Budgeting v Forecasting - The same but different

As we turn our thoughts to what the New Year may bring, I am having many conversations with my clients about budgets and forecasts for 2022.

Through these conversations, it has become apparent that there is some confusion over what the difference is between a budget and a forecast.

To the untrained eye, the differences are subtle but none the less the differences, and more importantly the interaction between the two, must be understood to ensure your proactive planning reflects reality.

A big part of the value I bring to my clients, is empowering them with the knowledge they need as business owners to achieve their goals and so I spend time with each of them helping them to understand the implications for their business.

In this blog, I wanted to share this insight in the hope that it will help other business owners achieve their goals in 2022.

Firstly – Profit v Cash

To take a step forward we must first take a step back and revisit the difference between profit and cash.

If profit is food, Cash is air.

I love how this simple statement sums up the inevitable, intricate relationship between profit and cash which is present in every business, large and small.

In essence, a company can survive longer periods without profits than it can without cash. Understanding the relationship between these elements within your business can literally be the difference between life and death.

I worked for over a decade in industry and for 3 years in Insolvency. In that time, I saw many profitable companies fail due to a lack of cash. Conversely, I saw cash rich companies fail because underneath it all they weren’t generating the profits they needed to survive.

By understanding this complex relationship, we can start the differences between budgets and forecasts.

Budgeting for Profit

A budget is defined as ‘an estimate of income and expenditure for a set period of time’.

The key word here is ‘estimate’. In reality, it is our best guess based on the information we have to hand and assumptions for the future.

A budget is a key tool to ensure the activity we plan to carry out in our business is going to generate a profit which will sustain the business. By budgeting we are trying to ensure our longevity.

The budgeting process involves considering each line of income and expenditure and making an assumption of the amount generated or incurred based on historical information and our knowledge of potential changes e.g. A new contract, a rent increase.

Some of these lines are within our control e.g. wage costs and some are not e.g., utility costs.

By creating a budget, we formulate a plan for the set period and we can see if, our assumptions are accurate, we will create profits and survive.

However, a budget will not tell you how much cash you will have in the bank at any given time.

For that, you need a forecast.

Forecasting cash demands

In most cases, a budget is required first to create a forecast since it will dictate our activities and so how cash will be generated and spent.

The key element that a forecast considers which a budget does not is timing. In essence, if we carry out the activities proposed in our budget, the forecast will show us when cash will be received and when cash will need to be spent.

For example, Sales invoiced in January may not be paid till February if payments terms are payment by month end following.

VAT can be another significant factor in forecasting cash demands since whilst a VAT liability is updated on a daily basis the amount does not crystalise, become due, for 1 month and 7 days after the end of the relevant VAT quarter.

A cashflow forecast will clearly show us if we can pay our bills on a monthly or even daily basis.

Company Law dictates that a director is responsible for confirming that at any point their company is solvent, i.e., able to pay its debts as the fall due. How can you fulfil this fiduciary duty without accurate forecasting?

Making it a reality

Accurate, up to date accounting records are the basis for any good budget and forecast. Ensuring you have a good grasp on what’s happened before can ensure your assumptions are as accurate as they can be.

Collaboration with your team and your advisors is also key to ensuring budgets and forecasts are solid and hold up to scrutiny.

Finally, don’t rush it. Give it the time and headspace it needs, and you can be confident in your predictions.

Until recently, I would always turn to Excel to create a budget or forecast but there are now many apps on the market that can do the leg work for you, giving more time for those conversations and investigations that will make sure your forecasting works for you.

At Nurture, we provide the technology, technical know how and support you need to create truly useful forecasting which will not only fulfil your fiduciary duty but will also inform your strategic decisions. And we’re in it for the long haul, as part of your team, through the good times and the bad.

If this sounds like the kind of accountant you want, please get in touch, we’d love to help.

Book a discover call here https://calendly.com/nurturecompanyhealth/60min