Planning ahead for your financial future is a key part of setting solid foundations for your business. Rather than just focusing on the day-to-day elements of your company’s finances, ambitious businesses will look to create a financial plan for the coming year, so the management team know where they’re going and how they’re going to get there.
But when it comes to budgeting, forecasting and building up future scenarios, there can sometimes be confusion around what these terms means – and how you each of them has a very specific part to play in helping you see the financial path of the business
In this post, we guide you through the key differences between budgeting, financial forecasting and scenario-planning, and explain how combining them together with the right data gives you the most accurate and robust insight into your financial future.
Revealing your financial future
At the start of the business year, you need to plan out your revenue goals for the year and set aside defined budgets for expenditure. During the year, you also need to produce meaningful forecasts of your cashflow, income, costs and profits, to monitor performance and maintain an ongoing picture of your finances.
By using data from your historic actuals, industry experience of your markets and setting revenue goals defined by the requirements of your overall business strategy, you can build a better picture of what the future pathway of the business will be.
But to do this effectively it’s important to understand the difference between the core areas of budgeting, forecasting and scenario-planning.
What is budgeting?
Budgeting is used to control your spend as a business and to set base targets.
It’s generally done at the beginning of a period and those numbers will be locked down and used as base comparisons across the course of the forthcoming period.
In essence, your budget is the annual financial plan you create to set up your goals, aspirations and route map for the year ahead. It’s typically an annual process (although it can be done quarterly), and it’s your chance to set targets for revenue and expenditure across each department, team or cost centre in the business.
By fixing the period you’re budgeting for, you can control and manage spending against your targets, and you provide a clear way to keep the wider team, shareholders and other stakeholders aware of the money that’s available for each area of the company.
Jonathan Bareham, co-founder and Director of London-based cloud accountants, Raedan, believes that, “Things move quickly in a small business, the ones that at least have a budget in place can react more quickly and confidently. They can already see if they have the ability to cope with the change but also the budget becomes the basis for the ‘what-if scenario’ they need to model.”
So your budget defines the size of the money pot at your disposal, giving you a benchmark figure to work against over the course of the business period you’re planning for.
What is forecasting?
Forecasting is used to predict your future financial position using the information you currently have available to drive your forecast.
It may sound technical, but in fact it’s just your ‘most likely scenario’ when predicting the future of your finances. The more data you have, and the more robust your current knowledge is, the more dynamic your forecasting will become (and the more accurate your numbers will be).
Where a budget sets your aspirational targets, forecasting takes your historic financial data and information relating to your key drivers and produces an estimate of your financial performance. In short, forecasting is about attempting to predict, as closely as possible, the real financial outcomes you’ll see over a given period.
Forecasting is also a more regular kind of financial reporting – where your budget is set over a given period, forecasts of key areas like cashflow and profit can be run at any time, and can give you predictions for the next month, the next quarter or the whole business year – depending on the kinds of business decisions you’re making and the sorts of information you need to hand to inform these decisions.
Scenario-planning and the ‘What if…?’ question
Scenario-planning is the process of trying out multiple different strategies – and projecting the most likely outcomes forward to see which one works best.
In essence, scenario-planning is about asking those all-important ‘What if….?’ questions, and trying them all out to find the right strategic or financial pathway for the business. It’s a process of trial and error, but with the whole scenario played out in theory, rather than in reality.
So, for example you may ask yourself:
- What if we put our prices up by 2%? – so you can see the impact this might have on sales, revenue and your overall cashflow position.
- What if we lost 5 members of staff? – so you can see the reduction in your payroll cost and the related boost to your monthly cash pipeline.
- What if we opened another office in New York? – so you can understand the hit this would have on overheads and expenses, and whether this is a sound business move in this financial year.
In basic terms, scenario-planning is there to help you understand the impact of your business decisions, and to reduce the potential risk by showing you the most financially astute pathway to take when it comes to planning for the future.
A better view of the future with cloud accounting and FinTech apps
The better the quality of your financial data, the easier it will be to create meaningful and robust budgets, forecasts and scenario plans.
Spreadsheets are not up to the task, being time-consuming to update, tricky to share and generally outmoded by the latest in online accounting software. Having a cloud accounting platform as your main accounting system adds real value, by helping the business to record every single transaction – and giving you a pool of real-time data to dip into.
Jonathan Bareham echoed this sentiment, arguing that, “A common issue with forecasts and budgets is that they are seen as a box ticking exercise, ‘we’ve done our budget now let’s move on’. Sometimes it’s due to a lack of understanding of how beneficial they are but more often it’s because they are so disconnected from the rest of the financial process. Spreadsheets are a powerful tool, of that there’s no doubt but whether you’ve adopted the cloud or you’re still stuck on desktop accounting, a spreadsheet doesn’t link with live data.”
Having this huge pool of financial information at your disposal allows you to create three-way financial reporting and provides a data source you can integrate with your choice from the latest in financial technology (FinTech) reporting and forecasting apps.
With a forecasting solution incorporated into your forecasting you can turn your numbers into a practical reality that you can then execute on. There’s an ever-growing marketplace of cloud-based apps you can integrate into your core system – and that means you can use budgeting tools, budget managers, KPI dashboards and business intelligence solutions to measure business performance and check out those ‘What if…?’ scenarios across the period.
Look to the future and succeed
If you’re serious about making a success of your business, you need to plan ahead, get your budget in place and run regular forecasts to check that you’re on track.
When you know what lies ahead on the financial road, you’re in the best possible position to avoid the challenges and make this year the start of your success story.