As a business grows and becomes more complex, the need for a successful budgeting and forecasting process becomes critical. Often, this task gets pushed to the side as growth becomes a major priority for small businesses.
Many small business owners find themselves juggling many roles and wearing many hats, and as a result, even simple P&L budgets get overlooked. There are 5 keys to budgeting and forecasting successfully that make it effective and worthwhile regardless of the size of your organization.
Why is Budgeting and Forecasting Important?
One of the most redeeming qualities of budgeting is that it forces the organizations leadership to establish tangible goals for the fiscal year. This is inherently good and gives direction to the business and aligns all of the staff from the top to the bottom.
The budget process uses these goals to create a roadmap to reach the goals of the business.
While there are many ways to approach budgeting, the resulting financial plan provides a basis by which to measure the organization’s success. Without it, there are arbitrary and ambiguous goals that are difficult to monitor and gauge.
Among the numerous benefits of creating a budget, perhaps one of the biggest and most beneficial is the examination of cost drivers. Understanding how costs rise with revenue and where the marginal benefit of adding resources arises is critical for smart business planning.
On the other side of the aisle is forecasting, which takes the budget and converts it into a projection of the future. In many cases, forecasts are used to measure future success if the budget is adhered to entirely. However, there are many other types of forecasting that add substantial value to the operations of any business.
Cash forecasting is perhaps the most common form of forecasting and is a crucial component when preparing for the coming fiscal year. Maximizing cash flow is extremely important, especially in low-margin industries.
Finally, the two work in tandem to produce a comprehensive guide to the upcoming fiscal year. On the one hand, the budget guides expense and income management, and on the other, the forecasts provide a means to measure how successful the organization was at implementing the budget.
This marriage provides a plan that helps to maximize enterprise value.
The Keys To Budgeting and Forecasting Successfully
Understanding the importance of budgeting and forecasting is important, but what is more important is understanding how to implement the process successfully.
There are 5 keys to budgeting and forecasting that, if followed, will yield significant benefit to any organization.
1. Make Sure The Budget Is Realistic
This might seem obvious but it is easy to get ambitious when sitting down to budget for the first time. It takes time to thoroughly review historical performance and identify cost drivers. Avoiding goals that are not grounded in reality is absolutely critical.
For example, it might be unreasonable to assume that cost could be cut by 50% or that revenue can grow by 60%. Always be sure to approach the budget with a reasonable expectation of what can be accomplished with the resources at hand.
Growing a business is not an overnight matter, and those who take a realistic approach to fiscal planning can expect to be rewarded with compounding results. However, there are many goals aside from growing that a budget supports.
For example, a budget might prioritize relieving debt or paying down lines of credit rather than prioritizing revenue growth.
Making a realistic budget starts with having realistic, measurable, and quantifiable goals. In this way, the budget becomes a tool for meaningful success, and the forecast becomes a meaningful gauge of performance.
2. Perform Scenario Planning
One of the things budgeting and forecasting attempt to do is provide a roadmap on how to navigate the fiscal year ahead.
However, unforeseen problems often interrupt the regular business cycle—COVID-19 was a great example of that. It is important to consider multiple potentialities and run scenario analysis when preparing budgets and forecasts.
One rule of thumb is to always prepare a base-case budget and forecast, a scenario in which everything happens according to plan, and then create a set of budgets and forecasts based on best case and worst case scenarios.
Approaching budgeting in this way provides a way to plan effectively against various scenarios.
3. Start With Clean Data
One of the major mishaps that can happen when striking a budget and forecast is the use of bad data. As the saying goes “bad data in, bad data out”.
It is especially important to start with a period that has been well reconciled and locked. Creating a P&L budget with outstanding P&L items or inaccurate payables/receivables can have serious negative consequences.
Always be sure to use clean data for your budget.
Because the forecast relies on the budget, this concept becomes paramount. If a forecast is created off of an inaccurate or incomplete budget, then essentially it is charting a course for disaster.
A forecast is essentially a financial model that attempts to predict the future given the inputs from the budget. If the inputs are bad, the forecast is bad.
4. Create Short-Term and Long-Term Plans Using Tools, Budgets, and Forecasts
Budgeting and forecasting yield the greatest benefits when they are used to do both short-term and long-range planning in tandem.
That is to say, a budget should be created for the near-term, less than 12-months, and a budget should be created looking forward several years. It is common to see 2-, 3-, and even 5-year pro forma financials based on long-range planning.
Due to the sensitivity of maintaining sufficient cash balances most businesses will forecast cash out monthly, and in some cases weekly.
These short-term cash forecasts are part of a larger years-long forecast. Similarly, budgets are created and reviewed quarterly, and in some cases monthly.
The reason short- and long-term plans are important is that they will highlight problems as they arise and allow for quick responses to ensure that issues do not get out of control.
In the same vein, they also help ensure the business is making progress towards its defined milestones, whether that be expansion, acquisitions, or even divestitures.
5. Regularly Monitor the Budget and Update Forecasts
Once a budget is drafted, it is important that it does not simply collect dust on a desk. This is a meaningful road map to achieve the goals of the business.
The only way to be sure that the organization is moving in the direction it should is to regularly monitor its progress against the budget and larger forecast.
It is a best practice to include regular milestones in your budget and forecast that, once achieved, make it obvious that the business is following the plan.
Achieving these milestones indicate that the organization is aligned with the goals laid down by management and can also be used as a means of gauging staff performance.
Certain instances might arise where unexpected events occur that interrupt the progress the organization has made on a budget and disrupts the initial forecast.
COVID-19 was a great example of a market interruption that few businesses were adequately prepared for. Because of this, it is important to regularly convene on the budget and the forecast and to make adjustments when necessary.
Using Budgeting and Forecasting Software
Because budgets and forecasts are so critical to the well-being of a business, many organizations are turning to software offerings that allow for more flexible and responsive financial management.
A good software package is one that is easy-to-use, easy-to-implement, and allows for responsive changes and reporting that is helpful.
Many organizations rely solely on Microsoft Excel due to its familiarity and cost, but this can be an oversight as fragmented workbooks and manual inputs can lead to errors.
These errors have larger implications at the end of the day. Every organization should be prudent and perform regular due diligence on software offerings that will add value.
Using DataRails, a Budgeting and Forecasting Solution
DataRails replaces spreadsheets with real-time data and integrates fragmented workbooks and data sources into one centralized location. This allows users to work in the comfort of Microsoft Excel with the support of a much more sophisticated data management system at their disposal.
Every finance department knows how tedious building a budget and forecast can be. Integrating cash flow forecasts with real-time data and up-to-date budgets is a powerful tool that makes forecasting cash easier, more efficient, and shifts the focus to cash analytics.
Regardless of the budgeting approach your organization adopts, it requires big data to ensure accuracy, timely execution, and of course, monitoring.
DataRails FP&A solution is an enhanced data management tool that can help your team create and monitor cash flow against budgets faster and more accurately than ever before.
Learn more about the benefits of DataRails CPM Solution here.