One of the biggest things first-time clients struggle with is their numbers. Everyone knows that to really know your business you need to know your numbers but many business owners have never been taught exactly what to look for and what they mean. It’s an area so many business owners struggle to comprehend and it’s a definite area to upskill in or get some help to increase your chances of both survival and flourishing.
The fact is, numbers do not lie. They can tell you what you are missing and not acting on… They really illuminate what is going well – and what isn’t. The first thing I do as a business advisor and coach is get under the bonnet to understand a company’s numbers and I’ll learn far more from this initial look than from any other kind of background information.
Let’s start with the basics — a budget and a forecast. The key difference is a budget is a plan for where a business wants to go, while a forecast is the indication of where it is actually going.
A budget is what you want to achieve. It’s usually done once a year and has a quantified expectation around what you hope to achieve in terms of results, financial position and cash flows. A forecast is an estimate of what will actually be achieved and usually just includes high-level revenue and expense line items plus a cash flow forecast. These are updated regularly – perhaps monthly or quarterly – and are used for short-term operational considerations such as staffing, inventory levels and production plans.
Having a budget is one thing but, in my opinion, having a forecast is more important as that is your reality check. This is how things are looking and how much profit and cashflow you are going to make based on what you think is likely to happen. Information is power. As an example of how important a forecast can be, when I was the CFO for Flight Centre (an ASX-listed company) in their head office in Brisbane in the early 2000s I was literally updating our forecast daily.
If you are aware of how your forecast is tracking, it will drive urgency, accountability and help you consider making important decisions sooner than later…
A budget, just like a business plan, will not be worth much if you never refer back to it. It really can drive some great accountability and success in business is all about accountability to do the right things and to push as hard as possible.
You really need an annual budget, broken down monthly to bring extra accountability. It is just a simple spreadsheet but it needs to go beyond just a sales top-line budget. If you can’t do it yourself, get your external accountant or business advisor to help you.
A key part of every business plan is to have a view on what your future success looks like — this includes what profit you want to make for the next year. So let’s talk about the two ways you can devise your profit target for the year.
The top-down approach is where you set your profit target first and then you build a budget to see what sales, gross profit (GP) and costs need to be to achieve your desired profit target. This is a way to check that your wanted profit level is actually attainable.
The bottom-up approach is where you do a separate budget considering the 3 key inputs to your P and L: your sales level, your GP and your related operating costs. You’ll go through a detailed consideration to land on what sales performance you feel comfortable committing to delivering; ditto with GP and operating cost structures. At the end of this bottom up approach, you end up with the leftover (hopefully a surplus!) which is your profit expectation. If you agree on this budgeted profit, then when you do your business planning, you’re going to need to need to ensure you come up with the right strategies to deliver this budgeted profit.
I suggest you start with the top-down approach then – via a budget – see what sales, GP and operating cost levels are needed to get you there. That way you can decide how attainable these required levels of performance are. This will help you in your planning and strategic thinking. I personally push this approach with my clients because I think for most businesses profit growth and value creation is the ultimate name of the game (beyond being a great employer) – if you start with what profit you’d like to make, it helps to drive a budget and expected levels of performance. When you go with the bottom-up approach, ending up with a profit budget being the leftover of the 3 key components, I think you’re just accepting the output profit rather than really considering what level of profitability you could achieve and which shareholders require.
By deciding early on in the process what profit target is appropriate, it helps to really push the strategic thinking of the business – this goes a long way to predicting success, in my experience.
I hope these explanations have helped you to understand your numbers a little better!