You guys are going to see me geek out today…this is seriously my favorite thing to talk about. I don’t even remember when I started using budgets in my personal finances. It’s something I’ve loved doing for as long as I can remember. Some people can curl up on the couch, snuggled under a soft blanket, holding a good book, and a cup of hot coffee (or tea or cocoa)…and just get lost in another world for hours. I do that with budgets. I know, I’m weird. It’s not just about paying bills or setting financial goals. It’s visualizing a future and figuring out how to get there. I get lost in the world of possibilities and the puzzle pieces that create them.
This right here is the heart of 4 Corners CFO. I promise not to get carried away. I won’t write an entire novel…yet…but this will probably be one of my longer blogs. Sorry not sorry. So here goes, I’m going to tell you what exactly a budget and forecast are, why you need them, and how to get started with your own realistic budget for your business. Being the heart of the business finance process, your budget and forecast draw from EVERYTHING we’ve talked about so far. I’m going to use a lot of terms in this blog that may not be familiar if this is your first time on my website. Don’t worry! Each term or phrase will be linked to a blog that explains them and dives deeper.
As always, you can skip all the words and schedule a quick consult call to learn all about how I can do this FOR YOU without worrying about how to do any of it for yourself. If you aren’t ready to take that step, you still need to know this information. Keep reading!
Budget vs Forecast
I use the terms budget and forecast interchangeably a lot. They are very similar but actually have a very important difference.
Your budget is the numerical representation of your company’s financial goals for the period (generally the fiscal or calendar year). It’s not just the goals but the plan to get there. Maybe your goal is to return to pre-pandemic revenue, or to pay-off the debt you relied on to get through 2020. Maybe your business was able to pivot and continue to grow through the pandemic and your goal is to increase profit by 10%. The budget shows what you want to achieve and how you intend to achieve it.
A forecast is the prediction of where your revenue and expense will be based on your historical trend, current status, and revenue/expense drivers.
Both the budget and the forecast are a projection of your business finances into the future. The key difference, is their purpose. Your budget tells you where you to plan to go. A forecast shows the trajectory of your current path. A forecast can also be used to show the impact of a certain decision or circumstance on your long-term goals. This is best described visually through a graph.
One line represents the budget, the goal, the plan. The other line represents the forecast. Based on where you are right now and the things you are doing in your business…where can you realistically expect to be in 3, 6, 9 months. Can you see how the two can differ? This difference would trigger you, as business owner, to question why and make some adjustments. Stay tuned for the variance analysis blog next week!
Tell Your Money Where to Go
Dave Ramsey is known for saying “A budget is telling your money where to go instead of wondering where it went”. I want to take that thought a step further…
Show me where you’re telling your money to go, and I’ll tell you where your business is going.
A budget and forecast save you the time you would otherwise spend “stumbling” into success. Yes, like everything else in this series of blogs, they do actually take time to do. But you KNOW your dreams for your business. This is just sitting down and quantifying them. Make your dreams a reality by putting them in writing and figuring out how to reach them. With a budget and forecast, you get to create your path to success.
How does a budget and forecast save you money? It eliminates (or at least points out really quickly) where you are wasting money. Remember that blog about the expense audit. We identified those expenses that just weren’t worth it compared to your business goals. Your budget shows you what eliminating those expenses can really look like long term. It sets the intention and motivates future spending with a visual of the goal and its achievability. When you spend with intention, with a budget, you are making more money because you’re wasting less of it.
How do you make a realistic budget?
Earlier, I talked about the difference between a budget and a forecast. There’s a reason I use the words interchangeably though. To me, a budget is only as good as it is realistic. A realistic budget will have elements of a forecast. It’s based on what you know your business is doing now, what you know your business is capable of doing, and where you might be able to push the boundaries of creativity, productivity, and efficiency.
2 Step Process
There are only two steps in creating a realistic budget. It really is that simple.
- Set a goal
- Figure out how to get there
Keep in mind, your budget can be as simple or as complicated as you want. The goal is to save time and money right? So don’t get more complicated (time consuming) than what adds value (money) to your business.
Set a realistic goal
We’re talking about budgets here, so that means I’m talking about a quantifiable financial goal. Realistic means you have to know where your business has been so you can be honest with yourself about where it can go. The goal can be as simple (you want to pay yourself six figures) or complicated (you want to increase your revenue by 10% while maintaining the current operating expense but also expanding your team).
It’s always easiest to set a pie in the sky goal. So that’s where I start with my clients. It doesn’t have to be SMART (specific, measurable, achievable, realistic, timely) yet. We will get there. See the infographic below for the exact steps every client goes through before I start creating their budget.
Figure out how to get there
Think of this part (the actual logistics of building out your budget) like a roadmap. Your starting point is your current financial status. Like I said earlier, this can be as simple or complicated as you choose. Your current financial status is usually best represented by your income statement or the revenue and expense section of your trial balance.
Your destination on this road map is the goal we just set. You’re going to express that goal at the same level as your starting point (income statement, trial balance, etc.)
What goes in the middle? The numbers you know, the possibilities, and the impact of those possibilities. That’s not specific enough, I know. The truth is, the middle is the magic and it’s different for everyone. To figure this out you need to know:
- Your current financial patterns
- Your possible solutions to get to your goal
- The impact of those solutions on your current patterns
Let’s say your goal is to increase profit by 10%. Now walk it through the three steps…
Your current patterns
- You average 10k a month in revenue
- You average 5k a month in expenses
Your possible solutions to get you to your financial goal
- Increase revenue – but how? What impact does this have on your expenses? How realistic is this increase? How long will it take to achieve this increase?
- Decrease expense – but how? have you done an expense audit? What drives the expenses associated with your revenue? How realistic is a decrease? How quickly can you eliminate it? How long will it last before you need that expense again?
- The impact of those solutions on your current financial patterns
Your impact. Because you have followed along with this whole blog series, you are able to make reliable and educated predictions in response to the questions. You know that:
- It would take one additional client each quarter to achieve your goal but that’s assuming there is no client turnover (loss). You know you cycle through about 20% of your clients each year. So you would actually need to aim for 2 clients per quarter to achieve your profit goal exclusively through revenue.
- You could cut $500 a month in expenses immediately with no impact to ongoing business. This reduction could be maintained indefinitely.
- You could attempt to negotiate other expenses with vendors that might lead to saving another $500 a month in expense but the process will take 3-6 months based on existing contracts and pending vendor flexibility and alternate vendors.
- You can think outside of the box. It’s been a while since you dug into your processes to find efficiencies. You could enlist your team and make an experience out of it. This would require time and the impacts are not yet known but they’re worth investigating further and updating for when found.
Now plug those into a month-by-month outlook of your budget for the next 12 months (or remaining year). Ta-Da! You have a budget!
You HAVE to know your numbers!
Can you see how easy your budget is if you’ve gone through all the other steps we’ve talked about throughout this blog series…your chart of accounts, your profitability and cash flow allocations, your revenue and expense drivers, and so many more. Those steps are the “how” of a realistic budget. That is how you know what is or isn’t realistic in your goal setting and plan to get there. It’s how you create a realistic budget that can actually get you to your goal.
You are not alone…
If you want help developing a realistic and customized budget that is made just for your company and your dreams…
There is nothing I love more than a consult call with a new business owner because I’ve been there, done that. I know how empowered, in control, and free you are going to feel on the other side of this business finance journey. Especially those of you that sign on for signature CFO services. I do all the heavy lifting for you, because numbers aren’t heavy for me…they’re my happy place. You get to stay in your happy place, your zone of genius, and grow your business.