What is the difference between a budget and a forecast?

This is the second post of my series, Client's Top Questions Answered. The thought is that if my clients' have the question, then I'm sure many other business owner's do too! 

What is the difference between a budget and a forecast?

First off, let me start out by saying, the number one mistake business owner's make when budgeting is NOT HAVING A BUDGET!  You can read more of the Top 7 Budgeting Mistakes in my article here. Let's get into it.  A budget is something that is typically set on an annual basis.  The budget does not change once its set.  The purpose of a budget is to set a goal or an expectation for the year so that you can compare your actual results back to the benchmark.  If your benchmark keeps changing, its impossible to see your progress against your goal.

A forecast is very different.  It is not a benchmark or a goal.  Rather, it is a prediction of the future. The forecast can change as much as you want.  The forecast's purpose to estimate where your business is going compared to where you thought it would be (i.e. the budget). 

So do I do both?  How do the forecast and budget work together?

I thought you'd never ask! The best way to monitor your business's performance is to first create a budget for the year.  Ideally you would budget for next year (2015 for example) at the end of the current year (November/December 2014).  The budget should be locked and no changes made to it once its set. You can budget by month, by quarter, or just for the year in total.  Its up to you.  The more detailed your budget, the more insight you can get from it. This budget is your benchmark going into 2015.

Like I mentioned, you can forecast as much as you want.  As a rule of thumb, I like to forecast at least every quarter.  Lets say in March 2015, I look at the first 3 months of the year and I now think that we are going to have more sales than I originally budgeted.  I create the forecast to reflect his.  I can compare how I think I will end the year to my budget. 

Why is this important?

Budgeting and forecasting are so important because you can see how the decisions you make throughout the year impact your goals that you set at the beginning of the year - either positively or negatively.  Having a budget and continuously forecasting give your business direction.  If you have a good forecast, you can make informed financial decisions for your company.

Have more questions for me?  Shoot me an email (bforssell@mytrustedcfo.com) or contact me via my website, www.mytrustedcfo.com.  Maybe your question will be the subject of my next article!

Cash or Accrual: Which is right for my business?

If I had to make a list of the top questions I am asked by clients, I would put this one near the top: “Which is the better way to track my small business’s financial performance – cash or accrual?” You ask this to any CPA and they are bound to have a different answer. This is because… there is no “one size fits all” answer. Some business should be using cash basis while others should be using accrual, and some should be using a hybrid of the two.

If I’ve already lost you, never fear. Most business owners have heard of cash and accrual in the context of accounting for their business, but few really understand the little nuances that make one method better than the other for their particular business.

Under the cash basis of accounting, revenues are recorded when cash is received and expenses are recorded when cash is paid. The foundation for accrual based accounting is called “the matching principle”. Basically, this is the idea that expenses should be recorded when an obligation is incurred. For example, cost of sales (an expense) is recorded when the product is sold not when inventory is purchased. Similarly, when a company records a sale, the sale is income to the company when the product of service is provided to the customer and not when the customer paid the bill.

True accrual accounting is complex and time consuming. In a perfect world, all businesses would be using the accrual method. It gives the most accurate picture of a company’s performance over time because of how it matches the revenues with the expense in the period that each are incurred.

For example, a car dealer buys a used car in an auction for $1,000 in January. In March, he sells it for $3,000 on credit where the customer will pay down the loan over time. In the cash method of accounting, his January Income Statement would show a $1,000 expense for buying the car and no income. Then in March, it looks like he didn't sell anything because the customer didn't pay cash for the car. This is not an accurate picture of his business’s performance at all. In the accrual method, he would record the sale for $3,000 and the $1,000 cost of the car as an expense all in March so his true profit is $2,000 in March – which is an accurate representation of his businesses performance in March.

But – a lot of small businesses will opt for the cash method because - let’s be honest now - it’s easier. A lot easier. And a lot of small businesses don’t have the extra time or money to spend on keeping their books under the accrual method – and that is ok. Like all things in business, you need to weigh the costs and benefits.

I've created a little flow chart to help you decide which may be better for your particular situation. (You can save the image or view it in another window in order to zoom in.)

Why You Should Fall in Love... with Accounting

We fall in love.  We get married.  Then we realize that we said "I do" not only to the wonderful man or woman we married, but to everything that comes with them: their family, debts, pets, and quirks.  Some of these things are not easy to love, but we need to learn to love those things that will ultimately make our marriages stronger and more successful.

Similarly, when we fall in love with entrepreneurship, we say "I do" to a business and all the "baggage" that comes with it. We open a coffee shop because we love coffee and we know a lot about coffee, but more often than not, we don't love the accounting that has to be done in order to manage the coffee business.

If you marry someone but don't get along with their mother, you have two choices. You can let this divide and potentially destroy your marriage or you can find a way to love or accept your mother-in-law.  In business, accounting is like the overbearing mother-in-law.  You may not want to deal with the accounting, but if you don't learn to love it or at the very least, understand it, your business will never reach its potential and could quite possibly fail. 

Without having a grasp on your company's financial situation, you are flying blind.  Its not enough to go through your books every year around tax time.  Business owners should be reviewing their financials each month, asking questions, and striving to understand the numbers.  I tell my clients that they should have the results from January by mid-February at the very latest - the quicker, the better.  That way you have timely information available so you can make adjustments on how you are running your business. How else would you be able to tell that your travel costs are getting out of hand, you're paying too much in unnecessary bank fees, your clients aren't paying you timely, or you have too much inventory on hand and its sucking up your cash flow?

So why should you fall in love with accounting?  If you want your business stand the test of time, you have no choice.  The good news is that you can hire an accountant to help with your business's finances... but you can't hire someone to deal with your mother-in-law. 

Learn more about Bonnie Forssell and her accounting practice here.