Budgeting vs. Forecasting: Differences and Uses
Budgeting and forecasting are accounting and finance processes helpful for setting goals and measuring a company’s growth.
Although the terms are often used interchangeably, they have some differences to be aware of.
What is Budgeting?
A budget is a detailed report of a company’s financial plan for an upcoming period — usually a month, a quarter, but typically a year.
Budgets often consist of several items-
- Sales and other revenues — Broken down into individual revenue sources
- Expenses — Fixed, variable, and semi-variable
- Overall financial statements including a balance sheet and income statement
These amounts can be planned and estimated from previous period’s financial statements along with each company’s expectations
How Does Budgeting Work?
Mid-sized to large companies often have a formal budgeting process coordinated by the CFO. During the budgeting process, each department of a company may provide input for each department’s expectations to formulate a company-wide, comprehensive budget.
Once completed, it may be shared with managers and decision makers so that the company can strive to meet budgetary goals. In smaller businesses, owners may complete budgets independently with some assistance
Why Do You Need a Budget?
Budgets are necessary to set financial goals for a certain period. These markers provide budgetary numbers vs. actual financial data points that can provide valuable information to make needed adjustments to the company.
Budgeting Best Practices
The following are some best practices when building a budget to assist with making sound business decisions:
- Theory of Conservatism: Be conservative and realistic
- Essential vs. nonessential expenses: Understand the business to know what is needed and not
- Add cash reserves: Rainy days are inevitable and must be planned
- Try to include debt payoff in your budget: Many companies have bank covenants to fulfill, build these into the forecast to avoid future issues
What is Forecasting?
Forecasts are what the company expects to do. The economy and other factors are dictating what will happen. Forecasting is often confused with projections. Projections are what companies expect to do given specific hypotheticals dictated by those calculating the projection.
Forecasts are constructed from the bottom up or the top down, and they can be short-term or long-term. They are updated regularly — sometimes in real-time — as the fiscal period progresses. In doing so, companies can analyze performance and make adjustments as needed.
Forecasting Best Practices
Below are best practices to follow when creating your financial forecasts.
- Ongoing forecasts: Regularly analyze and update forecasts so information is relevant and timely.
- Involve members from relevant teams/departments: Departments close to your sources of revenue are essential to include. Sales manager(s) will have valuable input on your forecasting.
- Create several scenarios: Build forecasts for varying levels of optimism and likelihoods
Is One More Important Than the Other?
Budgeting and forecasting are not mutually exclusive and often play off of each other. At the beginning of a period, budgets are developed. Both are important for management, planning and decision making of a company.
Need help creating useful budgets and accurate forecasts for your business? Let the experts at CFO Hub handle it. Contact us today for your free, no-obligation consultation.