A budget estimates how much money your business will earn and how much it’ll spend over a specific period. At its simplest, a budget lists fixed and variable expenses and determines how to allocate the money coming into the business.
A forecast uses historical and current transactional data, along with industry and market information, to help determine how to allocate budgets for anticipated expenses for a future period of time. Forecasting increases the confidence of the management team to make important business decisions.
Budget setting and financial forecasting have unique purposes, but they work best together. While a budget details expected future results, a forecast focuses on probable future events to inform whether a company will hit the targets set in a budget. To use the common analogy that the budget is a map, taken together, forecasting and budgeting are sort of like Waze or any map application on your phone. Budgeting is the map, and forecasting provides the tools to make adjustments in how you get to your destination.
- Budgets keep companies on track by laying out spending parameters and allowing for the comparison of anticipated results to actual ones.
- Forecasting looks at the budget targets and brings in past information, along with market and industry analysis, to predict whether the anticipated target will be achieved.
- Budgets allocate funds, while forecasting is a tool used to make those allocations.
What Is Budgeting?
Budgeting is the process of making a plan for how you will spend your business’s money over a given period (month, quarter, year, etc.). The budget estimates your company’s revenue and expenses for that period. Budgets are re-evaluated and re-adjusted on a periodic basis—in most cases on a quarterly basis.
What Are the 5 Types of Budgets?
There are five types of budgets a company typically produces in order to run the business.
- Building a static budget, which is completed by department and looks at fixed expenses, is often the first step in the budgeting process. A static budget remains unchanged even if there are changes to parts of the business, like sales levels.
- A master budget covers all departments across the company. These budgets are created each fiscal year. The master budget projects revenue, expenses, operating costs, sales, capital expenditures and other items used for financial statements.
- A financial budget presents a company’s strategy for managing its assets, cash flow, income and expenses. For example, if a company is looking to go public or going through M&A, they would build a financial budget to determine or show its value.
- Operating budgets predict the revenue and expenses from daily operations, including cost of goods sold and sales, general and administrative expenses.
- Finally, a cash flow budget makes assumptions about cash inflows and expenditures over a certain period.
Why is a budget important?
Budgets can be short-term or long-term. They keep companies on track by laying out spending parameters and allowing for the comparison of anticipated results to actual ones. By providing targets, they give businesses goals to aim for and a framework for meeting them responsibly.
What Is Financial Forecasting?
Financial forecasting is different from budgeting. It looks at the budget targets and brings in past information, along with market and industry analysis, to predict whether the anticipated target will be achieved. The forecast helps finance professionals and individual department leaders see if the company will meet the expectations laid forth in the budget—and gives them the information needed to make adjustments if they’re not on track to do so.
Why is Forecasting Important?
A financial forecast ensures business units have the resources needed to deliver on what the business needs—almost all organizations create a quarterly financial forecast. However, new customers, lost clients or an outside event like a pandemic can all significantly impact quarterly forecast accuracy. Agile companies incorporate rolling forecasts to make planning an ongoing process instead of a quarterly event. These companies then are able to be more responsive in a fast-moving market while avoiding the surprises of their quarterly-routine forecasts.
What Comes First, the Budget or the Forecast?
Budgets and forecasts must work together—one sets the targets; the other lends insight on whether they can and will be achieved. A forecast can be used to help build a budget or figure out how money should be allocated to specific areas of the business. But without a budget, the forecast has no real aim.
What Is the Budgeting and Forecasting Process?
There are four types of budgeting processes: incremental, activity-based, value proposition and zero-based.
Incremental budgeting is the most common method. It takes the numbers from the prior period and adds or subtracts a percentage to come up with a budget for the current period, according to the Corporate Finance Institute.
An incremental budget process is based on the idea that a new budget can be developed by making marginal changes to the current budget. For example, today’s budget can be used as a base to which incremental assumptions are added or subtracted from the base amounts to determine new budget amounts.
It’s a good method to use if your company’s primary cost drivers don’t change year over year, but it doesn’t take into account whether certain departments actually need more or less money to achieve the current period’s goals.
- Activity-based budgeting (ABB) sets a target and determines which inputs and activities are needed to get there. ABB is a method of budgeting where budgets are prepared on the basis of activity-based costing (ABC). It provides 3 types of information: activities to be done for the next year, the number of activities and the cost of activities. For example, a carwash aims to deliver 12,000 washes next year, and supplies cost $10 per wash. The activity-based budget for this initiative is $120,000 (12,000 * $10).
- Value proposition budgeting does exactly that. It considers the question of whether everything in the budget delivers value for the business by examining whether each line item creates value for customers, staff or other stakeholders.
- Zero-based budgeting also fits its moniker—every department starts at zero and must build a budget from scratch, ignoring all resources and expenditures currently at their disposal. Managers must justify every item in the budget.
Each budgeting method has value, depending on what the company is trying to accomplish and where it is in its growth journey. Zero-based budgeting, for instance, is a good tool for companies needing strict cost containment. Value proposition budgeting provides a valuable exercise for companies just starting to budget.
Forecasting brings in data on current and historical transactions and market conditions to determine whether budgetary targets are going to be achieved. For instance, take a monthly sales forecast, which provides information on inventory levels, changes in customer habits and news of what competitors are up to, coupled with actual sales data for a specific time period. By combining this actual sales data with sales forecasts and the budgetary targets, a business can confidently make necessary changes in its approaches to sales, marketing and more to ensure its performance goals are achieved.
Budgeting vs. Financial Forecasting
Budgeting and forecasting may seem similar at first glance, but there are some crucial elements that make them distinct. Below, we explain those similarities and also how budgets allocate funds, while forecasting makes those allocations.
Both budgeting and financial forecasting help management to make sound business decisions and provide guidelines to follow when recalibrating business plans. The finance team typically oversees both final budgets and forecasting, both of which pull in historical data to make assumptions about future events.
But there are important differences in financial forecasts vs. budgets. A budget (for that particular time period, generally a fiscal year) is static. A forecast can convince a company to make changes in its budget, but not the reverse. Budgets allocate funds. Forecasting is a tool used to make those allocations. Budgets provide targets. Forecasts let you know whether you’re going to hit them. Forecasting does not provide information on what actually happened in your financial past. Budgets do, relying on variance analysis of actual vs. expected results.
Both are crucial tools that work best together to make sure business plans remain on track.
An overview of the differences between a budget and a forecast: