As seen in the Boston Business Journal
With hazards like rising interest rates, perennially disrupted supply chains, inflation, and a possible recession on the road ahead, a thorough budget and forecasting process can give your company the guidance it needs to continue thriving. A company’s budgeting and forecasting functions are vital components of their executive oversight, operation, and finance functions. However, there is often confusion about what the budget is supposed to do and why the company even needs one in the first place.
Let’s start with the basics. To use the analogy of a road trip, a budget is the itinerary of the trip. It highlights where you want to go and what direction you are heading in. It is a strategic endeavor that should involve the executive leadership of the company. The projection and forecast are the navigation application on your smartphone. It provides you with details on the actual route you are going to take and, more importantly, provides you with feedback in the form of estimated arrival time, road conditions and alternative routes should issues arise on the way. The forecast is a tactical activity that is effectively in constant motion and will require managerial staff and department heads to take an active role.
There are a host of different methods a company can use to prepare a budget and its associated forecasts. Many large public and private companies have departments under the banner of financial planning and analysis (FP&A) that are tasked with creating, monitoring, and providing feedback on the company’s budget, forecasts, and operations. While this level of sophistication may be beyond the reach of most small and medium-sized companies, there are certain commonalities that all budget and forecasting functions should have that are achievable by companies of all sizes.
To have a successful budget and forecasting functions, companies should have the following to elements:
- A budget with buy-in from the stakeholders: It’s important that there is sufficient buy-in from all relevant stakeholders. If the budget is merely an Excel exercise of the accounting department or a “pet project” of an executive with little to no correlation to the company’s operations, it will add no value. Key decision-makers within the company need to take an active part in relevant portions of the budgeting and forecasting process. This includes staying updated on the status of the budget to actuals and being able to provide feedback relevant to their position in the process. For example, the head of inside sales should provide their projections of where they think inside sales levels will be for the upcoming budget cycle. This individual should also be kept apprised of how the sales levels and gross margins are trending relative to expected projections and provide feedback on year-to-date performance and their expectations for the remainder of the period. The more appropriate individuals involved with the budgeting process, the better accountability the budget can provide.
- A forecast relevant to the company needs: In addition to a budget, the company should have a forecast. Forecasting provides the budget with more agility to adapt and change as conditions or needs dictate. The exact form of the rolling forecast will be reflective of the company and its individual goals. Forecast periods range from as short as 13 weeks to years into the future. A critical component of forecasting is performing comparisons to actuals. In light of recently disrupted supply chains, inflating materials, and labor costs, a regular forecast to actual analysis helps to identify cost overruns or shortages in advance of missed covenants or empty shelves.
This process can add significant value when a company is going to have a potential issue with its current financing arrangement. For example, with significant inflation occurring and projected over the next year, companies should be projecting out their cash flow needs along with the availability on their sources of credit. Utilizing its rolling forecast, a company can project their growth and determine if the borrowing base on their line of credit will be sufficient to support that growth. The company can begin discussions with its lenders to determine a solution before the company is faced with a lack of availability and is forced to request an over-advance, which may or may not be granted and could hinder operations. Conversely, if a company realizes it is going to run into difficulty, such as non-compliance with a covenant or a borrowing base formula, the company will know in advance. This gives the company additional time to take corrective action and reach out to its lenders to work on a solution that minimizes its impact on operations. This will mitigate discovering issues after the year closes and there is less of a chance to adapt or modify business operations.
Solutions to help with FP&A
There is no “one-size-fits-most” approach to budget and forecasting, as there are a variety of methods and options to consider. The most successful processes are tailored to the needs of the company and its environment, have strong support from all necessary stakeholders, and are continually refined and improved upon. There are multitudes of products and services available to help companies automate this process, such as Vena Solutions. Vena integrates with many enterprise resource planning (ERP) systems and allows business stakeholders to collaborate on the budget and forecast process while utilizing an ergonomic MS Excel based system. In today’s tight labor environment, companies have started to utilize software solutions like Vena, rather than add additional forecasting responsibilities to their CFO and accounting teams. Although the system comes with a cost, it provides the significant benefits of real-time updates, greater precision, and flexibility.
Budgeting and forecasting are valuable tools that with proper support and resources can provide a company with multiple benefits. A company without a budget and forecast is like a road trip with no destination or navigation. While that can be a spontaneous way to spend a weekend, it can be an unnerving way to run a company. Proper budgeting and forecasting can provide key decision makers with the information to help make the journey a successful one.
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