Why Budgeting and Forecasting Are Vital for Your Business

Recently, a client in the financial services industry decided to open up several new locations over a 12-month span. I asked if they had a budget in place and a definitive timeline for opening up each location. Nothing concrete, they told me.

This isn't unusual. Many companies make up their budgets and forecasts as they go along. But this is like setting out on a long drive with no map, no GPS, no credit cards and no idea how much gas you have in the tank. Where you'll wind up is anyone's guess.

Plan Ahead by Looking Back
The next company that correctly forecasts its annual budget right down to the penny will be the first. Still, just because you don't know your exact operating expenses is no excuse not to come up with a reasonable estimate.

The best way to determine how much money you'll need in the next year is to carefully track how much you spent in past years. It's important not only to calculate the total amount you spent, but also to analyze seasonal highs and lows. Doing so will allow you to anticipate lean months and set aside additional funds as needed. Also, the more closely you scrutinize your spending, the more likely you are to find ways to cut costs and eliminate unnecessary expenses.

Typically, companies forecast budgets over a 12-month period. Depending on the nature of your business, however, you might want to forecast for six months, or even 30 days at a time. This will provide your employees with a detailed roadmap of exactly where you're headed and the resources you have to get there.

Does Budget Forecasting Work in the Real World?
So how did my client's planned expansion turn out? Very well, I'm happy to say. Together we looked at their sales trends over the two previous years. Then we analyzed the current market and economic conditions and came up with a reasonable sales forecast.

Next, we drilled down and looked at the costs of goods sold (COGS). We also calculated their business expenses over the past few years, noting increases in rent, insurances, advertising, employee expenses, accounting costs and legal fees. That provided the basis for a cash flow analysis, giving us an idea of the money coming in and money going out, including projected income and expenses. And that, in turn, gave us a reliable indicator of when extra cash was going to be available and when revenue would be light.

Based on this solid data, the client was able to proceed with their plan to open up additional locations.

Now, as the client moves forward, we carefully compare their actual cash flow against their forecast. By monitoring their finances on a regular basis, we've been able to identify potential problems at an early stage and formulate a strategy to correct them before they become major issues.

In other words, the client has been able to get where they want to go by carefully studying where they've been.