Being able to foresee and plan for the future is a crucial part of business sustainability. As such, improving your budgeting and forecasting processes should be a top priority. Efficient budgeting and forecasting is about more than just establishing financial goals. It will help you allocate resources effectively, monitor your company’s performance, support decision-making, and assist with strategic financial planning.
Whether you’re not sure of where to start, or need help refining how you budget and forecast, we’ll cover everything you need to know below.
Why Budgeting is Important for Your Business
In a nutshell, budgeting is the process of planning and reviewing your business’ income and expenses over a period of time, to determine how much money your company will need to spend in order to achieve its desired results. This allows you to identify available cash flow, allocate resources, and manage your spending.
Of course, there are different kinds of budgets, to cover a range of revenue streams. These include operating expenses, capital, cash flow, specific projects, or zero-based budgeting, which helps identify unnecessary expenses. Moreover, your budgets can be flexible (and allow for adjustments) or incremental (assuming that your expenses will remain the same as a prior year).
Regardless of the type of budget, it should be a clearly defined plan to reflect your company’s financial and operational goals. That’s why most businesses create an annual budget to provide guidance on what they expect to accomplish that year.
Accurate and efficient budgeting requires detailed documentation of your company’s sources and uses of revenue, to anticipate cash flow with accuracy. By comparing your budget to the current financial results available in your financial statements, you’ll get real-time insights into how your company is performing.
This makes it clear where and when resources are needed, so you can allocate them accordingly and keep the business on track.
Creating a Realistic Budget
Creating a budget is simple with effective accounting software platforms like QuickBooks and NetSuite. It’s just a case of noting your revenue streams and expenses. However, this needs to be as detailed and thorough as possible, taking into account all types of revenue and when to expect it, as well as all fixed and variable costs.
That means reviewing the inputs from your financial statements, analyzing previous budgets and historical data, identifying your key performance indicators (KPIs), and assessing opportunities for strategic growth.
However, the key to a realistic budget is to review it regularly. You can’t just create it and then forget about it. Equally important, you need to constantly compare it to your business actuals, as reflected in your financial statements.
Beyond plugging in numbers, your budget needs to reflect what they actually mean. Regular reviews will certainly help you assess your business’ year-to-date performance, but they should also be used to check if your finances align with your long-term plans and target operating model.
This means you need to use realistic assumptions about income and expenses, and account for flexibility and prepare for worst- and best-case scenarios.
Making adjustments as necessary
As mentioned above, no budget should be static. Flexibility is key in financial planning, as your operations are dependent on a number of external circumstances, including competitors, the economy, and customer habits and preferences.
But how do you know when you need to adjust your budget? Thankfully, there are some telltale signs. They include purchasing too much on credit or frequently going into overdraft. Alternatively, you may not have enough liquidity to cover your bills, or funds available for emergencies.
Also remember that different seasons or periods of the year may require different budgets. You may need to update or amend your budget monthly to account for possible changes, including inflation.
How to Monitor Spending
Expense management is the cornerstone of effective budgeting. This includes fixed expenses (which remain the same monthly) and variable expenses, which might differ between months. Tracking your spending can help your finance team identify where your company is overspending, and cut back on unnecessary costs to boost your bottom line.
The key to monitoring your expenses is regularity. By leaving this until the end of a quarter or month, you might miss something that will prevent you from identifying accurate trends to monitor future spending.
Track your business spending by regularly reviewing your accounts, to pinpoint exactly where your money is going. Then it’s important to categorize your expenses according to where they go, to identify which areas can lead to potential cost savings.
Of course, your expense management should be compared to your budget, to see that all your outgoing funds are accounted for and factored into your planning.
Thankfully, technology can make the process much easier. Tools like Divvy and Ramp can help your team keep track of your expenses.
Strategies for reducing expenses and increasing income
The first step in improving your bottom line is to ensure that you’re budgeting to zero. That requires accounting for every source of income and subtracting every expense, to end up at zero.
This allows you to account for every dollar that moves across your business bank account, and stops you from missing any transactions.
Unfortunately, although this gives you an overview of your account activity, you may still have unexpected financial emergencies that require quick access to funds to resolve. This can include unscheduled equipment repairs, increased supply costs, surprising professional fees for lawyers or consultants, or unexpected shrinkages.
When it comes to increasing your liquidity (or the cash you have on hand to cover immediate costs), there are a few things to keep in mind. Most importantly, you need to regularly identify potential risks. By being aware of potential external and internal factors that might affect your finances, you can strategize ways to prevent these.
Handling unexpected expenses
It’s not possible to prepare for all expenses, though. Even with the best-laid plans, you may need a backup plan to increase income and cover expenses.
One way to do this is to diversify your revenue streams. That way, you won’t have to rely on a single product or service for income. Consider expanding into new markets, offering complimentary services, or creating passive income to bolster your income.
Also make sure that your business has a dedicated emergency fund, to which you contribute regularly. That way, you’ll have a buffer for any unexpected invoices. These reserves should be held separately from your normal operating funds.
You can also consider financing options. Lines of credit or loans can help you navigate emergencies and alleviate the financial burden. However, remember that this means you’ll need to be able to repay these funds, as well as the interest they accrue.
Budgeting to Forecast and Plan for Future Expenses
Financial forecasting goes hand-in-hand with your budget. By analyzing your budget, along with historical and real-time data, you can predict what your business results will look like. It’s usually done after your financial statements are released after a month-end or quarter-end close cycle.
There are four main types of forecast methods:
- Straight-line forecasts assume a constant growth rate for revenues or expenses based on your historical figures.
- The moving average method uses the average of your current and past variable values to smooth out fluctuations and predict future values.
- A simple linear regression forecast is a statistical approach to determine the relationship between an independent variable (like time) and a dependent variable (like sales).
- The multiple linear regression method features more than one independent variable (such as time in addition to price or marketing) to explain the dependent variable.
Forecasts can help you plan the perfect time to make large purchases or significant expenditures. After all, they allow you to mitigate risk and proactively plan for the future.
For assistance with best practices for budgeting and forecasting to take your business to the next level, schedule a Discovery Call with one of our CPAs.
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