Budgeting vs Financial Forecasting: What’s the Difference?

0

Budgeting vs Financial Forecasting: An Overview

Financial budgeting and forecasting are tools companies use to establish a plan of where management wants to take the business – budgeting – and whether it is going in the right direction – financial forecasting.

Although budgeting and financial forecasting are often used together, distinct differences exist between the two concepts. Budgeting quantifies the expected revenue that a business wishes to achieve for a future period. In contrast, financial forecasts estimate the amount of revenue or revenue realized in a future period.

Key points to remember

  • Budgeting is the financial direction of where management wants to take the business.
  • It helps to quantify the revenue expectations that a company wishes to achieve for a future period,
  • Financial forecasts indicate whether the business is heading in the right direction, estimating the amount of revenue and revenue that will be made in the future.
  • Budgeting creates a baseline against which to compare actual results to determine how results vary from expected performance.
  • Financial forecasts are used to determine how companies should allocate their budgets for a future period.

Budgeting

A budget is an outline of the expectations of what a business wants to achieve for a given period, usually a year. Features of budgeting include:

  • Income and expense estimates.
  • Expected cash flows.
  • Expected debt reduction.
  • A budget is compared to the actual results to calculate the variances between the two numbers.

Budgeting represents the financial position, cash flow and goals of a business. A company’s budget is usually reassessed periodically, usually once a fiscal year, depending on how management wishes to update the information. Budgeting creates a baseline against which to compare actual results to determine how results vary from expected performance.

Although most budgets are created for an entire year, this is not a hard and fast rule. For some businesses, management may need to be flexible and allow for budget adjustment throughout the year as business conditions change.

Financial forecast

Financial forecast estimates a company’s future financial results by examining historical data. Financial forecasts allow management teams to anticipate results based on previous financial data. Features of financial forecasts include:

  • Used to determine how companies should allocate their budgets for a future period. Unlike budgeting, financial forecasting does not analyze the gap between financial forecasts and actual performance.
  • Regularly updated, perhaps monthly or quarterly, when there is a change in operations, inventory and business plan.
  • Can be created for short term and long term. For example, a company may have quarterly revenue forecasts. If a customer is lost to competition, revenue forecasts may need to be updated.
  • A management team can use the financial forecast and take immediate action based on the forecast data.

Financial forecasts can help a management team adjust production and inventory levels. Additionally, a long-term forecast can help a company’s management team develop its business plan.

A financial forecast is usually limited in scope, focusing on expense items and major revenue streams.

Main differences

There are critical differences between budgeting and forecasting. For example, budgets are created to achieve a goal, such as quarterly growth. The financial forecast examines whether or not the budget objective will be achieved throughout the proposed schedule. The contents of a budget and a financial forecast are different – the former contains specific goals such as the number of items to sell or the amount of money to be earned. The latter shows expectations as to how the budget will be met.

A budget is established for a specific period and is usually based on past trends or company experiences. A financial forecast examines a company’s current financial condition and uses the information to forecast whether or not a budget will be met. Financial forecasting can be done frequently while a budget is made for a specific period of time and cannot be done more than once, twice, or quarterly.

Special Considerations

A budget outlines the direction management wants the business to take. A financial forecast is a report showing whether the business is meeting its budget goals and where it is heading in the future.

Budgeting can sometimes contain goals that may not be achievable due to changing market conditions. If a business uses budgeting to make decisions, the budget should be flexible and updated more frequently than a fiscal year, which is in line with the prevailing market.

Budgeting and financial forecasting must work in tandem. For example, short-term and long-term financial forecasts could be used to create and update a company’s budget. A budget is not always necessary during a financial year, although many companies do. However, a financial forecast is relevant because of the information it provides as it can highlight the need for action. On the other hand, a budget can contain objectives that cannot be achieved if the budget exceeds the limits.

How can a budget help with financial planning?

A budget can help set a company’s expectations over a period of time, such as quarterly or annually, and it contains estimates for cash flow, income and expenses, and debt reduction. When the period is over, the budget can be compared to the actual results.

Which comes first, a budget or a forecast?

Typically, a budget is created before a financial forecast. A budget reveals the shape or direction of a company’s finances, while a forecast shows whether or not the company is meeting its financial goals as stated in the budget. Long-term financial forecasts can be done without having a budget first, but would likely use past key indicators from previous budgets.

What are the steps of financial forecasting?

When a company creates a financial forecast report, it decides on a timeline for the forecast and then gathers all past financial documents and necessary documents around the time period. The report will document, monitor and analyze critical data such as cash flow, income statements and balance sheets.

Share.

Comments are closed.