The Importance of Budgeting and Forecasting
Budgeting and forecasting is important to your business success because you set targets for income and expenditure and then you can hold yourself accountable to those targets as the year progresses. The most financially stable businesses practice this and will have a dedicated in-house or outsourced chartered accountant that helps them manage a budget and forecast.
Whilst budgeting and forecasting typically go together there is a difference between the two and they can be used individually. So what is the difference between budget and forecast?
What is budgeting?
When we talk about budget, we refer to the estimated revenue and expenses of that organisation over a specified future period of time. A budget plays an important role within an organisation and should be used as an internal tool by senior management.
What is forecasting?
Meanwhile, a financial forecast is the process or estimates or predictions of how a business will perform in the future. It takes into consideration sales goals and targets.
Whilst they can be used individually, we would recommend you use them together to get a better understanding of your financials for financial planning and analysis.
A forecast can be altered throughout the year but a budget should remain the same. For example, if there was a big bill due in January, there might be an increase in lead generation activities in December on the forecast to ensure enough new business came in to help cover January. These tools help ensure companies don’t overspend and run out of cash.
Below are the reasons why budgeting is so important and the advantages of having a cash flow forecast:
- Identify risk areas early
- Plan and predict cash flows
- Take control of what’s coming in
- Separate out a sub-budget for growth
- Manage your sales pipeline and track performance
- Make more confident strategic decisions
- Show potential investors
Identify risk areas early enough to rectify issues before they are serious
Rolling a financial forecast lets you see the profit and loss statement, which is integral to your business valuation. If you can’t prove you are profitable or that you will be in the future it will be harder to gain capital funding or any significant financial investment.
Plan and predict cash flows
There are many advantages of cash flow forecasting but the most important is it ensures you will always have enough cash to operate. For example, you may have a large tax bill during the year. If you don’t account for that you may not have enough money to pay HMRC which could result in massive fines and penalties. Companies fail everyday because they run out of cash to pay their bills, suppliers and staff. Cash is the lifeblood of any business, ensure you plan accordingly.
Take control of what’s coming in and due to go out of the business
If you don’t you could run out of cash to pay bills and staff, be owed money from customers, and be unable to gain new funding.
Separate out a sub-budget for growth with confidence in how much you can spend
Manage your sales pipeline and track performance against targets
You need to have full transparency on how well your sales team is doing. Is the conversion rate high? Who is performing best and why? If you know what to improve you can set about improving it with a clear action plan.
Make more confident strategic decisions
Show potential investors
Investors need data to make an informed decision. The more accurate financial plans you can provide, the better your chances of gaining funding.
There are many things you should understand regarding budgeting and forecasting. Your budget should be set before the financial year begins and should be fixed for at least a quarter before revising. Smaller businesses will revise the budget quarterly and larger ones will keep their annual budget fixed. The point of this is to give sales targets and limits for expenditure to keep you honest when spending money to grow the business.
Each month you should run a Budget Variance Report to show the actual results against the targets and discuss takeaways from the numbers. For example, one sales stream may be doing well but another may require more attention. It will help you identify areas of under-performance or overspend and rectify the issues before they grow.
Forecasts are the same as the budget at the start of the year but they are revised as things change. They flex and change throughout the year as your knowledge of the businesses position and pipeline changes. For example, imagine you win a big client, and then go and update the sales pipeline to show another £10k coming in each month for 12 months. You then update the cost associated with delivering that work (sub-contractors) and you now have an updated forecast. Your budget, however, will remain the same.
Typically business owners struggle to create simplified templates that are easy to maintain. Furthermore, often business owners want to do a monthly review of the budget variance report and revise the forecast but they either don’t understand it enough to alter it or they focus their attention elsewhere. To ensure you get the full benefit of budgeting and forecasting the most efficient recommendation would be to outsource this element of your business finances to a professional accountant. This will help ensure you can easily predict your cash flow and not run out of cash.
If you need better financial clarity book in for a free strategy session with a Senior Chartered Accountant today.
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