By Guy Rigby, Head of Entrepreneurs at Smith & Williamson
You will have to deal with many unexpected events during your business life, but by ensuring you do everything you can to anticipate scenarios and outcomes you’ll be better equipped for a fast and effective response as and when they arise.
The importance of budgets and forecasts
Budgets and forecasts are an essential part of the business and scenario planning process, as well as being a key risk management tool in your business. They are used both internally and externally — your bank will almost certainly take a keen interest in your calculations.
Budgets are typically fixed in advance and remain static for the duration of a selected period. They provide management with the ability to identify how and, more importantly, why actual results differ from those that were originally expected. It may be that sales have been over or underachieved, that margins have varied or that an unwelcome bad debt has arisen. There may have been unexpected currency fluctuations, or overheads may be out of line.
Whilst budgets normally remain fixed for the selected period, forecasts are updated as and when actual financial results become known. A forecast therefore acts as a rolling estimate for a given period, providing an informed view of likely outcomes based on current trading, as opposed to budgeted activity.
Many businesses prepare their monthly management accounts (an essential management tool) and compare these to both their budgets and their forecasts. Significant variations from forecast may indicate that market conditions may be changing more rapidly than anticipated, as the forecast information has been regularly updated. Significant variations against budget may indicate that original expectations may have been unrealistic and may lead management to consider longer term changes that may be required in the business.
Like a good wine, a business’s ability to prepare meaningful and accurate budgets and forecasts improves over time. Early attempts often overestimate income and underestimate costs. Budgeting in a subsequent year is generally easier than budgeting in the current year — more facts are known and the areas of variance will have been identified and can be built in more accurately.
Help with the budgeting process
Here are some tips to help you prepare your budget:
- Look at your track record of meeting budgets and consider whether your new projections are achievable. If your past performance demonstrates evidence of poor or over enthusiastic assumptions, take note of these and make suitable adjustments.
- Challenge your assumptions, or get someone else to do it for you. Talk to your management team and your external advisers — they will all have views and these can be used to clarify and tighten your expectations.
- Make sure your profit and loss, balance sheet and cash flows are fully integrated and reconciled.
- Think about sensitivity and prepare different versions of your budget based on different scenarios. Ultimately you will have to choose which final version you use, but it will be good to know that if your sales are 30% less than you anticipate, you will still have enough cash to survive.
- Ensure that you regularly review your budgets and forecasts against your actual financial results. If variances arise, analyse these and understand the likely impact on your business. Take action early to counter any threats.
Always remember that cash is king and, if you rely on your bank for finance, be aware that their view of your ability to prepare accurate budgets and forecasts will play a significant part in any lending decisions they may make.
For advice on budgeting and forecasting, contact Guy Rigby on 020 7131 8213 or email firstname.lastname@example.org
By necessity this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Article correct at time of writing.
Smith & Williamson Limited
Regulated by the Institute of Chartered Accountants in England and Wales for a range of investment business activities. A member of Nexia International.
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