November 4, 2011

A standard best-practice for decades, the annual planning and resultant budget have become familiar strategic tools for businesses large and small. Yet small businesses and entrepreneurial ventures often struggle to find value in the process simply because there's too much variability in their month-to-month performance to really project performance with any degree of accuracy.

Why the static budget fails

Here’s an example. A 3-year-old company has been struggling to generate a few hundred sales per month. They have a carefully planned annual budget, organized month-by-month, that reflects how they will utilize the revenue from these sales to pay their staff, run their business and have a little left over to invest in future products.

Then, almost overnight, their monthly sales break 1,000 units and they never have a three-digit unit sales month again…ever. This company’s annual budget became obsolete overnight, yet most businesses refuse to update their budget and try to analyze variances between their actual and budgeted performance. After one attempt, they realize this effort is futile and they abandon it altogether.

Although this example is extreme, it highlights the point that forecasting the future of small and entrepreneurial companies is usually more difficult than forecasting much larger companies with more predictable sales. So, is there a way to make the budgeting process more meaningful for entrepreneurs?

The rolling 12-month budget

Rather than a static, locked-down 12-month plan, what if business owners adjusted their forecast monthly based on everything they learned during the prior months? Some assumptions were likely validated, like the cost per lead. Other assumptions were likely invalidated, like the percentage of the leads that actually turned into paying customers. One important element of a rolling budget is the ability to change assumptions and outcomes along the way rather than be stuck with bad assumptions for an entire year.

Adding a new month as each old month closes
Another great feature of the rolling budget is that you always have twelve months forecasted with your most recent and valid assumptions, plans, strategies and tactics. When most companies use a static budget, the forward-looking nature of their predictions gets shorter as the year transpires. A calendar-year company, therefore, only has three months budgeted in October—not much of a forecast.

As you update your budget each month, you also add another month on the end, meaning you always have at least 12 months planned into the future. It forces you and your team to constantly be thinking about the future implications of your actions today, how your products or services are accepted by paying customers, what competitive pressures will do to your sales, how you should staff your business and so much more.

So, does adding a new month to your budget every 30 days take more or less time than a once-per-year budgeting process? I haven’t seen any empirical evidence to answer this specific question, but there are plenty of examples that cite improved results, meaning if any extra time is required, it will likely generate a desirable return. (Get more advice on budgeting.)

Software and drivers

Regardless of how you keep track of your budget, a monthly variance analysis is the catalyst to keeping the next 12 months dynamic, relevant and as accurate as possible. Many accounting and financial planning software packages exist, but this entire process can be accomplished even in a spreadsheet. No matter what tool you use, the basis for your month-by-month plan should be the key drivers in your business.

A key business driver is an assumption about how different parts of the business will be affected by one factor. For example, a driver of business performance may be sales. Since sales determines the amount of variable costs, the assumptions we make about sales is a key driver for many of the expenses in the business. Other examples of key drivers include employee headcount, leads generated, attrition rates, working capital days, among others.

The main point to remember is this: Once you determine your key business drivers, or the best way to make assumptions about what will happen in your business in the future, allow the drivers to determine the outcomes. So, whatever software you use, make sure it will support your use of drivers to create and update your rolling forecast. (Get more tips on business software.)

The bottom line

Different versions of rolling forecasts have been around for quite some time in large organizations, but they are becoming more popular in small and medium-size businesses (SMBs). Why? Because they are actually more valuable in companies with less predictable revenue streams and cost containment efforts. The rolling forecast is a powerful, forward-looking solution to help entrepreneurs spot key trends, make critical pivots and maximize their performance and results.

Related Topics

• Money

Related keywords

Ken Kaufman, Article, budgeting, forecasting

Join the conversation ( 1 )

• Sid Ghatak 6 months ago

  

  Great article Ken, small and medium businesses can benefit the most from a rolling forecast but are often swamped with “running the business” so they don’t take the time to do so. One key element that you touched on was the update process. To get the most benefit out of a rolling forecast, I think it is more important to update the periods that had been previously forecast than to add the additional month at the end. The near term periods are where tactical decisions are made, the periods further in the future align to achieving goals. To make this process easier, consider forecasting by month for the immediate 3 months and by quarter for the balance of the forecast horizon. Sid Ghatak, President, Rolling Forecast Solutions, LLC