Occasionally we ask an expert to share their insights on a specific topic that contributes to business value and sellability. Today we’re fortunate to have Ian Smith — founder of The Portfolio Partnership and author of Fulfilling the Potential of Your Business: Big Company Thinking for the Mighty Small Business — help us understand more about budgets, forecasts and why we need to get into the habit of doing them.
What’s the difference between a budget and a forecast? Do I need to do both?
Yes, you need both.
I believe there is only one budget once it is signed off. As the new financial year kicks off, your views may change about the roadmaps to success. The place to articulate those changes is a revised forecast. There should be at least 11 revised forecasts. After one month’s trading, you should have the ability to flex your view of the full year and each new month brings new information. The budget stays the same.
The purpose of the budget is to create a set of rigorously thought through policy statements translated into a financial plan that you believe at the time is deliverable. The budget is for you and your team to run the business better, to execute in a controlled, repeatable style and improve the odds of success.
What are the primary benefits of creating budgets and forecasts?
Knowing why you are successful is just as important as knowing why you are failing. Budgets, if well constructed, force you to explain success and failure. Explaining why results are different from a previously held view is important. The more you budget and forecast, the more the following happens:
- You understand your business better
- You understand the economics of your business
- You understand the resources required to scale
- You get really quick at the process
- You can explain your business better to new employees, banks, acquisition targets, etc.
Knowing why you are successful is just as important as knowing why you are failing.
If you don’t have a full-time CFO or controller on staff, who can help with this process?
I’ve seen local CPA firms do a great job. The key is to build a model you play with using 12, 20, or however many key assumptions/drivers you want. Think of these as your key policy statements. Here are 12 examples:
- Sales volume for each product/service
- Sales price for the same
- Recruitment – who & when
- Salary assumptions
- Healthcare costs
- Major cost departments like marketing, sales, production (build little cost center budgets)
- Accounts receivable (days)
- Accounts payable (days)
- Capital structure
- Gross margin (%)
- New product launches
How long does it usually take to put a budget together?
Maximum of five days once the model is built, but that will be spread out over several weeks.
Buyers often ask to see the past performance of a company in terms of budget v. actual, as well as forecasts that go out 1 to 3 years. Why?
- To understand your ability to manage
- To understand how your business works
- To understand future cash needs
- To validate their post acquisition plan
Will this habit increase the value of my business?
First and foremost, you need to build the budget around the correct policies and actions. When you do that, it will help you work on the right stuff.
If I’m going to start by doing just one thing, what should it be?
Build a financial model that mimics how your business works. Let the model start with your set of assumptions and build formulas that create a monthly set of P&L’s, Cash Flows and Balance Sheets.
Practice on 2014 until you know the model works. Break down last year’s drivers of your business that created the historical numbers. Now you have a set of factors that drive this year’s budget. Build your budget. As new facts emerge, change your assumptions, redo the original budget and call it a forecast. (Don’t call it a revised budget).
Are you ready to enhance the value of your business? Contact us and get started today.