For many business owners, budgeting and forecasting can feel like a task to tick off the list at the start of the financial year. The figures are prepared, the budget is agreed and then attention moves on to the day-to-day running of the business.
But budgeting and forecasting can be much more valuable than that. Used properly, they can help business owners understand where their business is heading, identify potential problems earlier and make more informed decisions about investment, costs and growth.
Budgeting and forecasting: what’s the difference?
Although the terms are often used together, budgeting and forecasting serve different purposes and it’s important to be able to differentiate.
- A budget sets out how you would like the business to perform over the coming financial year. It provides a plan against which actual performance can be measured.
- A forecast, on the other hand, uses the information you have available today to reassess where the business is likely to end up.
For example, if your original budget anticipated £500,000 of sales in a particular month but you are now expecting sales to be closer to £600,000, your forecast should reflect that latest information. The important point is that neither should be treated as a fixed document. Your circumstances change and your business’s financial plans should change with them.
Your budget shouldn’t sit in a drawer
One of the most common mistakes businesses make is preparing a budget and then not looking at it again.
If you don’t compare your actual performance against your budget, you’re missing an opportunity to understand what is really happening in your business.
Regularly reviewing actual results against your budget and forecast allows you to identify variances and, importantly, understand why they have occurred.
Perhaps sales are lower than expected because a large contract has been delayed. Perhaps costs have increased because a supplier has raised its prices. Or maybe one part of the business is performing considerably better than anticipated. The figures themselves are useful, but understanding the reasons behind them is where the real value lies.
Think of your forecast as your business’s sat nav
When you start a journey, you need to know where you’re going and have a route to get there. But if you encounter traffic or a road closure, you don’t simply continue following the original route regardless. You reassess and find a better way forward.
Your financial plans should work in much the same way. Your budget gives you a destination and a plan. Your forecast helps you adjust your route when circumstances change.
That’s why forecasting should be an ongoing process rather than something you only think about once a year.
Look beyond profit and loss
A comprehensive budget shouldn’t just focus on the profit and loss account. It’s also important to consider cashflow and the balance sheet, so that you’re looking at the overall financial position of the business.
For example, a business might look profitable on paper but also be taking on a significant amount of debt. Understanding how that debt will need to be serviced over the longer term is an important part of understanding the true financial picture. The aim is to see the whole picture rather than focusing on one element of the business in isolation.
Use your numbers to make better decisions
One of the biggest benefits of effective budgeting and forecasting is that it can help business owners make decisions with greater confidence. If you’re thinking about investing in new equipment, your budget can help you understand the likely financial impact and how long it might take to see a return on that investment.
If you’re considering taking on additional borrowing, forecasting can help you understand the effect of the additional repayments on the business. And if you’re facing rising supplier costs, scenario planning can help you consider what different changes could mean for your margins and overall financial position. In fast-moving businesses, scenario planning can be particularly valuable. Modelling different outcomes can help you prepare for the unexpected rather than simply reacting when it happens.
Don’t keep the information at the top
Budgeting and forecasting shouldn’t necessarily be the sole responsibility of the business owner or managing director. Sharing relevant financial information with senior leaders across the business can help give people ownership of their own budgets, costs and financial performance.
For example, sales and marketing leaders can better understand how their decisions affect the wider financial picture, helping everyone to work towards the same objectives. This can turn budgeting from a finance exercise into a management tool that supports better decision-making across the business.
Your budget can also help identify vulnerabilities
Preparing a budget is a good opportunity to step back and think about what could potentially have a significant impact on your business. What happens if you lose a key supplier? What if your customers change their buying behaviour? What if costs increase significantly? What if trends within your industry change?
You can’t predict every eventuality, but considering different scenarios can help you understand where the vulnerabilities in your business might lie and what you could do if circumstances change.
The value is in the planning
Perhaps the biggest misconception about budgeting and forecasting is that the final numbers need to be perfect. They won’t be; every budget is likely to be wrong to some degree because circumstances inevitably change.
The real value is in the process of creating it, thinking about what you want your business to achieve, why you want to achieve it, how you’re going to get there and what the financial implications will be. In other words, budgeting and forecasting aren’t simply about predicting the future. They’re about helping you understand your business today and make better decisions about what happens next.
Want to hear more?
Budgeting and forecasting are just two of the many areas where having the right financial information can help business owners make better decisions.
In the latest episode of our new podcast series, Garry Mumford and Simon Hammond explore the subject in more detail, including the difference between a budget and a forecast, common mistakes businesses make, variance analysis, scenario planning and how financial forecasting can support decision-making.
Listen to the podcast to hear the full conversation, via our website or on Spotify.
