It is important to build a budget for your small business every single year. Ideally you would build your budget towards the end of each year. You want to use your historical financial performance as a guide. Be sure to only use your past performance as a guide and that is all. What I mean is that a good budget needs to incorporate both logic but also your goals.
Blend logic based on your historical financial performance and what you want to happen. Apply this method to both your income and expenses to come up with the best budget possible.
The last step is to make sure to enter your budget into Xero by month, meaning each month separately. Once your budget is entered in Xero you should not change it and you should run budget vs actual reports often. This will allow you to keep your budget on track with your goals.
Create a Forecast
When you initially build your forecast prior to the start of a new year it should be identical to your budget. You may then ask what the difference between a budget and a forecast is. The answer is that a budget does not change throughout the year, but a forecast does.
Each month you want to redo your forecast based on your variance, which is essentially your budget vs actual. You want to look at your actual performance versus your expectations and use that information to help you modify your forecast for the future. You also want to take into consideration any business changes that have occurred. If you intend to hire an employee within the next two months then that should be accounted for in your forecast.
This approach is what is referred to as a rolling forecast. By taking your actual performance, comparing it to your expectations and using that information to modify your future forecast you really get a handle on your business financials. This allows you to really control the finances of your small business and spot any potential issues or opportunities. By re-forecasting you will literally be looking forward in your business.
Look Forwards not Backwards
It is really important to look forwards not just backwards in your business. When doing their financial reporting most business owners tend to look at a profit and loss from last month or last quarter. Looking at the past is often too late to react and fix any potential problems. While it is important to look backwards at your financials, it is much more important to look forward in the business. That does not mean just looking at what you have budgeted. When you look forward you should be using your actual performance to predict the future. You should then modify your forecast (rolling forecast or re-forecast) and analyze those results. Does anything concern you? Is there anything you can do right now to modify the future expectations that you are predicting?
If you follow my logic you can understand why re-forecasting is so important and how it can benefit your business. The next time you find yourself analyzing past financials remember it is more important to use those past financials to look into the future.