'It all adds up:
Business finance explained' podcast

Garry Mumford (00:07)

Well, hello and welcome back to the Insight Associates podcast. This is our second edition. My name is Garry Mumford. I’m the Managing Director at Insight Associates and I’m again joined this week by Simon Hammond, our Client Services Director.

Simon Hammond (00:13)

Hi, Garry.

Garry Mumford (00:14)

And also Mike Johnstone of TOMD, a business that we’ve worked very closely with over some years,  and Mike’s going to quiz us all again today from the aspect of what you should know as a business owner. So hello, Mike.

Mike Johnstone (00:28)

Hi Garry, thank you very much and hi again Simon.

Simon Hammond (00:31)

Hi Mike.

Mike Johnstone (00:32)

So yeah, today we’re talking about budgeting and forecasting, but you really need to explain to us what the difference is.

Simon Hammond (00:40)

No problem. Budgeting is a business’s plan for the year ahead, for the financial year ahead. It’s about setting out how you’d like the business to perform over the coming year. So that really is about setting a plan in place before the start of the year. A forecast is more about adapting your plans and your outlook for the remainder of the year based on what you’re actually seeing taking place in the business. So for example, if you’re budgeting sales in a month of £500,000, for example, and in reality, you’re looking at nearer £600,000, you’re re-forecasting based on the updated information. So that will give you a clearer picture of how your year will turn out based on what’s actually happening in the business.

Mike Johnstone (01:30)

I think as a business it’s really quite hard to be doing that, to be doing the budgeting and the forecasting. And the temptation is that you do it and then kind of leave it and don’t revisit it. But I think from what you’ve just said, that probably isn’t the right answer.

Simon Hammond (01:46)

No, there’s real value to a business in budgeting and forecasting, but the value is then comparing your actual results, your actual trading performance versus that budget. So you’re giving yourself goals to perform against. You can then look into any variances around why you’re performing not as well or in some areas better than expected when you were setting the budget for the year.

Mike Johnstone (02:10)

So obviously you’re an outsourced business, you obviously have to be working really closely then with not only the business owner but presumably the directors, the head of sales, head of marketing, whoever it might be. Presumably that’s to understand why things didn’t go to plan and what that might mean for the future because it might just be that a big contract slipped a month or something I suppose.

Simon Hammond (02:29)

Exactly right. What we do is we report against budget and re-forecast monthly, if appropriate, in terms of reporting actual trading results for the month and the year to date for our clients. And then, as you say, we work with senior people within the client’s business who are responsible for whatever area of responsibility that we want to look into. But it’s about communicating with the client and identifying where things have slipped, what they’ve done differently to what they originally expected. So it’s helping a business to understand what the effects of changes they’re making will have in the financial outlook for the business.

Mike Johnstone (03:11)

And that’s quite interesting because I suppose where you’re working so closely with them, that really is a true outsourcing function, isn’t it, where you’re working in partnership as part of the team because you’ve got to understand everything about the business to be able to give accurate forecasting and budgets.

Simon Hammond (03:28)

Yeah, I say it all the time. We work best with our clients when we are adding value and adding value means that we have to really understand our client businesses as well as the business owners and managers are themselves. The forecasting and the budgeting process can be seen as a bit of a drag. It’s about reframing that and turning it into a valuable tool for the business and something they can use to help make sensible decisions around investment or cost cutting, whatever it may be.

Garry, did you want to add anything there?

Garry Mumford (04:00)

Yeah, I had a thought. I remember when you talk about that, Simon, I remember someone told me years ago or suggested to me years ago that you should look at it as like the sat nav of your business. When you get in your car, you set the sat nav to your direction. It’s giving you a plan for how you’re going to get there. And again, if you hit traffic or something, the sat nav will redirect you to still get you to your destination. So the process is very much like that. You don’t set out on a journey without understanding where you’re going. So I think that’s another valuable way of looking at it really.

Mike Johnstone (04:11)

And just extending that analogy then, so obviously on a journey, as you say, it is resetting. So you’re saying really that if you’re projecting 12 months forward, it’s an ongoing process. It’s not something you do in January and think about again the next January. In February, you’re looking for the next 12 months and March the next 12 months. So it’s not based on calendar, it’s based on a rolling 12 months. Is that right?

Simon Hammond (04:53)

Yes, I think that’s where the most value will be given to a business. In reality, most businesses tend to budget on an annual cycle and then re-forecast throughout the year. But that re-forecast may become a rather than a 12-month budget, it might be a three months actual plus nine forecast and then a six plus six. So, it’s about refining during the course of the year and trying to pinpoint where you’re going to end up. And as I say, from that information you’ve got fair headwind in terms of being able to make decisions based on what the end picture is going to look like.

Mike Johnstone (05:25)

And do different businesses in different sectors need to forecast on a different period? Do some need to look five years ahead just because they’re buying a lot of plant or whatever it might be. Is it different in different sectors?

Simon Hammond (05:37)

Absolutely. We’ve got businesses in a fast-moving sector. It’s not unreasonable to reforecast certain elements on a daily basis even. Quite a few clients of ours revisit their sales forecast daily and rework how their sales team are going to be planning and attacking their customers if you like to achieve what they want to achieve there.

Mike Johnstone (06:00)

Gosh, interesting. And what should a comprehensive budget include? What would you include in that?

Simon Hammond (06:08)

Ideally, it will be a profit and loss account, which everyone, or I like to think most businesses see as a budget. But really, in addition to that, you need a good cashflow budget and ideally balance sheet budget as well. So, you’re budgeting the entire financial position of a business, not just the profit and loss accounts. So, for example, a profit and loss budget may not take into account a huge amount of debt that you’re adding to the business and will need servicing over a long term.

So, it’s about seeing the whole picture rather than just an element of it. In terms of a profit and loss budget and forecast, you really want to be doing that at the level that makes sense for the business. So, if your business is monitored on a departmental basis, for example, it makes sense to build up your budget on a departmental basis as well. So, you’ll get all those different elements creating the whole.

Mike Johnstone (06:58)

And what would you say are the most common mistakes that people make when they’re budgeting?

Simon Hammond (07:04)

Probably, as you’ve already alluded to, doing it once and then putting it away and never thinking about it again. Some businesses see budgeting as a tick box exercise, “we know we should do that, but now it’s done. We don’t have to worry about it anymore.” So not reporting against the budget means that they’re not getting the value out of it. They’re not identifying their variances versus where they thought they would be. And that means they’re really hampered in terms of decision making because they don’t have all the information available to them.

Mike Johnstone (07:36)

Interesting. Garry, any thoughts?

Garry Mumford (07:39)

Yeah I was thinking about that as well. I think one of the things that we’ve found really adds a lot of value to monthly reporting and the monthly management information pack for businesses is comparatives. So, you’re looking not just at what you’ve done in the month but you’re looking at it compared to what your budget was, maybe what any re-forecast is and maybe what prior years were as well. It brings context to your actual numbers for the month. Otherwise, I think the focus tends to be, haven’t we done well or have we not done so well? And not actually understanding the journey that got you to that point or where you expected to be compared to that. So, I think that it helps with that in picking up Simon’s point. The budget needs to be a living and breathing document throughout the year because after all, that’s what you’re trying to achieve.

Simon Hammond (08:23)

I was going to give you a second part of an answer of the answer to your question there. I think another really valuable part of budgeting, which is under looked quite often is empowerment to senior leadership within a business. It’s about giving sales department heads, marketing heads, whoever it may be, the responsibility and the ownership for managing their own cost base and their financial picture. Quite often that’s not done effectively within a business because the information is if you like hoarded by the managing director or whoever it may be. So, it’s about sharing that information and empowering the senior leaders to all pull in the same direction for the business.

Mike Johnstone (09:05)

Yeah, and I think that makes sense. Is it solely an internal document? I know in the previous podcast, we were talking about, you know, working with lenders and HMRC and so on. Is it anything that you sometimes have to share externally?

Simon Hammond (09:17)

Yes, it is. I think for any lending opportunity, lenders always want to see financial forecast for at least 12 months, quite often longer, because they want to be able to see that there’s, well firstly, that the business is financially viable, but also that they’re able to service any debt that the lender might be putting in place. They need to be able to have confidence that in order to lend, the business can afford that lending.

Mike Johnstone (09:45)

We talked earlier about different businesses in different sectors, if they might have to plan five years or one day ahead. What about, does it vary for businesses in different situations, maybe one that’s growing quickly, one that’s got some financial issues? How different is the planning process for them, the budgeting process?

Simon Hammond (10:04)

The process is generally the same, but it’s about how often that’s revisited. If you’ve got a business in a fast-moving industry with lots of moving parts, scenario planning is essential. You need to be able to model different scenarios. What’s the effect of a price rise of this on our customer base? What’s the effect of this supplier raising its prices by 20%? That sort of thing.

So, it’s not just at all for monitoring your financial performance, but it’s also about helping plan and develop contingency plans for things that might be unexpected.

Mike Johnstone (10:45)

And we’re obviously living in a volatile world. Not that long ago, we had a pandemic. Presumably those sorts of events for some businesses mean that budgeting is really, really important.

Simon Hammond (10:59)

Yes, it is. I think the effects of some of the, I’m going to say global shocks without being too over dramatic, in some industries that really wiped out a lot of businesses. Being able to, although admittedly you might not be forecasting the effects of a global pandemic in your financial forecasts, you do need to be able to build in some robustness in terms of shocks of some sort that might affect your industry.

Mike Johnstone (11:27)

Just to bring you in on that Garry, is there anything you’d like to add?

Garry Mumford (11:31)

Yeah, so I just had another thought on that really I mean I think in producing the budget for business that is determining what your plan looks like for the coming year. It’s a useful time also to revisit the vulnerabilities in the business and to critically analyse what things are potentially the ones that would have the most effect on that business, be that the supply chain into the business. So, loss of a key supplier or some supply chain issue. Or maybe the impact of customers or even changing trends within the industry and those sort of things. So, I think the budgeting exercise should be seen as a good opportunity to consider the broader picture, not just internally for the business.

Mike Johnstone (12:14)

I just want to change the subject very slightly. I’ve heard accountants talk amongst themselves about variance analysis. What does that mean?

Simon Hammond (12:23)

So, variance very simply is the difference between what you are budgeting or forecasting to happen and what has actually happened. So, on a sales line, for example, you might have been budgeting for £50,000 and your actuals are £25,000 and you’ve got a variance of £25,000 there, positive variance. So, variance analysis is about identifying material in key variances throughout your profit and loss statement and investigating why that change has happened. Not all variances are created equal, so there’s some that are very minor, both in terms of value or in terms of the impact within the business, and largely they can be ignored. But variance analysis focuses on the key variances, the larger ones or the most important elements of a business’s trading and then lets you investigate where that variance has come from.

Mike Johnstone (13:20)

Right, okay. That explains it, thank you. That was very simply put. So how does good budgeting and forecasting help decision making for senior people? From what you’ve said it actually needs to go beyond just the senior people and potentially throughout the business, but how does it help people make decisions?

Simon Hammond (13:39)

Well, if for example, you’re expecting or you want to see the effect of purchasing a new bit of equipment for £25,000 next year, a good budget will build that into the budget and you’ll see how long it takes to see a return on the investment that you’re making there, or it will build in the additional costs for lending that’s required to purchase that equipment. So, it’s about giving you options or rather it’s about you being able to see what the effects of different options on the financial picture of the business. And from there, you can make informed decisions.

Mike Johnstone (14:22)

I think from what you’ve said, it sounds as though you’re working very closely with your clients. So, when it comes to something like maintaining an effective budget and forecast, is it something that you do with them at the beginning and then they kind of get on with it during the course of the year? Or is it something, as I know you said with cashflow forecasting that you’re constantly monitoring and talking to them about?

Simon Hammond (14:48)

Well, we’re monitoring it monthly as part of our monthly reporting deliverables. In terms of actually undertaking a re-forecast during the year, we do it on a case-by-case basis, depending on the industry or whether, for example, the actual performance of a business has significantly slipped away from the original budget or something sizable has happened in terms of trading or the industry. So, there’s usually a key trigger point that causes us to address that with the clients and suggest maybe we need to take a look at our forecast again and see where we’re going to end up based on new information.

Mike Johnstone (15:28)

And presumably, I know you kind of use the word partnership when you’re working with clients, that partnership can look different in different cases then depending on their requirements. Also, I suppose, depending on their stage of growth and so on and what their plans are.

Simon Hammond (15:43)

Yes, we operate quite a turnkey model with our clients. So, we’ve got some situations where client personnel will be responsible for say the sales department and booking sales invoices into the accounting system, whereas others we may be handling that on behalf of the clients as well. So, it’s about a clear dialogue and making sure that all of the information is shared, whether that’s from the client themselves or whether we’re able to build that picture ourselves from what we know with what we’re doing. But it’s about, as I say, it’s about clear dialogue and making sure that all the information is available.

Mike Johnstone (16:19)

Simon, that’s been really interesting once again. And again, I’ve learnt a lot. Garry, just anything you want to add at this point.

Garry Mumford (16:29)

I think, it’s been really useful again to highlight some of these areas, and you were right at the beginning Mike, to highlight the fact that business owners often see this as a chore and something they don’t need to do, and I think we’ve seen over the years from many situations that the businesses that are well managed by going through this process often get a huge amount of benefit out of it. I’m reminded of a famous quote by Dwight D Eisenhower which is “that the plan is nothing but planning is everything” and it is often the process of planning that brings out the value, not the actual end result of the plan. Because actually I joked with a client just last week, I said in all my career I can guarantee you every budget I produce has been wrong, and it is the reality of the situation any plan is clearly in any forecast is almost wrong the day you finish it. But it is a process of getting there which actually adds the most value because you’re thinking about your business, you’re thinking about what you want to do, why you want to do it, how you’ll do it and then understanding the financial implications of that as well. So I think that’s really the important part of this, and it was an interesting question for you and Mike at the beginning as to why bother almost, because really I think there’s a huge amount of value in it and that’s something that we’re really keen to help our clients understand and lead them down that path.

Mike Johnstone (17:50)

And just actually on that, Garry, would you say then that especially for new clients, the depth of your involvement in something like you know budgets and forecasting is something they find surprising because it’s not what most people would think a traditional accountancy firm would do?

Garry Mumford (18:09)

I think the word traditional ended with us Mike didn’t it? As a firm we’re not focused on all the compliance stuff, obviously we get that done. As Simon mentioned before, our real raison d’être if you like is to add value into our client relationships. We want to feel that we’re giving more back than being taken out, and the budgeting and forecasting process is a really key part of that to get them thinking. And it’s often quite easy for us to help that process because we’re not emotionally involved in the business in the same way as the leaders of that business are. So, we can ask the difficult questions, we can challenge them in a way that maybe they would never challenge themselves. It’s quite interesting.

Mike Johnstone (18:53)

Absolutely.

Simon Hammond (18:54)

And linked to that, Garry, we’re also able to ask the questions that as a fresh pair of eyes that they might not think of themselves.

Garry Mumford (19:04)

That’s right, they never thought of that, it’s a different angle. And we see that quite often, so it’s really quite valuable. So hopefully that’s been another useful few minutes and everybody’s got some value out of that. Just to wrap up, I remind you again, if you want to learn any more about the work of Insight Associates, maybe a good starting point is to sign up to our blog, which you can get to at insightblog.co.uk. And we look forward to talking to you again very soon. Thanks for listening.