Building a cash flow budget and forecast to determine capital requirements

Within the financial planning process, most businesses prepare an annual budget that remains fixed throughout the year and also a long-range plan that covers a period of around 3-5 years. This results in several versions of budgets and forecasts for any given year, which have each been prepared at a different point in time and for a different purpose.

Your budget is an essential tool towards driving the business to achieve your desired financial performance. During this video, experienced CFO and CEO Stuart Trood provides top tips for preparing a budget:

Budget ownership

The budgeting process should start with the Board. A budget is a business tool, not a finance tool. It is essential that you make the business feel accountable for their budget and that they take full ownership for delivering it. Otherwise, the business will look for ways to make your finance team accountable for any shortfalls in revenue or for any cost overruns.

The CEO needs to be involved throughout the process and should lead on communicating your budget to the business. The CEO needs to have strong knowledge of what is driving the budget and to be capable of discussing it with the workforce.

It makes sense for the CEO to communicate the headline numbers and for the finance leader to talk through some observations and finer details. You will need to properly prepare for your presentations and be joined up so that you are communicating the same messages.

Quarterly revisions

Your approved annual budget should be locked down for the year within a specified timeframe and then benchmarked against actual performance. Finance leaders should revise your forecasts on a regular basis throughout the year, for example quarterly. This helps to reflect unexpected outcomes, including:

1. Any unexpected results from your ongoing performance;
2. New strategic initiatives launch during the period; and
3. The impact of any external events on your business results.

Finance teams will need to stress-test different scenarios and update your budgeted assumptions. This helps to quantify their likely effect on your financial budgets and to re-forecast your expected annual performance.

These revised versions are often referred to as 3+9, 6+6 and 9+3.

Mastering the budgeting and forecasting process

Budgets are typically used to set minimum delivery targets for performance management purposes, whilst forecasting helps to inform decisions and model outcomes. They have different purposes, different users and suffer from different politics.

During this video, experienced finance leader and FP&A specialist Catherine Marks shares insights regarding the budgeting and forecasting process:

The way that you prepare your forecast depends upon who is the intended audience and therefore what level of detail is required.

If we think about operationalizing a budget for performance management purposes, that is likely to be very different to a long-range plan that is more focused on strategic direction and the overall shape of the financials. Or for example, sharing with potential investors as part of a fundraising exercise.

Finance is often too focused on the accuracy and predictability of planning cycles. But actually, good forecasting is not so much about accuracy. It is more important that it is comprehensible and flexible enough to inform decisions and drive outcomes. You should also make sure that you have an effective feedback loop as inevitably we will get things wrong.

Often, we try to use one forecasting approach for too many purposes. It is important to keep coming back to the following considerations: what is the purpose, who is it for and what level of detail is required?

Picking up on some of the above examples:

• A budget: one of the main purposes of this is to set minimum delivery targets. It is therefore important that we work hand-in-hand with business stakeholders to drive accountability. It is likely that this will be needed at a very granular level to provide clear ownership to individual budget holders at cost center level.
• A long-range plan: you may wish to separate this from the budget politics and focus on a manageable number of variables, both financial and non-financial variables, with a clear logic.

You should adapt your processes to the purpose of your forecast in order to add the most value.

Determine capital requirements

The budget and forecasting process will help you accurately determine capital requirements to make informed decisions about your operations and investments. Looking at your sales forecasts and cash flow projections will provide insight into future capital requirements. Your funding requirements will vary throughout the year based upon the projection of your cash balance throughout your annual cycle.

Once you have identified the necessary capital requirements for future operations, the next step is to determine where the funds are coming from. It is essential to look at both the short-term and long-term when considering how to finance your business.

Action required

Participants should complete the following exercises:

1. Write down the purpose and intended audience for both your budgets and forecasts.
2. Collate a list of the decisions that people are making as a result of the information provided.
3. Hold a discussion with each person to corroborate their needs and level of detail required.
4. Determine whether you are providing them with the right level of information and whether anything else needs to be included to support such decision-making.
5. Create and implement a list of action plans to further improve your budgeting and forecasting process.