A small business budget without a forecast is really just a guessing game.
Why? With financial forecasting, you’re using your past expense data to estimate your company’s future needs and performance. By looking at what you’ve spent in, say, the last five years and identifying patterns, you can reasonably predict how much you need to set aside for every expense across the business.
Sound financial planning enables you to forecast future cash flow, profit, and revenue while also maintaining a healthy balance sheet.
Additional benefits of careful financial planning include:
- Managing your debt load
- Understanding your cash flow and identifying streams of income
- Knowing how much you will be spending on operational costs
- Making confident investment decisions
- Setting money aside for emergencies
Additionally, a thorough plan frees up money for other essentials like marketing.
Can you have a budget without a forecast? Of course (You have to get started somewhere). But you’re more likely to hit your goals if you’re using historical data to inform them. There are also You will want to take into account the different methods to financial forecasting and choose the one that fits best with your business goals.
There are a lot of moving parts and various elements to take into consideration—from fixed and variable expenses to knowing if or when to invest money back into the business.
Here are a few key elements to get you started:
Determine your monthly business expenses and income
To create a yearly forecast, begin by determining your business expenses by working out what you spend every month.
Next, divide them by 12 to get your average monthly costs. You can simplify this part by filling out a Schedule C form to calculate profit and losses for the year.
After figuring out the average amount of money you spend per month, decide which expenses are necessary vs. non-necessary. Necessary expenses relate to your business growth or operations. For example, paying for office space or electricity bills.
Non-necessary costs are those you can cut back on without impacting your company's ability to thrive. For instance, using home equipment instead of renting out extra office appliances.
Next, look for patterns throughout the year. Do you spend more on cooling your office during the summer? Do you need to hire extra help over the holidays to handle a rush? Plan for these moments you know will happen every year.
Find the right balance for your business budget
As a business owner, you need to find the ideal balance between spending and saving. Begin by listing your goals and how much achieving them will cost.
Once you know what your focus is, it's time to start looking at your priorities. This might be areas like salary or expansion plans or paying down debt. From there, decide how much of your budget to allocate to each of your goals.
Include fixed or variable expenses in your forecast
There are two types of costs to include in your budget forecast: fixed expenses and variable expenses.
- Fixed Expenses are costs that don't change from month to month, like rent or insurance premiums.
- Variable Expenses change regularly, like marketing or materials.
When you’re creating a forecast, it’s a great time to see if you can cut back on any of these costs. For instance, could you negotiate a cheaper insurance premium or reuse packaging?
If you decide to cut back, just make sure your forecasts align with your short-term and long-term business aims.
Consider how much you need to reinvest
Sometimes you’ve got to spend money to make money, and sometimes it makes more sense to put cash back in reserve.
How do you decide when to invest and when to save? Use the 50/20/30 rule. You divide your after-tax income into:
- 50% for essential business needs
- 30% for wants
- 20% for saving
There are variables of this method, but Senator Elizabeth Warren suggests this formula in All Your Worth: The Ultimate Lifetime Money Plan. That’s quite an endorsement.
Factor in your cash flow
To manage cash flow, you need to have an idea of your monthly income and expenses (Read: go back to step one and come back when it’s ready). Once you’ve completed your budget, you’ll have these key figures to work from.
If you’re a start-up, you may not always know the exact number of clients or where the money is coming from. But you can still manage your cash flow by:
- Keeping detailed financial records
- Using a simple accounting system
- Cutting expenses where you can. For example, you may not need office space to begin work as working from home is sufficient.
- Having money set aside for unexpected costs
It’s also essential to keep your assets and liabilities in mind when managing cash flow to avoid a deficit.
Budget for success
There is no fixed answer to this as every business has different needs, and it all depends on your company’s mission, values, and how quickly you want to grow.
The easiest way to determine this is to set your forecast based on your company’s goals. For instance, if you want to grow your customer base, set money aside for outreach. If you decide to invest in new technology, spend more money on R&D. Include these expenditures in your balance sheet to help with planning.
A forecast is an essential tool for small business success
A little insight always helps. That’s what a forecast can do for your small business. It provides you with a financial framework for both the short-term and long-term and gives you a clearer idea of what your business is likely to spend in the coming months.
Although forecasting a yearly budget is a vital step in driving your company forward, it’s something that business owners sometimes overlook.
But by following a set of simple steps, such as finding the right financial balance and managing cash flow, you can keep your business on a solid footing, plan for the future, and ensure you have cash put aside for when you need it most.