It is always good to be prepared. In business being unprepared for the unexpected could lead to loss of clients, reduced profits, damaged reputation, et cetera. Small business are not exempt from this either. Budgets and Forecasts need to include a reserve for the What ifs, such as, what if the office gets flooded?, what if a machine breaks down and a replacement is required ASAP?!, What if our supplier’s plant gets flooded?
Many companies use historical budgets (utilizing and analyzing past expenses from 3-4 past fiscal periods) to see revenue and expenses trends and using this information to create the current budget. The problem with this budget method is that it does not consider the future, therefore, it is impaired by the unforeseen. To minimize this risk, companies should assess all business operation risks and add reserves for the accounts that have “high budget risks”.
For example, let’s say your business is growing and you just finalized a big contract deal, but this is now the 2nd quarter of the fiscal year. Now you have to analyze sales, hiring and purchasing forecasting data and update the budget accordingly. This is also true when you lose a big client, you have to be prepared to revise your budget despite efforts to replace the lost client to ensure profitability at the end of the year; meaning cutting costs.
Continuous budgeting ensures that your company is abreast of all risks, revenue and expenses trends that are and could affect the company. Companies that have a frugal mindset (e.g. Apple, Microsoft, Google) and hoard their cash are always prepared for the worst. Historical budgets essentially just demonstrate the past and provide a budget amount base for all your accounts but you have to ensure sales demand, hiring, purchasing and risk data is taken into account to finalize the budget properly and update accordingly per any changes in the business.