Why Your Business Budget is a Guessing Game: And How to Fix It!

Ever feel like managing your business finances is a bit like predicting the weather? One minute it’s sunny skies, and the next, you’re hit with a massive, unexpected storm cloud in the form of a giant bill.

If you want to grow, you can’t just react to what’s happening right now. You need to look ahead. When you look to do forecasting and budgeting in your company, you have to find a way to make the unpredictable… predictable.

Thankfully, accountants have a couple of brilliant secrets up their sleeves to help you do exactly that. Let’s break down two powerful concepts that will take the guesswork out of your business budget.

1. The Magic of Prepaid Expenses (and the Obsession with “Matching”)

Accountants sometimes use a device they call prepaid expenses.

Prepaid expenses occur when there’s a large expense that applies to an extended period of time: like when you buy a full year of business insurance all at once. If you pay $12,000 in January for the whole year, recording that entire amount in January makes it look like you had a terrible, unprofitable month… even if your sales were great!

Now remember: accountants are obsessed with what’s called the Matching Principle.

The Matching Principle: We’re always trying to match expenses with revenue in the same period. We want to align things that occur in the same month, the same week, or the same quarter.

When we have these large expenses, the way that we apportion that expense over the year… the way we match it against revenue… is through prepaid expenses.

Here is how it works behind the scenes:

• The Purchase: When the disbursement is made, when we buy the insurance, it lands on your balance sheet as an asset called a prepaid expense.

• The Monthly Routine: Then, every month as part of our closing procedures, we recognize exactly one-twelfth of that total.

• The Adjustment: We make a smooth monthly adjustment, and that small chunk… one-twelfth of that prepaid expense… gets recorded on the income statement.

That way, we’re preserving the integrity of the matching principle and keeping your monthly profit reports completely accurate.

2. Factoring in the “Rumsfeld Factors” for Future Planning

Smoothing out your past expenses is only half the battle. What about forecasting your future income and costs?

To build a bulletproof budget, you’re going to want to account for what I call the Rumsfeld Factors. Donald Rumsfeld was a US Defense Secretary, and he famously talked about three categories: the known knowns, the known unknowns, and the unknown unknowns.

Your business forecast should account for all three types of these things:

• Your Known Knowns: These are the events that are highly likely to occur… and you know exactly who those people are. These are the loyal customers who have already signed contracts, or the recurring revenue events that you absolutely know are going to happen.

• Your Known Unknowns: These are opportunities you’ve clearly identified, but you just can’t completely quantify yet. Think of prospects sitting in your sales pipeline, or your upcoming holiday season sales. They are going to occur… it’s just not a 100% certain thing yet. Even so, those should absolutely be estimated somewhere in your forecast.

• Your Unknown Unknowns: These are the wildcards… the things you think might happen in a year. Dealing with this category is really all about planning for risk.

The Ultimate Goal: Better Data, Less Stress

The trick to becoming a master of your business finances is to chronicle and list all of the assumptions that are going in around your unknown unknowns and your known unknowns.

Why do this? Because as you get better and more experienced with forecasting, you will start to move more and more things into the “known knowns” category.

When you pair smart forecasting with steady accounting practices like prepaid expenses, your financial data goes from a confusing mess to a strategic roadmap. You’ll see exactly where your money is going, exactly when it’s leaving, and exactly what’s coming around the corner.