Balancing the Budget
Budgeting and Forecasting is a vital key to business success as the budget is part of the goal-setting process for any thriving company. The forecast helps the business owner understand if he or she is on track to achieve both short and longer-term goals during a set time period.
Many businesses have fallen into the trap of “…I have money in the bank so I must be doing well.” Running a modern business is not easy. There are too many moving pieces and it can be hard to see the forest through the trees when you are in the moment. Are you a project-focused business that has just billed multiple clients so it looks great on paper? How does your pipeline for the next month look? How does it look three months from now, or twelve months out? If you are a seasonal business in the busy season, what is the cash flow going to look like in your slow period? How much excess cash do you need to save now to weather the “cash burn” months?
What is a budget and why should I have one? A budget is a plan for your financial future. At its core, it should clearly illustrate your current financial picture, but another vital aspect of the budget process is to set economic goals for your business. If done correctly, the budgeting process will be a useful tool that will enable you to reach and maintain your overall financial aspirations for your company.
What are the steps to take in creating a financial plan that encompasses both a month-to-month budget and the setting of overall economic goals? There are several different ways you can create a budget, and over time the business owner should use all of these different methods of budgeting, as you will get new perspectives on your business from the different approaches that are used.
Zero-based budgeting (ZBB):
This is a method of budgeting where all expenses must be justified for each new period (usually a year). In other words, the year starts from a zero base and every function, every expense must be analyzed and justified from the ground up. Budgets are then built around the analysis and the items that were justified. This method does allow for budgets to be smaller year over year, assuming you can eliminate the expenses that have not been justified for this new year.
An incremental budget is one that is prepared using a previous period’s budget or actual performance as a basis with incremental amounts added for the new budget period. For example, revenue will grow 10% and expenses will grow 7%, so the budget includes both the current year revenue plus 10%, and the current year expenses plus 7%. This method assumes all of last year’s costs will be incurred again. This is a very common approach used by the federal government, or huge organizations that have very unwieldy and diverse operations.
Top Down Budgeting:
This method is often used by large corporations, where corporate HQ dictates the budgets down to the operation units. This method gives “front-line” leaders, managers, and employees very little input into the budget process.
Bottom Up Budget:
Opposite of Top Down, this system gives front-line leaders, managers, and employees a voice in the budget process. In many ways, this approach is like a brainstorming session, where the local inputs are recognized and considered in the process.
In most cases, large organizations run a combination of these methods in order to agree on the final budget.
Goal setting is important part of life, one that corporate America has adopted with vigorous enthusiasm. How many corporate workers have had annual, bi-annual, quarterly, or even monthly performance appraisals? These sessions, while not all focused on goal setting, are an important part of it. The reason this approach is gaining so much traction is that it has had a positive impact on the overall organizational performance. It can help to ensure companies establish some consistency in goal-setting across the business.
“But wait, I am not part of corporate America, I left so I could get away from a system that forced me into a box.“ Yes, you are right, but there is no reason why you cannot use good ideas and apply them to your business. Budgeting is most important, as it makes you set a goal, and figure out the road map to reach that goal. The budget process forces you to answer the “what if” questions, what if we invested here, how would the P&L look at the end of the year?
What about forecasting, how does that fit into the puzzle? The forecast is the tool used to track your in-period performance against the budget and predicts where you will end the year compared to the budget. The forecast helps you see the way forward needed to achieve your goals. It helps you see the answers to the following questions:
Are you falling behind the budget?
Are you beating the budget?
Do you need to hire more staff to meet the higher service required for your higher revenue expectations?
“My company has 15 customers, but the budget says we should have 20. Our prospect list currently sits at 25, with a probability of winning their business of 50% or better, therefore we have a relatively high degree of certainty we should achieve our goal of 20 customers by the end of the year. If we are correct in our prediction, we should end the year closer to 32 customers than 25 (50% of 25, or likely 12 additional accounts).”
Forecasting is essential to any business; it allows business owners see in detail how their company operates, and how each move contributes to the business performance.
Creating a budget and a forecast is a key function of the Chief Financial Officer (CFO). Many small businesses do not have the scale to warrant a full-time CFO. CFO Shield is dedicated to helping small businesses leverage the CFO expertise on a part-time basis.
To find out more, visit CFOShield.com.