Thinking about growing your business?
Before anything else, you should consider the importance of budgets and forecasts!
A decision to start scaling a company will have implications across the entire business – for employees, for clients, for vendors and of course, for the owners.
Key commercial decisions should always be based on the maximum amount of relevant information available. This can often be the difference between success and failure.
To generate real growth, a company must understand what it needs to do, how much it is going to cost, where it is going, how it is going to get there and when it is likely to be there.
So from where does a business generate this information? Budgets and forecasts.
Is there a difference between budgets and forecasts?
A budget will generally include an estimation of income and expenses, a balance sheet outlining assets and liabilities and a cash flow budget. It is an estimate of what management believes it can achieve financially during the budgeted period.
It is common for budgets to cover a time period of a year or less.
At the end of the budgeted period or at a mid-point, a business should perform a review to confirm if the budgeted objectives are being met. If not, changes should be considered.
A financial forecast is used to identify the overall financial status of a company at a particular point in the future.
Forecasts are generated by using present and historical financial data relevant to the company to show where the company is headed. A forecast will take into account proposed strategies and major events that are likely to affect the company’s financials.
A forecast may also use the information contained in a budget to understand if the company is meeting its budgetary objectives.
Importantly, while a forecast will generally deal with higher level strategic matters and a budget deals more with day to day business objectives, both tools should be monitored and reviewed together to really understand the optimal method for achieving sustainable growth.
So how does budgeting and forecasting help with business growth?
Planning and predicting cash flows
Cash is the lifeblood of a business. Understanding where cash shortages or surpluses are likely to occur allows management to take proactive steps to manage these situations.
Cash flow budgets can help a company identify the right time to make capital expenditures, pay off existing debts or negotiate terms with creditors or debtors.
The following are examples of proactive steps a business might take if alerted to a certain matter via information generated within a budget:
a. Apply for credit lines during periods of cash deficits
b. Request for longer payment terms from suppliers during periods of cash deficits
c. Delay or move forward the purchase of assets
d. Increase or decrease payment terms of clients or suppliers
A company’s books of accounts will hold important information for preparing a budget. So make sure that any individual helping with the preparation of a budget understands which system of accounting the company is using!
Forecasts help management take early action in advance of situations that might have an effect on cash flow.
For example, say a company has budgeted to acquire P500,000 worth of inventories for the October-December period. However, the forecast model generated in September shows that the company will actually need P700,000 during this period.
With the benefit of the information obtained from the forecast, the business will have time to plan to acquire the additional P200,000 worth of inventory. The risk of lost sales opportunities and client dissatisfaction decreases as a result.
For more information on the importance of managing inventories, check out our recent blog article here.
Identify risk areas early
Financial risks are an unavoidable reality of running a business.
The good news is that budgeting and forecasting can help a business mitigate against some of these risks.
Budgeting is just one tool to help understand the financial practicality of a proposed strategy. By plotting forward-looking financial estimates, a company can understand where its financial weaknesses are and where the main risks are likely to arise.
For example, if a company is planning to implement a new strategy that provides all sales agents with a P10,000 monthly allowance. Management will only understand if the business can handle this expense after budgeting for all other income and expenses during the same period.
After having developed a budget to account for the proposed new strategy, management might realise that it can only offer a P2,000 allowance. Otherwise, they will incur significant losses. The information obtained from the budget has helped mitigate the risk of a significant and ongoing cash deficit.
Remember, the type of risks will differ depending on the industry or business model of a company. For example, many of the risks associated with e-commerce companies will be quite different to companies in the restaurant industry.
Based on present and historical financial data, a forecast can identify which risks will arise and when they will arise.
For example, suppose the business decides to change its payment terms for customers and offer a 45-day payment term. Management can input this proposed change into a financial forecast to understand if the business will have enough working capital to cover expenses in the future months.
One conclusion might be that, in fact, customer payment terms need to be shortened to ensure that the company has enough cash to execute an upcoming strategic campaign.
To monitor progress
Budgets and forecasts are commonly used as tools for monitoring a company’s progress.
Budgets are used to monitor and measure any differences between a company’s actual financial performance (income, expenses, etc) and the budgeted or estimated financial performance as at the start of the budget period.
Simply, a budget created at the beginning of a period can be reviewed during or at the end of the period to understand if the business is meeting its day to day objectives.
So how does budgeting help with business growth?
It helps management identify which expenses must be monitored more closely or which revenue sources need to be boosted. Management can also identify steps to get a company back in line with its budget.
Budgets are generated based on expectations derived from information available at the start of the budgeted period.
Financial forecasts, on the other hand, will take new information into account. Forecasts are updated to give the business an understanding of what is happening from a financial perspective at a given point in time.
For example, if the company executes an online marketing campaign which yields positive results much more quickly than anticipated, the financial forecast could be adjusted to recognize greater revenues over a shorter period of time.
Budgets and financial forecasts are important tools that help potential investors to understand the present and expected financial status of a business.
A detailed budget would show potential investors how their investment might be used and how it could affect daily business activities in the short term.
A budget might identify and establish the reasons why a company might need an investment and provide investors with a rationale for investing. For example, a business might require a cash injection to get the company through a difficult period.
The budget might show the positive effect that an investment would have and how the business will be able to generate more cash once the difficult period ends.
Advanced forecast measures, called “forward-looking multiples”, are based on forecasted figures.
Investors prefer forward-looking data because they will want to know what will happen to their investment. This is particularly the case where a business is seeking funds from investors with the objective of achieving sustained business growth.
Financial forecasts can show investors where the business will be in 1, 2, 5 or maybe 7 years. The financial forecast will take into account the investment, the strategies to be adopted with the help of the investment or the plans for expansion or capital expenditure.
Investors will want to see what the owners expect the company to look like financially at various stages of the projected growth.
If you have a tech start-up in the Philippines and are considering scaling, check out our recent article which provides 5 expert finance tips to prepare your tech startup for growth in the Philippines.
Let CloudCfo help with your budgets and forecasts
CloudCfo are experts at assisting and guiding clients through periods of growth. We are much more than traditional accountants or bookkeepers.
We are process driven and customer focused. We use cloud accounting to provide the most efficient, transparent and collaborative processes and services for our clients.
When clients are looking to grow their company, we want to grow with them. That’s why we don’t stop at making sure the accounting books are balanced.
We help generate value-added financial budgets and forecasts for our clients. We advise on commercial practices. We also advise on financial models for more complex transactions such as financing, fundraising and business restructuring.
Our team of experienced professionals provide a range of outsourced accounting, bookkeeping and finance services in the Philippines. Visit us at cloudcfo.ph or contact us at firstname.lastname@example.org for your free initial consultation.