6 Secrets to Creating an Effective Business Budget

Build a forecast you can use all year round to drive your business forward.
As a business it is smart to prepare multiple versions of a budget plan in case of different operating scenarios. (Photo: robuart/Shutterstock)
Tage Tracey

According to Tracy, forecasts should be rolling and adjusted according to market conditions. (Photo: Tage Tracey)

Back in the day, let’s say 25 years ago, budgeting was a rather mundane task, scheduled for once a year (or maybe twice for more progressive companies) toward the end of each fiscal year with the goal of creating a budget or projection for the upcoming year.

Oh how times have changed. In today’s hyper-competitive environment, even the term “budget” is a relic. Accounting types (like me) talk instead about rolling 12 month forecasts or active projections because businesses must constantly have 12, 24, and even 36 months of visibility at any point during the year to adapt and adjust to rapidly changing market conditions.

In order for your forecasting process to be effective, your “budget” must be a living, breathing thing. You need to constantly update it with real-time information on different “what if” scenarios.

With this key concept in mind, here are six tips for creating an effective, useful budget and, more important, structuring a forecasting model to bring real value to your business.

Make it a team effort

Critical assumptions and data input points will come from every function in the business, so the forecasting process should involve key team members from each one, such as marketing, sales, operations, finance and production. All management team members must “buy in” to the process to make it effective.

Design the forecast with key performance indicators in mind

All too often, accountants will want to account for and budget every last expense in the income statement, no matter how small. But don’t get consumed by the details or “lost in the forest.” Keep your eye on the big picture — the key assumptions and data points that really help a business move the needle.

Decide on a top down or bottom up forecast

A top down forecast model focuses on sales first and then works down the income statement accounting for costs of sales, operating expenses and overhead. For younger, smaller and/or rapidly growing companies that are still trying to figure out their real business model, a top down approach usually works best.

In a bottom up approach, best suited for larger, more mature and stable businesses, expenses by type or category (such as personnel costs and advertising expenses) are addressed first, then the forecast is built from the bottom up through the top line revenue.

Prepare multiple versions based on “what ifs”

Most businesses should prepare multiple versions of a forecast to evaluate and plan for different potential operating scenarios.

Historically, forecasts are prepared under three operating scenarios: high, medium or low. “High” is the best-case situation and “low” is the worst-case. The expected, or medium case, scenario is the one most companies ultimately rely on to manage their business.

I recommend developing a fourth scenario: the “Arm” version, for if Armageddon hits. Before the Great Recession of 2008 through 2010, nobody really paid attention to this version, but in today’s economic environment, you need an Arm version so you’re prepared to act, and act quickly, if all hell breaks loose.

Develop one forecast for internal and one for external use

Forecasts for internal use tend to be more detailed and center on critical and confidential business data points that are essential for management to understand.

Forecasts for external use, targeted for distribution to third parties such as lenders, investors, and/or regulators, tend to be more summarized and don’t present highly sensitive or confidential information. You would be amazed at how many companies are clueless when it comes to what is and isn’t appropriate to distribute to external parties.

Include your balance sheet and cash flow statement

All too often companies prepare an income statement or P&L forecast and neglect the balance sheet and cash flow statement. They focus on calculating how much money they can make and how to improve their margins. But trying to run a business without understanding how much capital you need to execute your business plan or how much cash you’re consuming is like a football team attempting to execute its game plan without an offensive line. The quarterback and running backs (the P&L) may get the glory, but the blocking is done by the offensive line (the balance sheet and cash flow statement). And you can’t win a game without it.

Editor’s note: Tage Tracy is a financial consultant and co-author of several books including “Cash Flow for Dummies,” “Accounting All-in-One for Dummies” and “Small Business Financial Management Kit for Dummies.”

Want A Demo?

Sign up for a POS demo from NCR Silver today.

Let’s Connect

Have a direct line of communication with NCR Silver and get the latest news on the social media site of your choice.