Business budget forecasting is a management process where plans are made for the future keeping the past in mind. Forecasting is used as a way to make judgments on how well the firm might perform in the upcoming period (which could be a month, quarter or year). This is an ongoing process wherein the numbers need to be reviewed and updated as and when changes occur. This is done for sales, expenses as well as cash flows.
Tips for Effective Budget Forecasting for Businesses
However, many businesses fail to give enough importance to forecasting or do not do it properly. Everyday distractions push financial planning lower down the business priority list. This can result in lower earnings for the firm.
Some questions that forecasting answers are: What would be the business expenditure next year? What about sales? When would money come in from customers? Forecasting business sales, expenses and cash flows is never simple, and changing industry trends can make things difficult to predict. However, there are some simple rules businesses could follow to make a good budget forecast.
It would be really easy to put off budget forecasting as it might seem like a daunting task. However, it is critical to know what would be coming in and what would be going out. Lack of a cash flow forecast is a recipe for certain disaster. For example, without cash forecasting, a business might not know when it would have the money to pay its creditors. With the forecast, it would easy for the business to inform its creditors when they can expect their money.
Forecasting is not only for cash flows but also for expenses. Without forecasting expenses, it is no use forecasting sales or cash flows. For instance, a business might have a good cash balance and think that they are in a good position. But if they include the fact that VAT has to be paid quarterly, suddenly the cash balance might seem insufficient. All these expenses also need to be forecasted.
Budget forecasting should not be an annual exercise. The further ahead that a business forecasts, the less meaningful it is. In the real world, changing economic and industry conditions create the need for constant review and updating of the forecast. Sometimes it might be necessary to review the forecast every month. The budget forecasting needs to be flexible, and accurate financial reports and ratios should be available for assessment and analysis at all times. .
A business should perform ‘Know Your Customer’ before creating any budget forecast. The secret to good cash forecast is knowing the business as well as knowing the customers’ payment habits. For instance, if a business has the habit of giving grace period for customers, it needs to include it in the forecast. Only then the business will be able to predict with greater accuracy when it will have the money in hand. Having the right information, regarding the payment terms, discounts, payment period and other customer-related factors, can help to improve the accuracy of the budget forecast.
Forecasting should not be based on the business performance and forecasted performance alone, but also based on the market around the business. The business needs to know its customer base and competition, inside out. Changes in competitors’ activities might compel the business to make changes in its plans. For instance, if the competitor is suddenly announcing big discounts, the business might have to rethink its budget forecast so that it does not lose customers.
Poor credit control can drastically impact budget forecasts. If a supplier executes poor credit controls, then they will not take the initiative to chase the business, threaten it with legal letters or charge interest for late payment. You get money only when you demand it. So businesses must make sure they shout the loudest when it comes to money owed to them.
It is crucial that a business keeps track of the various interest rates they pay, and forecast accordingly. Businesses will typically have overdrafts and, loans. Some businesses enter into hire purchase agreements for equipment. Most businesses take on these liabilities without comparing interest rates. Also, these interest rates might change as time goes by. It is important to include these in the forecast. If this is not done, any increase in interest rates might lead to higher cash flows.
Businesses usually forecast only for the worst. They hardly plan for the best. Opportunities might disappear if one does not plan for the best. For instance, suppose a discount offered works so well that the number of customers you expected would purchase your product doubles, then you might need more stock to meet the demand. The production needs to match up. For increased sales, this needs to be included in the budget forecast.
Planning product discounts goes hand in hand with planning sales and inventories. Discounts might lead to requiring more inventories. Also, if the sales and inventories are forecasted on a quarterly basis, then discounts also need to be forecasted on a quarterly basis.
There are specific types of business forecasting software available, such as Sage. But most small businesses tend to stick with programs they know, such as Excel. From utilizing a simple projection of the bank balance, to employing a variety of short-term tools, including an annual budget, individual sales targets and monthly re-forecasts of revenue and cash flow, enterprises utilize a combination of tools to achieve accuracy in their budget forecasting activity.
A budget is not a forecast that can be put together over a weekend. It comes out of coordinated efforts of a team. Budget forecasting therefore requires some time and thought. Initially the forecast might not be so accurate but as time goes by, forecasting can get better with practice. External support of an expert Finance and Accounting outsourcing services provider can be sought to supplement the efforts of the internal team.
Budgeting is all about giving your company a direction to follow in different scenarios, and at the level of detail where it matters. If a business tries to forecast every little expense, the forecast can go haywire. Also, it is best to be realistic. High optimism might induce companies to project higher sales and end up with insufficient cash.
Every business has only a finite amount of resources available for use. If it must spend money for something it did not budget, then it has to decide which budgeted items can be compromised for the new expense. Without this tradeoff, it will almost always overspend. Also, businesses should buy just the things that are absolutely necessary.
It is important to check the reliability of the final numbers. Businesses should check if the assumptions are in line with historical and industry trends.
Once a business is done with forecasting, it must perform results analysis before the beginning of another budget exercise. Key questions in this analysis should include: How is the business doing in comparison to the budget? Did the results differ from the plan? What can be done to bring the results closer to the budget? What are the learnings from the budget to be used in the next one? As time goes by, businesses would become better at forecasting, leading to an increase in sales, earnings and cash flow.