Budgeting and forecasting are two of the most important financial functions for a business of any size. Budgeting and forecasting are often linked together, as they should be, but they’re not the same thing.
Here’s a guide to help you determine the differences between the two and how each can help your business.
Businesses need to create a budget when they need a detailed financial outline of what that business thinks will happen over a period of time (often a year) financially. The budget will include details about the company’s revenues and expenses as well as its cash flow and financial position. This information should be available from your company’s financial reports. Check our financial statements guide to learn more about financial reporting and to download a free customisable template.
Depending on the size of a company, there may be a budgeting process—often done later in the year—with input from the company’s various functional departments and profit centres, which should be managed by your head of finance.
In smaller companies, the budget might be done by the business owner alone or with the help of a few key employees. The process and timeframe to complete the process are likely shorter in these cases.
Most budgets are static and set for the company’s financial year. However, some organisations use a continuous budget, adjusted during the year based on changing business conditions. While this can add accuracy, it also requires closer attention and may not necessarily yield a better outcome.
Ideally, a budget is used as a management tool to run the business. Actual financial results are compared to budgeted amounts while a variance analysis is conducted. If expenses in a certain area are higher than the budget, then a company should determine if the overage is tied to an additional business or just overspending.
Are revenues and profits on track with the budget? Did the company add additional revenue or lose business that was part of the budget? Reviewing the budget on a regular basis is a key tool in managing business goals.
In some companies, the budget is used as a factor in awarding performance-based compensation.
Here are a few things to consider in making your budget a useful tool in managing your business:
A forecast is a projection of what will happen at a higher level, generally key revenue items and overall expenses. Forecasts can be done over long-term and short-term time horizons. These can be done from top-down or bottom-up.
A longer-term business forecast might look out over several years and feed a longer-term strategic business plan. Shorter-term forecasts are generally done for operational reasons. The revenue forecast will drive adjustments to headcount, production planning, and inventory levels for businesses that produce or distribute a physical product. A convincing forecast may also help determine the terms of bank loans.
Service and consulting organisations will generally use these forecasts to determine staffing levels.
Financial forecasting is an important tool to help a company make necessary adjustments in spending and focus during the year as the business changes. For example, if a major customer will be reducing or adding to their volume of business with your company, this will have a major impact on operations and cash flow.
Here are a few things to consider when doing forecasts for your company:
Consider using more than one forecast, perhaps three: one that reflects an optimistic outlook, one pessimistic, and one most likely. This allows you to create a financial plan for growth but also to adjust in case some opportunities don’t materialise or happen slower than originally thought.
Update your forecast on a regular basis. Things change, so don’t be caught off-guard.
Involve key members of your team, such as managers from sales and operations. They are often closest to what is really happening. This will provide better information and keep these key managers involved in the process.
While budgeting and forecasting are different functions, they are not mutually exclusive of each other. In fact, a good forecast feeds the development of a sound budget. During the year, comparing the most recent forecast to the budget for the rest of the period can help a company make needed adjustments to meet changing business and market conditions. If all this sounds a bit confusing, accounting software such as QuickBooks can help small businesses generate budgets and projections without much effort. You should also reach out to an accountant to make sure you’re on the right path.
While budgeting and forecasting are different functions, they are not mutually exclusive of each other. In fact, a good forecast feeds the development of a sound budget. During the year, comparing the most recent forecast to the budget for the rest of the period can help a company make needed adjustments to meet changing business and market conditions. If all this sounds a bit confusing, accounting software such as QuickBooks can help small businesses generate budgets and projections without much effort. You should also reach out to an accountant to make sure you’re on the right path.
TAKE A NO-COMMITMENT TEST DRIVE
Our customers save an average of 9 hours per week with QuickBooks invoicing*
By entering your email, you are agree to our Terms and acknowledge our Privacy Statement.
Intuit helps put more money in consumers’ and small businesses’ pockets, saving them time by eliminating work, and ensuring they have confidence in every financial decision they make.
3x WeMoney Award Winner
