.
You should also consult an accountant to make sure you’re on the right path.
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