Budget forecasting is a crucial aspect of business success.
If you’re not familiar with the term, you might confuse it with either a budget or a forecast. Although both are paramount for your company’s financial health, they aren’t the same.
The budget is typically a static plan for the year, based on a combination of historical assumptions and updated expectations. By summarizing the organization’s goals for the coming year, it acts as a roadmap to assist company management with decision-making.
On the other hand, a budget forecast is a more dynamic attempt to predict your future budget.
It’s updated more regularly and is an attempt to predict the outcome of a period under the assumption that the budget is followed exactly. It also serves as a projection of your figures and can be used as a basis for variance analysis.
But how can budget forecasting be used to improve performance?
Let’s dig in.
Budget forecasting is one element of creating a complete fiscal picture for your company.
It’s more than just a projection based on historical data; it contains the entirety of your plan for the coming year.
For example, say you plan to double advertising in the next year. Historical data alone won’t provide accurate information. You’ll need to add your plans as well.
Based on your assumptions and by using your drivers – e.g., advertising expenses – you’ll expect increases in sales based on your sales and marketing metrics. Advertising dollars will lead to additional sales, which you can estimate based on your expected conversion rates and customer churn percentage.
These additional sales will, in turn, increase your operational resource needs. Production, sales, and customer service teams may require more headcount. For a physical products business, material expenses will also increase. And depending on the level of sales increase, you may also need to extend the company’s overhead structure.
This budget forecast also provides a better data point for variance analysis. You’re not just hitting or missing a dollar amount. If you didn’t double your ad spend, you’ll see it and ask your revenue team, “Why not?”
Budget forecasts also lead to better, more detailed metrics. Defining these metrics adds a mechanism for measuring company performance in many areas.
For example, your projected budget for your sales representative compensation (assuming you offer commission) will require using hiring metrics, sales quotas, and customer relationship metrics.
Higher sales expectations mean higher production or delivery costs, and it can also affect margin expectations. Perhaps you expect volume discounts from suppliers or better efficiency through throughput, assuming that higher sales won’t exceed existing capacity.
There are three basic steps to setting up your budget forecast.
Budgets are often created on an annual basis, with little thought given to phasing. Dividing by 12 is the simplest way to split your budget into periods.
However, reality rarely happens in a straight line. KPIs are cyclical, and you’ll see natural ups and downs throughout the year, as well as phasing due to seasonality.
A business that’s been around for a few years should have good data from past years. Use this as a starting point for your budget forecast phasing.
Keep in mind that your full-year total should remain the same.
KPIs are an effective way to steer your business. Implementing KPIs that reflect your business success allows the management team to see if performance measures up quickly. If it doesn’t, you’ll have gaps and should easily pinpoint the problem areas.
Your KPIs should ensure that operations and results match your budget forecast throughout the year.
The budget forecast serves as your financial roadmap for the coming year. But when the results don’t pan out as planned, you need to act.
Variance analysis on your KPIs will highlight where you have gaps and risks. These are where the management team needs to focus attention.
Management by KPIs allows your teams to address problems before the situation gets out of hand.
Budget forecasting is an integral part of maintaining a complete financial picture for your company. A solid budget forecast gives your startup’s management team a roadmap for success for the year and provides a basis for steering your company.
Because the roadmap can be translated into KPIs, your team can readily identify and address underperforming areas. There’s no need to wait until the end of the year to fix situations that are slipping.
Are you ready to implement a budget forecast and get your company set up for success?
Founder’s CPA’s team of startup experts is prepared to help. Set up a free consultation with our experts to plan your startup’s roadmap to financial success.