When you plan for the future of your small business, you assign yourself two important tasks: budgeting your dollars and forecasting how your business will behave in the year ahead.
Preparing a complicated annual budget seems challenging until you realize that forecasting is even more complicated, because you have to account for the unknown. Both budgeting and forecasting force you to confront the months ahead, but you’ll need to tackle them with very different approaches in order to be successful.
Budgeting
In a budget, you itemize all all your revenues and all your costs. This allows you to allocate your spending wisely, whether on marketing, supplies, or hiring. Having a budget can help you better manage your cash flow. It can also help you make financing decisions, by pointing to the holes in your budget and where a loan might make sense along with identifying the revenues that can be used to pay the lender back.
To make a budget, look at revenues and expenses from the year prior, and adjust numbers so they’re realistic for the period ahead. (If you’re a new business, see if you can find a model that’s similar to what you’re doing.) Identify the income you expect to make from sales, contracts, interest, and accounts receivable as well as all the cash you know you’ll have to lay out for payroll, marketing, overhead costs like rent, and equipment upgrades.
Remember, your budget is real: you can’t spend more than you have, and if you don’t make the revenues listed in your budget, you will be in a pinch. Be thorough and accurate.
Forecasting
A forecast, on the other hand, is a projection of the future that takes into account both known expenses and revenues and unknowable internal and external factors, like the market or industry trends.
Whereas a budget may be as simple as opening up a spreadsheet or entering numbers into software, forecasting is more difficult. Useful projections are a combination of both business data and gut-level intuition. Like a budget, your forecast considers revenue coming in and expenses going out, from sales to taxes and administrative costs. The difference is, your forecast involves your expertise and experience in addition to your numbers. A forecast will translate plans, pitfalls, and goals into a solid working document that can inform business strategy.
How to Forecast
As a small business owner, you can make better and better forecasts. Here’s how to get started.
- Collect historical data. The past can’t exactly predict the future. But if you organize and analyze numbers from the last several years, you should be able to get an idea of what to expect from your business in the upcoming period.
- Don’t ignore your intuition. You know your business, your industry, your customers, and your employees. Think hard about your experience from years prior and try to remember how customers, for example, reacted to a product, policy, or season in the past. Use your experience to give context to the data. Remember that not all important information can be condensed into numbers.
- See double—or triple. You don’t need to make just one official forecast. Pinpoint events that could render your year subpar, normal, or remarkably good, and draw a custom forecast for each prospect. This will help you deal with revenues that are lower than you hoped. This practice can also help avoid surprises if business is far better than expected and you need to ramp up purchasing or hiring.
- Account for randomness. This sounds like a contradiction in terms! How can you calculate an event you can’t predict? First, look at chance happenings from the past. You probably won’t repeat the same triumph or defeat, but you might experience something on the same scale.
- Be idealistic, then pragmatic. Forecast the best-case scenario for your business. Then work backwards to see how you’ll work to get there. If the practical steps don’t add up to the optimistic outcome, scale the forecast down and try again.
Improving Your Forecasts
In the beginning, you may feel like you are pulling numbers for your forecast out of thin air. Sure, your guesses are educated, but they still feel like guesses.
With forecasts, there is a silver lining to all that uncertainty: you can revise your projections as often as is useful. While an erroneous budget may lead to a real cash crunch, a wide-of-the-mark forecast simply gives you the opportunity to step back and think about where you went wrong. Were you too optimistic? In the beginning, your estimates may very well be sunnier than reality. Did an unexpected event alter the path forward If an older forecast becomes obsolete, don’t stick to it, even if it seems time-consuming to work on a new one. The revised forecast will be more relevant—and give you a chance to strengthen your forecast-making muscles.
This year, make sure you set aside time to forecast in addition to budget. Don’t be discouraged if your forecasts are inaccurate at first. Forecasting takes a lot of practice, and your preliminary estimates will likely be off. But the more often you forecast and take the time to compare what actually happened to what you predicted, the better you will be at sensing what the future holds for your business and preparing for it.