Budgeting & Forecasting
When you start out in business it’s a good idea to have a budget. You may have a formal one or informal but the better quality of budget you have then the more chance you have of succeeding.
People often get budgets and forecasts mixed up; the best way to think of them is like this;
Budget = allowance
Forecast = what’s probably going to happen
The secret of a good budget or forecast isn’t whether it’s right or not – it’s how wrong it is.This is because you’ll never get it 100% right but if you can get it within a reasonable margin of error then it gives you a fighting chance.
If you are buying an established business or a franchise then you should be able to get some form of information to help you plan, if not then you’re on your own. But don’t despair.
How to build your budget
There are different ways to build up a budget but the three most common top down, bottom up and ZBB.
Top down (or target budgeting) as the name suggests is a method of deciding where you want to get to and making the budget fit. So you may decide a level of profit you need to make or an amount of sales you expect and then work from there.
As an example imagine I decide that I need to make £1000 per month. I would then add on my fixed costs of say £500. This gives me the amount of gross profit I need to make.
I know that my gross profit is normally 1 3rd of my sales so I can work back to say that I will need to sell £4500 per month to make £1000 net profit.
Bottom up is a method of taking a what is occurring and seeing where you end up.
So you’d start by making a budget based on where you are. Let’s imagine that as above I am selling £4500 per month. I know that my gross profit is 25% of sales = £1125. I also know that my fixed costs are £500 and I generally spend £125 on other expenses. This leaves me with an initial budget of £475.
Now if my aim is to do the same as in example 1, earn £1000 in net profit per month then it’s clear I need to adjust my budget. Critics claim that this is more complicated than the first method, people who like it say that it’s likely to be more accurate and honest.
The other option is ZBB or Zero Based Budgeting. In this method nothing is taken for granted and everything is up for challenge unlike the first two methods that build on prior performance or costs. So if we take our example 2 we wouldn’t just accept that we are going to sell £4500 per month just because we had in the past, what we would do is to work out where the sales were coming from and adjust the amount accordingly.
Similarly for costs we’d do the same but everything would be examined and the questions asked ‘why are we spending this’. This is much more complex and time consuming but people who like it claim that not only is it more accurate but that it drives costs down because money doesn’t get spent just because ‘we’ve always done it like that’.
Budgets are important because they give you that financial line in the sand to start from. They shouldn’t change throughout the year whatever happens but should be used as a way of assessing how you are doing now based on how you thought you were going to do.
Forecasts however do change. Remember that they are a method of working out what will probably happen. Businesses may do forecasts yearly, quarterly, monthly, weekly or even daily. A business that’s tight for cash will do a cash forecast very regularly indeed.
There’s no mystery to them, we do them every day of our lives.
For example I have £100 in my pocket, I need to buy fuel (£50), I need to get groceries (£20) and at the end of the day I should have £30 left. That’s a forecast.
If in fact I have £100, I buy Fuel and groceries but when I get home my Daughter borrows £10 I’m left with only £20 that’s an actual.
£30 – £20 = £10 that’s a variance.
Your forecast can be as detailed or simple as you like, it very much depends upon your audience and the reason you are doing it. If you are doing purely an internal cash flow forecast then it may be simpler than a reforecast for the bank.
The first step to building a prosperous company is working out what you are going to do and when you are going to do it and good budgets and forecast form a key part of your business plan.
Budgets and forecasts are very specific skills and you may want to take advice or get help from someone experienced in this area.A professional accountant can help you, either by producing a budget or forecast for you, helping you through the process or sitting down with you and assessing your performance against budget/forecast and helping with a plan.