A budget states what the owner intends. A forecast states what the owner now expects. Small businesses need both, and they need them tied to the financial statements the firm already prepares. This article sets out a method a CPA firm can repeat across clients, built around drivers rather than line-by-line guesses, with the structure the Small Business Administration asks of a business plan's financial section as a reference point.
What the SBA expects of projections
The SBA's guidance on the financial plan in a business plan asks for a prospective financial outlook for the next five years, with forecasted income statements, balance sheets, cash flow statements and capital expenditure budgets. It asks that the first year be more detailed, with quarterly or even monthly projections, and that an established business include historical statements for the last three to five years. It also asks the owner to explain how much funding is needed over the next five years and what it will be used for. A lender or investor will read the client's numbers against that structure, so a model that produces all three statements is the standard to build to.
The method
1. Start from reliable actuals
Projections inherit the quality of the history. Confirm the trial balance ties to reconciled accounts for the periods used, and clean up classification before building. See catch-up bookkeeping and cleanup projects.
2. Identify the revenue drivers
Replace "grow sales" with the mechanics that produce sales: units and price, billable hours and rate, customers and average order, contracts and renewal. Each driver should have a historical figure and a stated assumption. Write down why the assumption is reasonable, because the owner will be asked.
3. Separate fixed, variable and stepped costs
- Variable. Materials, commissions, payment processing, delivery. Model as a function of volume.
- Fixed. Rent, insurance, salaried staff, software. Model by month with known changes.
- Stepped. Costs that jump at capacity, such as a new hire, a second location or a larger lease. Model the trigger.
4. Build three linked statements
Income statement, balance sheet and cash flow statement should be linked so that a change in one flows through. Working capital is the usual source of surprise: receivables and inventory grow ahead of cash. Model days sales outstanding, inventory turns and days payable explicitly. See days sales outstanding, inventory turnover and working capital. Include debt service, owner distributions, estimated tax payments and capital expenditures. See estimated tax payments.
5. Run scenarios
Prepare a base case, a downside and an upside, changing only the drivers that matter. The downside should test the covenants, the cash minimum and the line of credit. Report the month in which cash is lowest and what funds the gap.
6. Get the owner's sign-off
The assumptions page, signed or approved by email, is the record that the budget belongs to management. The firm builds the model, and the owner owns the assumptions.
Capital spending and hiring plans
Two items move a small company's forecast more than any other: equipment purchases and headcount. Treat each as a schedule that feeds the model. A capital expenditure schedule lists the item, timing, cost, funding source and depreciation method, and it flows to the balance sheet, the cash flow statement and the tax projection. See section 179 and bonus depreciation for the tax effect. A hiring plan lists the role, start month, loaded cost including payroll taxes and benefits, and the revenue or capacity it is meant to support. If a hire has no linked revenue or capacity gain, ask the owner why it is in the plan.
Forecast, not just budget
A budget is set once and compared to actuals. A rolling forecast replaces the months already closed with actuals and extends the horizon, so the client always sees the next twelve months. Update it after each close. Compare each forecast with the one before and list what changed and why.
Monthly review
- Load actuals after the close.
- Compare to budget and to the prior forecast by line.
- Investigate variances above thresholds set in advance, in dollars and in percentage terms. The method follows flux variance analysis.
- Classify each variance as timing, volume, price, mix or error.
- Update the forecast and the cash projection.
- Record decisions and owners.
Common failures
- A budget with no balance sheet, so cash is a surprise.
- Revenue set as last period plus a percentage with no drivers.
- Ignoring seasonality in working capital.
- Treating the budget as a target to defend rather than a tool to revise.
- Building a model nobody at the client can read.
- Sharing projections with lenders without stating the assumptions. If the firm's name is attached to prospective financial information for third parties, a different standard applies, so decide the firm's role in advance. See CS Section 100.
Documentation
Keep the model version, the assumptions page, the source of each driver, the scenario results and the review sign-off. Version the model each time it changes.
FAQ
How far ahead should a small business forecast?
The SBA asks business plans for five years, with greater detail in the first year and quarterly or monthly figures for it. Operating forecasts commonly look twelve months ahead and roll monthly.
Who owns the assumptions?
Management. The firm documents and challenges them.
Is a forecast a guarantee?
No. It is an estimate based on stated assumptions, and the file should show those assumptions.
CORAA prepares ready-to-review audit files for US CPA firms; see /us.
Sources
- SBA, Write your business plan (financial plan): https://www.sba.gov/business-guide/plan-your-business/write-your-business-plan
- SBA, Manage your finances: https://www.sba.gov/business-guide/manage-your-business/manage-your-finances
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AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error