Budgeting and Forecasting: The Basics
Let’s start with the obvious: It’s not imperative for every business to have a budget, and most small companies do just fine without one. However, if you have a rapidly growing business, or if you plan to apply for a bank loan or seek outside financing in the near future, then you've probably reached the point where you need to give some thought to budgeting.
If you’ve never created a budget, the idea can feel overwhelming at first. Where do you start? What information do you need? How do you make reasonable predictions? The good news is that budgeting is not as complicated as most people think. In fact, the basic budgeting process can be boiled down to three main steps:
Step 1: Look back at your financial history
The starting point for any budget or forecast is to gather your financial results for the past two or three years and lay them on the table. Unless you’re launching a new business (in which case there’s nothing to look at), this data will serve as your foundation and will provide the best indication of what’s going to happen next year. As the old saying goes, “Past results are the best predictor of future performance.”
Step 2: Write down a few reasonable assumptions
Next, take a step back and make a few educated guesses about the future. Don’t worry about crunching any numbers yet, just start by asking yourself some fundamental questions: Is the market for your product or service increasing or decreasing? What do you think your sales growth will be next year? Will you face any big expenses in the near future?
Trust your instincts and try not to overanalyze. Most business owners have a strong sense of intuition about these things.
Step 3: Forecast your expected revenues and expenses
This step takes a little time, but it’s not as hard as it sounds. The basic idea is to take your historical financial data in one hand and your forward-thinking assumptions in the other, then use them to forecast your expected revenue and expenses for the next twelve months. The result is a projected income statement (or forecasted P&L), and this will serve as your operating budget for the coming year.
When it comes to sales, it's often a good idea to create two scenarios: a conservative one and an aggressive one. Why? Because most entrepreneurs constantly fluctuate between a safe sales forecast (what they know they can get) and a more optimistic vision (what they'd like to achieve if everything goes well). The truth often ends up somewhere in between, so when you’re budgeting it’s useful to look at both scenarios.
Legal stuff: This information is provided for educational purposes only and does not constitute advice for your specific situation.