What you’ll learn
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- Why predicting future business expenses is so important
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- The differences between a budget and a forecast
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- How to decide if budgeting or forecasting is right for you
Predicting revenue. Tracking expenses. Monitoring cash flow. Small businesses have to stay financially organized to survive. If used properly, budgets and forecasts can equip your business to make smart spending decisions, work toward important milestones, and adapt to new data based on performance. Here’s everything you need to know about budgeting and forecasting as a small business:
A budget is a plan that outlines baseline expectations on how you will spend money over a specific period of time to achieve certain business goals.
A forecast is a progress report based on performance data (like balance sheets and revenue statements) to see whether a company is on track to meet budget goals.
So, which is right for you? The answer depends on the specific needs and goals of your business.
What is budgeting?
In plain terms, budgeting is the process of creating a financial plan to help achieve business goals. Budgets identify available capital, predict spending patterns, and estimate revenue. Having an accurate budget helps small business owners make better decisions and allocate their resources effectively.
Why should I create a business budget?
There are many reasons why small businesses should create a budget. Budgets are an effective way to organize, plan, and track progress toward your financial business goals. Running a business without a formal budget is a bit like flying blind. You won’t have visibility on projected revenue and expenses, and you won’t be able to strike a balance between earnings and costs to grow your operations.
How do I create a budget?
Creating a budget is simple if you follow a few clear steps:
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- Calculate business revenue. If you’re just starting out, you won’t be able to use historical data to inform your projections. Instead, look to industry averages and competitor data to guide your work here.
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- Identify fixed and variable costs. Fixed costs stay the same no matter what happens. For instance, you might have a static rent budget because you know how much you’ll owe each month. Variable costs often fluctuate based on market conditions or the amount you need per month—things like fuel, printer paper, and utilities.
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- Determine key financial goals. The goals of your budget will depend on the stage of your business. New companies may choose to focus on revenue growth or extending customer LTV. Budgets for more seasoned businesses might be focused on opening in new markets or activating revenue streams by launching additional products.
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- Organize capital to work toward those goals. Once you understand the end goal, you can organize your budget to work toward that outcome. You can predict the money you expect to earn, the costs you expect to incur, and where/how/when to allocate the profit in pursuit of your vision for the business.
Most businesses revisit and update their budget annually or semi-annually. You can make minor adjustments as you track throughout the year—to help reduce spending or invest in new revenue opportunities as needed—but generally, it’s not advisable to make major changes.
If you get apprehensive about performance or want to see how accurately your business is tracking toward hitting budget milestones, forecasting is the way to go.
What is a forecast?
A forecast offers more up-to-date projections of your business’s financial future. Rather than a budget, which is essentially a planning document based on goal-setting, a forecast uses historical data to predict future performance.
Forecasting can be done using two methods: judgemental forecasting and quantitative forecasting. Judgemental forecasting relies on expert opinion to get a sense of the future. Quantitative forecasting, on the other hand, uses data to identify patterns and create future performance models.
How do I create a forecast?
Before you can create a forecast, you’ll need to gather some data. This usually includes sales records, financial statements, and other data points that will help you understand past performance of your business.
Once you have all these materials you can start to make predictions about the future and test them against reality. This means keeping track of your actual income and expenses over time and comparing it to your forecast. This will help fine-tune your predictions and make sure they are accurate.
Why should I create a business forecast?
Creating a forecast can help you understand historical performance and identify trends in your business, which in turn help you make better decisions about the future.
For example, if you notice that your sales tend to increase in the summer months, you can predict this trend going forward and plan accordingly to maximize the seasonal revenue opportunity—hire additional staff, increase inventory, etc.
Forecasts are much more agile than set budgets, allowing you to adapt your strategy as new information comes to light. Let’s say you lose a major client unexpectedly. You can use a forecast to adjust for that new reality and see how it affects revenue in the immediate future. That information will then give you a sense of the overall impact to your budgeting goals.
Budgeting vs. Forecasting
Now that you understand the basics of budgeting and forecasting, it’s time to compare them. Here are some key similarities and differences between these two financial tools:
Similarities:
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- Both budgets and forecasts can be used to track income and expenses.
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- Both budgets and forecasts can be used to make informed decisions about how to grow your business and work toward key financial goals.
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- Both budgets and forecasts can be helpful documentation to have on hand when it comes to securing financing from investors or lenders.
Differences:
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- Forecasting relies on expert opinion and historical data, while budgets are created using your best estimate of what you think your income and expenses will be.
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- Budgeting is typically done on an annual basis, while forecasting can be done on a monthly or quarterly basis to track progress toward larger goals.
Using budgeting & forecasting together
Ideally, small businesses are able to use both types of financial documentation together. You can create a budget for the year ahead and then use forecasting to adjust your budget quarterly.
Keep in mind that budgets should be created first because this will give you something to compare your forecast against. If any changes are made based on forecasting data, they should be reflected in the budget.
Budgeting and forecasting for small businesses
Trying to decide which makes more sense for your business? Consider your goals. Budgeting can be a good option if you’re trying to save money and don’t have a lot of variability in your finances. Perhaps you’re servicing a core group of customers who are locked into long-term contracts. However, forecasting is much more useful if you are trying to grow your business and need to make adjustments on financial strategies as you go.
There are also times when you’ll need to use both budgeting and forecasting. For instance, investors and lenders usually want to see both because a budget provides an overview of your expected income and expenses, while a forecast shows how these might change over time.
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