A budget and a forecast are both financial planning tools that assist a small business in making decisions. Although these two techniques may sometimes overlap when analyzing an area of business, they are two completely separate ways to strategize and plan. While both items rely heavily on estimation, the scope of each tool is different.
Characteristics of a Budget
A budget uses estimation to devise a plan for where the business wants to go. It is a resource allocation tool that controls the activity of a business, so operations and spending occur where management wants them. Once a business knows what to expect from the market, it uses a budget to make a plan for upcoming periods. A budget serves as a control check against spending, while a forecast is a control check against expectations.
Characteristics of a Forecast
A forecast uses estimation to devise a plan for where the business is going, regardless of management desires. Industry trends and market outlook strongly influence a forecast. It is also highly contingent on customer spending patterns, the anticipated growth of the company, and other external factors, such as politics, current events, or even weather. For instance, if record snowfall is anticipated next winter, your snow removal business will forecast higher sales. A forecast provides the information that is used in the development of a budget.
Next year, a small business hopes to earn $300,000 in total revenue. The business first performs a forecast by analyzing company growth, industry trends, and market possibilities. Unfortunately, it discovers it will most likely earn revenue of $200,000. This forecast is then incorporated into the company’s budget.
The company now has relevant information to build its budget upon. If sales revenue of $300,000 was used, the budget would not have been helpful because the plans would not match the operating results. Instead, the forecast will translate to more relevant and useful information.
A forecast is updated frequently to adapt to new market conditions and variables. While a company may refer to previous forecasts for process improvements ideas, a forecast is generally only forward-looking. A budget relies heavily on past results. Although both incorporate historical figures, a budget retains them while a forecast adapts them to form expectations.
Variants of Reports
Both tools can be developed in a number of ways, further blurring the distinction between a budget and a forecast. A budget an be static and not change. It can also be adjusted through the year through the use of a flexible budget. In addition, a forecast can be performed using an average approach, drift method, time series methods, or econometric models. Both a budget and forecast can be rolling – a method of adding an additional period at the end of the report as the current period ends. Still, the general principle remains for all items above: A budget allocates and plans for the use of resources, while a forecast identifies what those resources will be.