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Accounting & Audit

Analyzing the Results of Budgets and Forecasts

By December 21, 2017No Comments

At the end of each year, it is important to both look back and see how well your organization performed against its budget and look forward to forecasting for the future. Budgets and forecasts are important tools to help you plan for your business’s future, and to gain insight into areas of improvement.

A budget is an important management tool used to analyze past operating results by detailing financial information of what an organization expects to happen over a period of time, typically a year. A budget will include details about your organization’s revenues, expenses, cash flows, and financial position. Most budgets are static and set for the organization’s fiscal year; however, some organizations use a continuous budget and adjust during the year based on changing business conditions. While this can add accuracy, it also requires closer attention and may not necessarily produce a better outcome.

With a budget, actual financial results are compared to budgeted amounts and the resulting variances are analyzed (actual minus budgeted equals variance). These variances help to identify specific areas for improvement within an organization. After determining your budget variances, you have generally two options to correct the gap: you can implement a flexible budget, which adjusts the budget in future periods to conform to revenue or spending realities; or, you can implement a static budget – keeping the budget the same but taking actions to impact future spending or revenue to bring future budgeted amounts and actual results more in line with each other.

A forecast is an estimate or projection of what will happen at a higher lever such as revenue and overall expenses. Forecasts can be prepared on both a short-term and a long-term basis, with a short-term forecast focusing on operational outcomes and a long-term forecast focusing on strategic business outcomes.

It is often advantageous to develop more than one forecast: a best-case scenario, a worst-case scenario, and a most-likely scenario. This will allow to plan for organizational growth while being able to adjust in instances when business doesn’t materialize or occurs slower than originally projected.

You can follow these easy steps in calculating a forecast:

  • Project Sales Revenue and Other Income – It is good practice to set sales or revenue targets first, then the remainder of your forecast will be based on this number. One good way to estimate revenue is by looking at last year’s financial results and use those to develop a reasonable goal for sales and profits plus or minus new or lost customers or contracts, etc.
  • Calculate Operating Expense – Estimating operating expenses includes fixed expenses such as rent or loan payments, as well as variable expenses such as utilities or supplies. A good starting point for estimating variable expenses is to average expenses in past years, and determine if they appear reasonable for the coming year, taking into account market increases, cost of living increases, and expected changes on the horizon for the business.
  • Calculate Cost of Sales – Direct costs of sales can be calculated by estimating your total amount of sales, and by estimating the total cost per unit of that sale. This generally includes the cost of inventory, or of services rendered.
  • Determine your Profit Margin – Profit margins are the result of the factors listed above: when you start with sales then subtract out operating expenses and cost of sales. This will give you a reasonable estimate of what your profit margin should be for the coming year(s).

Although budgeting and forecasting serve different purposes, a solid forecast assists with the development of a sound budget. For additional support or general questions about the process of preparing a budget or forecast, or setting one up in QuickBooks, feel free to contact Kristi Yanover, Audit Partner, at (858) 558-9200, or any member of our Accounting & Assurance Team; we would be happy to assist you.

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