Let’s be honest: The vast majority of small businesses don’t need to worry about budgeting and forecasting. Most entrepreneurs have a good feel for how their business is performing and do some type of informal budgeting and forecasting in their heads.

However, if you have a rapidly growing business or you want to apply for a credit line or bank loan in the near future, then it might be time to building some type of formal budgeting system. Here’s a quick summary of the what that process looks like:

Step 1: Look at your prior financial results

The starting point for any budget or forecast is to gather your financial statements for the past 1-2 years and lay them out on your kitchen table. Unless you’re starting a new business from scratch (in which case there’s no historical data to look at), this will serve as your foundation and provide the baseline for what’s going to happen next year. As the old saying goes: “Past results are the best predictor of future performance.”

Step 2: Write down some reasonable assumptions

Next, take a step back and make a few educated guesses about what's going to happen with your business in the coming year. Don’t worry about crunching any numbers yet, just ask yourself some basic questions. What’s happening in your industry? Is demand for your products/services increasing or decreasing? What happened with revenue last year, and what do you think is going to happen this year? Are you anticipating any increases in your costs or expenses? Try not to overanalyze, most business owners have a good sense of intuition about these things.

Step 3: Forecast your expected revenues and expenses

This step takes some time and work but it’s not as difficult as it sounds. The basic idea is to take your prior financial results in one hand and your reasonable assumptions in the other, then use them to build a projected P&L for the next twelve months. And voilá: This will serve as your sales forecast and operating budget for the coming year.