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FINANCE, BUDGETS AND CASHFLOW
Budget vs. forecasting: What’s the difference?
Budgeting and forecasting are two of the most important financial tools for small businesses.
A budget is what you’d like to happen, and a forecast is a reflection of what might actually happen. So, they’re closely linked, but they’re not the same.
Budget vs. forecast explained
Financial reports are confusing – including budgets and forecasts. So you’re certainly not alone here.
So, budget vs forecast?
What is a budget?
A budget sums up where you’d like your company to be over a particular financial period. It’s a summary of your goals, over the next few months or even years. You’ll base your budget on your forecast of revenues and costs.
Most budgets are static and set for the company’s financial year. However, you can use the static budget as a guideline, and be flexible if business conditions change. You can adjust your spending if that’s the right business decision at the time.
How businesses use budgets
A budget is a key management tool for any small business. You can compare actual financial results with budgeted figures, to test your company’s performance. And that’s vital in the business world.
Your budget will show:
The sales figures you’d like to achieve – a plan of action
What you have to spend and how you plan to prioritise this. If you do this accurately, you won’t run out of money to do the things which are crucial to your business
A point of comparison at the end of a period, so you can gauge how well you’re doing
Here are a few things to consider when creating your budget:
Start with a realistic cash-flow projection. Your revenue forecasts will drive this in part, but they may not fully materialise. It’s better to be conservative here
Differentiate between essential expenses like broadband and electricity, and expenses that are less essential to running your business. And prioritise your spending accordingly
Build debt reduction into your budget, if you have any
Try to incorporate cash reserves into your budget. This way any extra profits can serve as a cushion against a future downturn in business
Review your budget on a regular basis
Put your budget to good use – test your financial position. Are revenues and profits on track? Did the business add more revenue or lose business that was included in the budget?
What is a forecast?
A forecast is an estimate of what your business might achieve. In other words, it’s a projection of what might actually happen, and is generally restricted to revenue and expenses. In essence, a forecast will help you achieve your business goals.
Forecasts can be used for the long or short term. When you’re starting out in business, you may find monthly or even weekly forecasts necessary.
Your forecast will show: * Start-up costs - you may want to allow for more than you expect * Sales – and review these regularly to identify problems before they happen * Expenses – always consult industry benchmarks * Cashflow – the lifeblood of your business, so watch this closely
A longer-term forecast might span several years and feed a strategic business plan. The revenue forecast will drive adjustments to head count, production planning and stock levels for businesses that produce or distribute a physical product. A convincing forecast may also help you with getting bank loans on favourable terms.
How businesses use forecasts
Forecasts are an important tool. Forecasting helps you make any necessary adjustments in focus or spending, as business can change over the course of a year. For example, if a major customer is reducing or adding to their volume of business with you, this will have a major impact on your operations and cash flow.
Here are a few things to consider:
Consider using more than one forecast. One that reflects an optimistic outlook, one pessimistic and one most likely. This allows you to plan for growth but also to adjust in case some opportunities don’t materialise or happen more slowly than expected.
Update your forecast on a regular basis. Things change, and you don’t want to be caught off-guard.
Involve key members of your team, so you don’t miss any angles. Consult those closest to what is actually happening. Not only will this provide better data, you’ll keep key staff involved and happy.
Types of forecast
There are 3 main types of forecasting, which are financial, general, and sales.
Financial forecasting
A financial forecast provides businesses with a predicted figure for their future finances, taking into account information such as:
Their current revenue and revenue potential, any revenue coming from external sources such as investments, and sales revenue.
Expenses and costs such as overheads, one off expenses, staffing, and more.
Industry averages and competitor financial positions (if known)
Projections of the company’s financial growth over a given period.
General forecasting
A general overview of your business forecasting, this may include:
Historical financial data on the company and the demand for their service/product
The current financial position of the company
Projected revenue and expenses
Market trend information covering historic data, present, and future
Competitor market position
Sales forecasting
This type of forecast will detail your historic and present sales figures, which can be used to predict future sales, company growth, and market trends. This may include:
The amount of sales a company can make during a predicted period, such as from products or services.
The costs related to manufacturing, production, or providing services.
The projected profit from sales.
How to create a forecast
Now that we have discussed what a forecast is, and the various types of forecast available, you can begin to create a relevant forecast for your business using a number of data sets.
1) Collect data
Gather any relevant financial information from your systems. Ideally, this information will relate to the most recent financial period for your company, and run up to the date you begin your forecast. Once this data is collected you can categorise it by type, such as sales revenue; production costs, staffing costs, etc. You should then designate whether these costs are fixed, variable, or if they are one-off payments that will not reoccur in the next year.
2) Analyse data
By analysing your gathered data you can begin to identify trends, discrepancies, increases or decreases in profit, or any other relevant statistics. Once you have completed a full analysis of your data you can use your results to calculate averages for revenue, expenses, and deductions. These calculations will form the basis of your financial forecast.
3) Define a budget period
You will need to define a budgetary period for your forecast, which could be annually, quarterly, or monthly, and use this information to create your forecast. It may be beneficial to use the lowest figure for your predicted profit, and the highest figure for predicted spending, to ensure that you are not caught out if your company does not reach its highest earning potential.
4) Develop a revenue target
Using the above information, you can develop a revenue target for your prediction. As mentioned above, it is not usually advised to provide your highest earning predictions in your forecast, as factors such as market fluctuations in the coming year may cause you to fall short of your predicted revenue target if it is set too high.
5) Set aside an emergency fund
Finally, your company should be prepared for unexpected costs or expenses. An emergency fund should be defined in your forecast to prepare for unpredictable costs, meaning you will have access to your own funds should the need arise. By defining an emergency fund, you can avoid issues such as debt, closure, or late payments.
The difference between budget and forecast
Budgeting and forecasting perform different functions, but they’re not mutually exclusive.
Whilst the budget is a plan for where you’d like to go, your forecast shows you where it’s actually going. A good forecast feeds the development of a sound budget.
Over the course of the year, compare your most recent forecast to the budget for the rest of the year. This will help you make any necessary adjustments to meet changing business conditions.
Using present data and future predictions
The budget you create will be based on the goals of your business, but they are not guaranteed as your actual financial earnings can change in the period you wish to achieve your goals. Whereas your forecast uses your current data to make predictions on what your actual earnings will be.
Adjustable and static data
Your budget is likely to remain unchanged, making it a static set of data, whereas a forecast is likely to change throughout the period it relates to. By using the business budget, the forecast will likely be adjusted depending on business or industry changes to more accurately align with the budget.
Need more help?
Accounting software such as QuickBooks can help generate budgets and projections without much effort. And you can be confident of accuracy – all the data is automatically pulled from your accounts.
You should also consult an accountant to make sure you’re on the right path.
Feel better informed about how to use budgets and forecasts? Know the difference? The QuickBooks Blog covers a wide range of business-related topics – it’s all part of our mission to help small businesses grow.
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