Rolling Forecast v. Budget

With many of our clients we have moved to a rolling forecast instead of the traditional budget model. Why? To be frank, we started with this method a few years ago because so many of our micro businesses just used the budget more as a forecast anyway. Many solo entrepreneurs and micro business owners make quick decisions and run their businesses a bit on the fly. The mention of a budget is a painful thought to some of them and one that they resist as unnecessary with all their heart. They did not use the budget in the traditional sense of controlling their spending each month but rather as a forecasting tool for looking at where they will be now that they already made a decision and spent the money.

While this method served our small clients, it has actually become critical with our larger small businesses. With the rapid changes in technology and the continual political and economic uncertainty, small businesses need to be able to adapt to changes in the business environment in a very short time. It is no longer a certainty that you will be able to turn to a bank or outside investment to shore up a temporary short-fall in cash, so having a better way to plan the future and having the agility to adapt is crucial to success.

The purpose of a Rolling Forecast is to be able to foresee risks and opportunities, adapt your strategy given those risks and opportunities, and assign resources in a continual planning mode. The model depends upon identifying the key drivers in your business. In other words, identify what might cause your plan to vary, how you will know it is deviating from your original plan, and what you need to measure to see the deviation. And the model also needs to incorporate a cash flow aspect in the rolling forecast, since cash flow will make or break your business.  For some businesses, for example, the key drivers in your plan might be the dollar value of open sales orders as of a certain day of the month, the price of raw materials, the number of credit sales and the average accounts receivable days outstanding.

Once the drivers are identified, various forecast models can be built to predict expected, worse case, and best case scenarios. By using a rolling process, you are constantly looking at what your results were versus what you expected, and by using multiple predictive models you will have already planned ahead and assigned the resources to act quickly given your results.

No Need to Budget!

“I have never made enough money to need a budget.” I heard a variant of this comment at least three times this month. I want to dispel this myth. If you are ever to get ahead in life, EVERYONE needs some sort of budget. Before my daughter went away to school this fall I sat down with her and we looked at the money she had saved, what other sources of income (i.e. jobs) she might have coming in, and developed a budget for her to follow. Since her finances are simple, we set her up on Mint.com so that she could easily track her spending versus budget.

Tracking expenses and budgeting needs to be done at EVERY level of income in order to get ahead in life. I have seen people not able to make ends meet on $20,000 of income, on $50,000 of income, and on $100,000 of income.

The discussion of setting a budget for small businesses often leads to the discussion about personal budgets as so many micro entrepreneurs’ personal and business financial positions are intertwined. People don’t track personal spending and don’t set personal budgets and therefore they rebel against these tools for their business as well.

If you are ever going to succeed, you need to be purposeful in what you do. Planning and budgeting is a tool for being purposeful and not just letting your financial position unfold. It is the difference between controlling your destiny and letting it happen to you. This is true in both the personal and the business realm.

People don’t track expenses and use budgets because it is not a FUN activity. It requires self-discipline. I am a financial analyst and have utilized these tools my entire life and I still grumble every time I sit down to work on my family finances. The feeling is universal! However, the rewards are great!

People don’t like budgets because they fail to account for surprise expenditures and they don’t have savings to fall back on. The key is to make savings a priority with each paycheck so there is an emergency fund to dip into if necessary. Be creative if necessary to come up with the extra. My husband always empties the change out of his pockets at night and does not put it back in his pockets in the morning. Early in our marriage I used to scoop up that change and that was the beginning of our savings.

So here’s the quick technique in a nutshell. It is nothing that you haven’t heard before, but it is a dose of common sense and perhaps brutal reality.

1.       Discuss as a family your goals and priorities for this year, for five years, for long-term.

2.       Stop using credit cards to pick up your extras. Credit cards should only be used with careful foresight and should be paid off in full every month. Using them to shore up your lack of income only leads to worse financial problems.

3.       Track all of your expenses so that you understand what each member of your family is spending money on.

4.       Write down your monthly income.

5.       Decide what portion of your income needs to be put into savings (emergency fund first, then short-term and long-term goals) and make that happen. This is a key point to your budgeting success!  There MUST be some surplus somewhere to cover the unexpected. You CANNOT say that there is nothing left for savings. Savings must come BEFORE your expenses.

6.       Make sure that your savings + expenses are not greater than your income. You will only continue to dig a deeper hole if you spend more than you earn. If savings plus expenses are greater than income then  you need to make some changes (and the answer is NOT to cut out savings):

a.       Take on a temporary second job until you reach your goals of paying off old debt or building up the initial emergency fund.

b.      Cut your expenses. This could simply mean cutting out your daily coffee or cigarettes, but if things are really tight it could mean making tough choices about where you can afford to live and what you have and what activities your kids participate in.

Make the changes necessary to live within your means, to manage your finances with purpose, and to get ahead in life. 2011 is your year!

Focus Your Business With An Effective Budget: Part II

So how do you create a budget for your small business?

In these challenging times, it is more important than ever to put together a comprehensive budget for your business to use in the next year. We recommend creating both a budget for your Profit & Loss and a budget for your Cash Flow needs. For those of you who are new to the budgeting process, here are a few pointers:

Pull out your prior years’ income statements and look at your historical data. Which income streams have been most successful for you and have provided you with the highest margins and therefore the most money? Which products or services have not performed as well as expected? Consider whether they can be improved and if not, eliminate them.

Look for patterns in your income stream and expenditures. If your money coming in from sales doesn’t match with timing of your major expenses such as seasonal inventory purchases, real estate tax payments or insurance premiums, setting a budget can help you make sure you are saving enough money to pay for these items.

Think about using zero based budgeting. Don’t just take last year’s budget and add an arbitrary increase in sales and expenses. Do some research and consider what a reasonable sales figure will be. Figure out what your staffing needs will be based on this sales figure. Talk to your major suppliers and your utility providers and see what price increases may be in your future. Consider what items are necessities and which expenditures are really luxuries. Evaluate every item in your budget and consider whether it is in line with your strategy for your business. With the economy still recovering, you need to maintain a lean approach to both your budgeting and the actual managing of your business. There is a wealth of information available to help you with the creation of your budget if you do a little research.

A well planned budget process can take some of the stress and fear out of managing your cash flow throughout lean times and allow you to spend your money wisely and avoid running up credit card balances.

Focus Your Business With An Effective Budget

We often encounter resistance at this time of year as we begin to speak of budgets with our small business friends. The feeling is that budgeting is a time-consuming process with little benefit. What's the point. We disagree. This blog is the first of a three-part series to make our case for the need for small businesses to devote some time in the next two months to establishing a good budgeting process.

Before you can create a budget, you need to know your long term (the next 5 years) and short term (2010)goals and your strategy for reaching those goals. So pull out your old business plans and take a look. Have you been following your plan? If you have not been following it, why? With the changes in the economy, do you need to rethink the direction of your company or are you just taking a little business detour?

If you do not have a business plan, then now is the time to at least formalize your operating strategy. What is your business? What differentiates you from other businesses offering the same services in your industry? Who is your target market? Are you reaching them? Do they know that you exist? After you have given some thought to these questions, take out a piece of paper and draw 3 columns with the following headings: 5-year vision, 1 year strategy, and tactics.

Under the 5-year vision, write down specifically how you want your business to be defined. Where do you want to be in 5 years? For example, you might want to be known in your market as the cutting edge new idea generator. Be clear here to define on paper who your target market is for the cutting edge new idea generator. Who do you expect your customers to be? Do some research to find out who these people are; who they are currently buying from so that you know who your competitors are; why they are buying from them. What is happening in your industry as a whole? Do you need to be considering alternative products and services if you think that your current products are going to be obsolete in the future? Under the 5-year vision you might also want to consider internal operations as well: what skill positions do you think you will need? What work environment do you want to create?

Next analyze where your business is compared to that 5-year vision. How close are you to achieving those results? What do you need to do to get there? Under your 1-year strategy column, write down where you need to be by the end of 2010 in order to be on track for your 5-year vision. This may include some specifics as to the dollar amount of sales that you need to achieve or the staff that needs to be in place by year end, etc.

Under the Tactics heading, start writing specifics. This is where you place your need to develop your specific advertising and promotion plans, your foray into social media, your need to create a specific video for your website. You might have a tactic to develop job descriptions and procedure manuals for your staff. Be as specific as possible here as this is the content that you will use to create your budget.

Now that you have your vision and strategy in place, you are ready to create a budget that helps you to reach your goals as opposed to a budget that merely states how you have been spending your money over the past few years. Tune in next week for a discussion on how to use this information to create a good flexible working budget.