Most business owners know they should be budgeting and forecasting as part of the financial plan for their company. However, short term priorities and the day-to-day pressures of running a business can often distract from this important task.
We’re here to help, so read on to learn the five most important steps to successful budgeting and forecasting.
Why do we budget and forecast?
The more you know about your company’s financial position, the more empowered you are to make confident decisions about your business goals.
Think of a profit and loss (P&L) budget as a plan for your business, consider it your financial plan and an essential part of your business plan. A P&L budget looks at revenue and expenses, and you can use it to set targets. You can measure your budgets against actuals and work out the difference to check everything is on track too.
A budget is also useful for sharing with lenders or investors so they can get a good understanding of your business activities. It helps them, and you, see if your business will be profitable. Many businesses choose to review their budget once every fiscal year, although some do so more frequently to respond to changing market conditions.
So where does forecasting come in? Well, something essential that you need to bear in mind is: your P&L budget will not include taxes, dividends or repayment of loans. P&L budgets also work on an accruals basis, which means they don’t reflect your cash basis – in other words, when you will actually make payments and be paid. What a budget can’t do is give you a real-time, up-to-date picture of money in the bank. This is where cash flow forecasting comes to the fore.
While your budget is a plan for your business, cash flow forecasting looks into what’s actually happening with your business finances. There are many advantages of cash flow forecasting, including tracking if your spending is on target, alerting you to any cash gaps that might be on the horizon, identifying areas where you may have surplus cash and understanding the implications of business decisions on your bottom line.
Your cash flow forecast requires a more hands on approach than your annual P&L budget, as payments constantly flow in and out of your accounts and this means your cash flow position will be in a constant state of flux.
Put simply, a P&L budget shows your business’s potential to be profitable and a cash flow forecast gives you an accurate view of your business’s finances. Want to dive into that a little deeper? Then hop on over to this blog post about the difference between a budget and a forecast, and we’ll meet you back here in around 5 minutes, ok? Great.
A step-by-step guide to successful budgeting and forecasting
Now we’ve looked at why budgeting and forecasting is so important, let’s look at how you can ace your own business’s budgeting and forecasting.
What does success look like to your business? And at what point do you need to take action if your cash falls below a certain level? Setting milestones is an integral part of budgeting and forecasting, as it will help you see if you are on track or need to slightly readjust. For example, by a certain milestone you may be ready to take on your first employee, or you could have hit a certain threshold of sales. Milestones will let you know when it’s time to act. This is true for small businesses to big multinationals.
Create an accurate forecast from the start
It’s important your budget and your forecast work together to provide a clear overview of your company’s finances. When you first start forecasting, we recommend you reconcile all outstanding invoices in your accounting software. This means your bank balance and statement balance matches, so you can build your cash flow forecast on a stable starting block.
Plan for the long-term and the short-term
Both budgeting and forecasting are most effective when they take into account the immediate future as well as long-term, which is anything from 12 months to 3 years. Your short-term cash flow forecast will flag up anything imminent that could impact the day-to-day running of your business, while the long-term forecast will flag any future problems well in advance of them becoming a serious problem. Looking long-term at your cash flow will also help you plan for business growth, such as taking on a new employee or moving to a bigger office. If these milestones are in your business plan, make sure they are in your forecast too by developing a long-term cash flow forecasting habit.
Consider different scenarios
Speaking of big decisions, there is one forecasting tool every business owner should have in their toolkit. Scenario planning helps you map out potential ‘what-ifs’ and is an essential step in good budgeting and forecasting.
Business owners can prepare for the unexpected by cash flow forecasting for different scenarios that may impact their business in the future. While we may not want to think about the things that could go wrong – loss of a key client, temporary closure of premises etc. – it is important to have a plan for what action you’ll take if the worst happens.
The fifth, and some might say most important, step toward successful budgeting and forecasting is to regularly check in to make sure everything is up to date. Reconciling or matching payments with invoices and bills and update your predictions will keep your forecast accurate. Checking your forecast to make sure you have a continuous healthy cash flow will help you rest easy at night, and who doesn’t love a good night’s sleep?
Remember, regular budgeting and forecasting gives you an overview of your business’s finances. Float integrates with Xero, Quickbooks and FreeAgent to create a cash flow forecast based on real data.
If you’d like to give it a go for yourself, we’re offering a free 14-day trial of Float where you can create your own forecast in our easy-to-understand cash flow software. It’s really straightforward and we’re always here to help you with your forecasting!