... and use all three to steer a safe course through the tricky waters of financial management, writes financial consultant Adrian Goodman.
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FOR UK-based SMEs, understanding the financial landscape of your business is critical to sustainable growth. Three key tools – budgets, forecasts, and targets – are essential in guiding decision-making and ensuringfinancial stability.
Though sometimes used interchangeably, these terms serve distinct purposes and contribute differently to your business’s financial health.
Budgets: The Financial Blueprint
A budget is essentially your business’s financial blueprint for a specific period, usually a year.
It sets out planned revenues, expenses, and, ultimately, profits, based on past performance, known deviations and an understanding of the resources available. It’s a comprehensive plan that should account for both fixedand variable costs, ensuring that you have a realistic view of what your business will look like financially.
The key benefit of a budget is that it establishes a framework for financial discipline. It allows you to allocate resources efficiently, identify potential shortfalls early and set clear financial boundaries.
When adhered to, a budget ensures that funding and resources have been properly allocated, prevent overspending and ensure economic viability. However, it’s important to note that a budget is a static document – it doesn’t account for unexpected changes or opportunities that may arise during the year, and, once approved and issued, should only be amended under exceptional circumstances.
Forecasts: Adapting to Change
A profit forecast, unlike a budget, is a dynamic tool that evolves as your business grows and market conditions change.
While a budget is set at the beginning of a financial period, a forecast is updated regularly – often monthly orquarterly – to reflect actual performance and new information.
Forecasts consider current sales trends, economic conditions, and other variables that could impact the eventual performance of your business.
The primary function of a forecast is to provide a realistic estimate of your future financial position. It enables you to adjust your expectations in response to real-world developments, making it a critical tool for proactivefinancial management.
Although it’s not the same as a budget, it will often be viewed alongside your original budget to apply context to visible trends.
Targets: Driving Performance
Financial targets are the specific goals your business aims to achieve within a given timeframe.
Unlike budgets and forecasts, which are rooted in reality and ‘best estimates’, targets are aspirational. They set the bar for performance, challenging your team to reach new heights.
Targets can be related to revenue, cost reduction, profit, market share, or any other key performance indicator that aligns with your strategic objectives.
Setting realistic yet ambitious targets is crucial. They should be challenging enough to motivate your team but setting them out of reach can damage morale. Targets also play a crucial role in performance management, helping you to measure success and hold your team accountable.
When targets are met, they validate your strategic approach; when they aren’t, they provide valuable lessons that can inform future planning.
Financial control is not just about having a solid budget or an accurate forecast; it’s about integrating these tools effectively.
A budget provides the financial foundation. Forecasts offer the flexibility to adapt. Targets drive your business towards its goals.
By understanding and leveraging the unique strengths of each, business owners can navigate the complexities of financial management with confidence, ensuring long-term success and sustainable, profitable growth.
Adrian Goodman is managing director of PPX Consulting.
01536 856 740
Click here to buy my new book Achieving Profitable Growth.
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