Budgeting vs Forecasting: When Last Year’s Performance Isn’t Enough

No matter a company’s size or industry, evaluating the previous year’s performance is an annual exercise that business executives approach with varying amounts of trepidation. The challenge: how can we allocate next year’s budget in a way that will maximize the probability of growth and success?

And so, anxious decision makers typically default to the latest profits and loss statement to develop a budget for the upcoming year. Looking back on historical data, the questions begin. Which expenses can we reduce or eliminate? Which can or should be increased? Which stay the same? How can we increase profits – or at least minimize losses? These and other decisions – many based on guesswork, others based on gut instinct – often keep these decision makers up at night.

The problem with this planning approach, however, is that it can be restrictive. Some use the terms “budget” and “forecast” interchangeably; I prefer to distinguish the two. Budgeting only uses past data as the planning benchmark, and therefore can only take you so far in determining what you can or cannot spend. A budget-based plan is fairly static – often representing where you have been, rather than where you want to go.

Forecasting, on the other hand, is a dynamic, forward-looking process that produces a systematic plan based on the strategic business goals of your enterprise. Forecasting asks critical questions such as: What is the potential in this business? What do I expect to achieve? What are the measures of success? Armed with these types of goal-specific insights, forecasting becomes the financial representation of management’s expectations and the actions it will take going forward to achieve desired results.

Our advice to clients is to work SMART – an acronym for a concept first introduced in 1981 by George Doran and popularized by Peter Drucker in his work on Management by Objectives (MBO). It provides a clear understanding of what the company expects to achieve and everyone’s role in making it happen. Here’s how SMART forecasting works:

S – Specific. It’s not enough to say you want to improve profits. A SMART goal identifies how much you realistically expect to increase revenue and grow the business over a specific period of time.

M – Measurable. Unless specific measures of success are defined, management is operating blindly. How many units do I need to sell per month? How many sales calls need to be made to achieve a sale? Whether it’s in sales, delivery, or management, every associate needs to understand his or her role and accountability – whether it’s number of sales in a month, or deliveries in a day.

A – Attainable. Don’t set yourself up for failure. Aim high but set goals that can be realistically achieved given available resources.

R – Relevant. You want to allocate funds to develop a new website and rebrand your company. Is the expenditure relevant? Will the rebranding improve the company’s image and enable a better connection with customers? Will a rebranding contribute to the management goal to increase revenue?

T – Time-related. Specify when the results can be achieved. Set up a schedule to evaluate performance. A periodic progress report will guide management decisions with clear, understandable data.

By focusing on goals rather than last year’s performance, SMART forecasting enables management to maximize resources and derive maximum value from the business. It takes the guesswork out of budgeting and provides the systematic framework for moving the company forward.

Forecasting also helps decision makers make important team member decisions that bring greater efficiency to the company’s organizational chart. It provides clarity to questions such as: Do I have the right people in the right place? Are they functioning with clearly defined goals and accountability? Are my sales targets and strategy consistent with management goals for growth?

Another important aspect of budget and forecasting is creating a sales forecast using the SMART technique, and how the exercise will help optimize the chances for the success of your growing enterprise. Are you and your organization taking these precautions when evaluating your companies future budget and plans? Withum advisors are happy to help you make informed decisions.

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