How to Budget and Forecast for your Small Business

Budgeting is one of the most crucial aspects of any business. Every business owner knows that a budget is essential, however only a few understand how to get it right. In the case of small and medium sized businesses (SMEs),every aspect of budgeting becomes crucial, and that is why every step of the process is of utmost importance. Often the terms budgeting and forecasting are interchangeably used. Here is what you should know about budgeting and forecasting

What is a Business Budget?

A Budget is a document that is made annually or bi-annually, which is indicative of how funds will come in and be used in a business for a period of time. It usually has two parts, and that is (i) fund inflow and (ii) fund outflow. Funds come into the business through capital brought by shareholders, loans, or revenues and then fund outflow happens through salaries, rent, inventory, and other expenses. Thus, budgeting is the art of estimating how much money you intend to use and how do you raise these funds. Furthermore, it indicates how much you propose to earn from your business in any given year or period of time for which the budget has been prepared.

What is Financial Forecasting?

A Forecast is a prediction of what is likely to happen in your business based on historical data. Put simply, a financial forecast will show you where your business is heading. This is because a Financial Forecast relies heavily on past data, which is usually not available when starting a business. When starting a business, one can base estimates based on market research and industry benchmarks. However, as the business grows, one can gather the information that is relevant in Forecasting. Regular forecasts and updates will be helpful to develop solutions to issues faced.

Small businesses should prepare pro forma financial statements that would help the business owners track actual events against financial forecast and prepare adjustments as the year progresses.

How then do you Budget and Forecast for your Business?

Below are the key steps:

Determine the Projected Revenue

How much money do you intend to raise for your business? Where will it come from? Here are a few areas that you can raise money;

• Revenues – What is the month-on-month revenue the business expects to generate. Is there a seasonality trend? What are the various revenue streams? For example, if the company is selling certain IT equipment, is there an annual maintenance contract that could potentially become a second revenue stream. Revenue is typically a function of pricing multiplied by quantities or volume sold.
• Capital – Funds brought in by the shareholders as equity which is injected into the business.
• Loans – Debt funding from banks or financial institutions.

Determine the Projected Expenses

The outflow of funds from the business is typically expenses. Some of the expenses in small business include:

• Salaries and related expenses – This includes base salaries, accommodation, travel, and other expenses to be budgeted including leave salaries, air tickets, and end of service benefits.
• VAT expenses – Determine the taxes you will owe to authorities and include that in the budget.
• Payments to suppliers – Supplier payments are another key item. Credit terms are to be managed carefully. Determine how much you intend to pay, based on agreed payment terms.
• Overhead costs – Overheads include items such as rent, utilities, insurance, marketing, legal, accounting, and more.

Other cash outflows could include loan repayments or promoter withdrawals.

Prepare a Profit and Loss Statement

Once you get to know how much you intend to make and how much you plan to spend, you can now draw up the P & L. The main aim here is to determine the profits or losses you will make in your business.

Determine your assets

Assets are everything that your business owns. They include:

• Fixed Assets – Vehicles, buildings, property, plant, and equipment
• Cash at hand/cash in banks
• Credit that is yet to be paid by your debtors
• Inventory / Stock

Determine your liabilities

Liabilities are what your business owes others. Here are some examples:

• The money you owe suppliers and other creditors
• Both short-term and long-term loans
• End of service liabilities

How to do a financial forecast for your business

It is important to note that financial forecasting and budgeting go hand in hand. That being said, let us run through how to do a forecast for your business.

Sales Forecasting

We all understand that business goes through different seasons, and sales are affected by various elements. However, you can still use data from the last couple of seasons to make a forecast. Studies have shown that humans and businesses are predictable and we can use that to our advantage. Divide the year into four quarters and determine the sales made for each period in the previous years. This may be referred to while preparing a sales forecast. For established businesses, while may you refer to prior period data to make forecasts, also take into account the current market or economic conditions.

Cost of Goods Sold Forecast

The Cost of Goods Sold (COGS) is the cost you incur to produce or while preparing to sell your products. It usually entails things like:

• Wholesale of buying the products including raw materials, or finished goods
• Packaging costs
• Freight costs
• Logistics/transportation
• Sales commission

To determine this, you need to do a sales forecast first. The main reasoning here is, sales will have a more significant bearing on your COGS. The higher your sales, the higher the COGS.

Cash Flow Forecasting

As the name suggests, cash flow is the money that comes in and goes out in your business. The inflows are usually the receipts, and the outflows are usually the payments. You can make a cash flow statement annually or at any time you feel is necessary for your business. Cash Flow Estimates are vital to any business as they allow you to know the months when you will have excess cash, and when there will be cash shortages. Always review your cash forecasts to see if your cash payments are more than cash receipts – it means there is a fund shortage in the business. This, in turn, helps you make better business decisions.

Parting Shot

Small business owners cannot assume that an expected profit on the P & L implies that all is well. Since profit is not the same as cash, a projected cash budget has to be developed to ensure that the business is cash-flow positive. A small business owner also needs information from the balance sheet.

By now, you understand how budgeting and forecasting are essential for a business. Calculating the two may seem easy on paper, but it requires skills to do it correctly. This is where a finance professional, an outsourced accountant, or a part-time CFO can assist.