Budgeting and Forecasting Financial Planning

Learn to Create a Small Business Budget and Forecast Action Plan

Nov 1, 2009

A budget and forecast are important financial analytical tools that give a business direction for future profitability, asset management and cash flow requirements.

Many business professionals believe that creating a budget and forecast are a waste of time. The general consensus of these adversaries is that the future is impossible to predict, so why even bother. A budget and forecast are never 100% accurate. The budget and forecast should not be considered a prediction of the future, but more of a tool to maximize profitability.

The budget and forecast acts like a gauge of future operating activities. Since they’re not a guaranteed prediction, they shouldn’t be set in stone. As a vital financial tool, they should be changed and updated as necessary, as the business conditions change. The budget and forecast should be a reflection of the reality of current and future business economic conditions, not unrealistic goals that cannot be achieved.

What is a Budget and Forecast for a Small Business?

The budget is basically a tool that allocates expenses overtime. There are generally two categories of expenses, fixed and operating expenses. When creating a budget, there is usually more emphasis put on operating expenses, because they tend to fluctuate with operating activities. Some examples of operating expenses are:

The forecast is a report of future revenue and income expectations. All future sources of income are projected and usually separated by revenue categories. Generally a forecast is based on the same revenue GL accounts that are listed on the income statement. For better analysis, the forecast may have different income categories than what’s reported on the income statement.

The Relationship Between the Budget and Forecast

Since the budget’s main function is for the allocation of operating expenses, the forecast should be created first. The main tool that’s needed to create the budget and forecast is the income statement. The top portion of the income statement shows revenue and income, while the bottom portion reports expenses. Once the forecast is prepared from historical income data, as well as other projected business factors, the budget is the next step.

For preparation of the budget, operating expenses should be compared to total gross profit from income statement averages. To get the actual monetary amount to apply to the budget, divide gross profit into each individual operating expense. From the previous operating expense examples, we’ll assume the following historical average expense to gross profit percentages.

These historical average percentages are then used to formulate the budget. Simply use these percentages against the expected gross profit from the forecast to create the budget.

Since the budget and forecast are tools for estimated future operations, they should be adjusted periodically as conditions change. If a trend is developing, where certain expense categories exceed the budgeted projection, action should be taken to reverse the negative trend. If economic conditions change that will affect revenues, the budget and forecast should be updated to reflect the economic conditions.

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