Budgeting and Forecasting: The Basics
Updated February 7, 2018
Let’s start with the obvious: It’s not imperative for every business to prepare a budget. 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 capital in the near future, then you may have reached the point where you need to start budgeting.
If you’ve never created a budget before, the idea can feel overwhelming. Where do I start? What information do I need? How do I make accurate forecasts? The good news is that budgeting isn't as complex as most people think. In fact, the basic process can be boiled down to three 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 no data to look at), this will serve as your baseline and will provide the foundation for 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 basic questions: Is the market for your products 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 difficult as it sounds. The basic idea is to take your historical financial data in one hand and your forward-looking 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 forecasts, it's often a good idea to consider two scenarios: a conservative one and an aggressive one. Why? Because most entrepreneurs constantly fluctuate between a safe sales projection (what they know they can get) and a more optimistic outlook (what they hope will happen if everything goes well). The truth often ends up somewhere in between, so 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.