Budget vs Forecast: Functions and Differences
Budgets and forecasts play a crucial role in companies’ financial well-being during every stage of the business lifecycle. They help businesses achieve their financial goals and targets and prepare for potential uncertainties.
And while budgets and forecasts work in tandem, they serve distinct functions. Put simply, the budget sets out a firm’s strategic direction, while forecasts track whether it meets its financial goals on an operational level.
But that’s not the only difference between a budget and a forecast. Let’s define the concepts and juxtapose budget vs forecast.
Table of Contents:
- What Is a Budget?
- What Is a Financial Forecast?
- Key Budget vs Forecast Differences
- How Budgeting and Forecasting Work Together
- Budget vs Forecast: Wrap Up
What Is a Budget?
A budget is a financial tool for estimating financial performance over a specified period. It helps companies prepare for uncertainties and serves as a baseline to compare targets to actual results.
The main budget components include:
- Revenue and expenditure estimates
- Anticipated cash flows
- Fixed and variable costs
- Expected profit and loss
- Anticipated debt
The benefits of budgeting are numerous. This process helps companies make important financial decisions in various ways. For instance, capital budgeting allows for the adequate allocation of funds across projects.
Budgets are prepared for a particular period—typically, one year. That’s why it is usually referred to as the Annual Business Plan (ABP), which outlines the following factors (among others):
- Development standards and procedures
- Prevailing market conditions
- Relationships between the company, customers, and vendors
- Calculation methods, assumptions, and others
The primary types of budgets businesses prepare include:
- Cash flow budget
- Capital budget
- Operating budgets (sales, production, SG&A, etc.)
The following is an example of a sales budget:
|Units to be sold||5,500||6,500||7,500||8,500|
|Multiply: Expected price per unit||$10||$10||$11||$11|
|Less: Discounts & Allowances||$1,000||$1,500||$1,250||$1,500|
Before we continue with the budgeting vs forecasting comparison, let’s define forecasting.
What Is a Financial Forecast?
Financial forecasting is the process of estimating and providing insights into a company’s financial well-being and future. It relies on historical sales, purchases, expenses, and costs data, as well as pro-forma financial statements: balance sheets, cash flow statements, and income statements with projected financial data. Forecasts can also be based on position statements, industry trend analyses, and competitor trends.
The purpose of forecasting is to estimate companies’ future financial well-being and make financial decisions based on the latest available information and trends. This activity also helps businesses allocate their budgets adequately and evaluate whether the business plan is achieved.
The following table is a financial forecast for the fictional company XYZ Inc.:
As you can see, forecasted net sales may be the same as the budgeted (in Q1), above them (in Q4), or under them (in Q2 & Q3).
Key Budget vs Forecast Differences
Budgeting involves creating an ABP for a specific period, including projected revenue, expenses, cash flows, and investments. It requires input from multiple departments such as sales, production, finance, marketing, etc.
Forecasting, on the other hand, projects where a company is headed based on the latest available information. While budgets are static and usually prepared for a year or longer periods, forecasts are updated monthly or quarterly.
The following budgeting vs forecasting comparison table summarizes the primary differences:
|Definitions||Strategic plan for financial performance||Projections based on the latest financial data and trends|
|Main purpose||Setting targets for a specified period||Estimating whether the overall performance achieves the targets|
|Timeframe||Long-term projections (one year or longer)||Short- or long-term projections|
|Flexibility||Rarely adjusted, static document||Frequently updated|
|Application||Short- and long-term strategic business plans||Short-term management of operational performance|
Budgets and forecasts serve distinct purposes, catering to different needs within financial planning and management. The former provides a detailed plan for resource allocation, while the latter offers a forward-looking estimate of financial performance based on currently available information. Both tools are valuable for decision-making and financial control within an organization.
How Budgeting and Forecasting Work Together
Budgeting provides a baseline for performance analysis by comparing projections with actual results to determine the variance. And forecasting helps a company estimate its financial future using historical data.
Combined, budgeting and forecasting provide a complete, comprehensive, and reliable financial plan or strategy. Through forecasting, the company can determine whether it’s on the right course and set realistic expectations.
With the help of budgets, these expectations turn into concrete goals, which are compared to reality at the end of the period. These processes allow companies to evaluate performance, adjust expectations, set realistic goals, and ultimately, grow.
Budget vs Forecast: Wrap Up
Budgets and forecasts are crucial financial planning components. They help manage financial risks and develop action plans to achieve targets. The current article provides a very brief overview of their primary functions and differences.