Budgets and forecasts are two of the most important financial tools at your disposal. We break down the difference between a budget and a forecast, and look at how to use them in your business.
As a small business owner, chances are you’ve come across the terms ‘budget’ and ‘forecast’ on a regular basis. Budgets and forecasts are key management tools that are used to plan and track your business finances.
However, if you’re scratching your head thinking, “what is the meaning of a budget and forecast?”, don’t worry. You’re definitely not alone. With so many financial terms to wrap your head around, it can feel confusing to say the least — especially when you’re just starting out.
To help you out, we’ve put together this guide which explains what a budget and forecast is, what they do, and how to use them in your business.
What is a budget?
A budget sums up your financial goals for your business. It outlines the financial position you’d like for your company to be in over a particular period: for example, over the coming quarter, year, or even years. Budgets are created based on previous data, such as your company’s expected revenue and costs, market trends, cash flow and more.
As a general rule of thumb, a budget includes:
- The sales results you’d like to achieve, as well as a plan of action to get you there.
- What you have to spend and how you plan to prioritise this. For example, do you need to scale your costs if your operations increase? How much do you plan to allocate towards marketing costs to promote your business?
- Specific and measurable results for the end of a period, so you can gauge how well you’re doing. It could be your financial performance compared to the same period of time last year, or a percentage of growth that you’re aiming to achieve based on your market and business goals.
When should you use a budget?
Most budgets are static and lay out expectations for your business’ financial year. However, these don’t have to be set in stone. You can use your budget as a guideline, and be flexible if business conditions change. This way you can revisit it and adjust your spending, if you feel it’s the right decision at the time.
What is a forecast?
A forecast is an estimate of what your business might actually achieve from a financial standpoint. In other words, it’s a projection of what is likely to happen based on the revenue and expenses associated with your business.
Forecasts will typically include:
- Start-up costs associated with setting up your business. In most cases, it’s good to have a buffer as launching a new endeavour generally costs more than you expect.
- Sales figures, which should be reviewed on a regular basis to make sure your business is on track with revenue.
- Expenses, which should be based on industry benchmarks (or previous spending if you have any).
- Cash flow to help you pinpoint any gaps between income and expenses.
When should you use a forecast?
Forecasts can be used in the short term as well as the long term. If you’re just starting out, you might find it necessary to do monthly, fortnightly or even weekly forecasts to ensure you stay on top of your business finances.
However, in the long run, it’s a good idea to create a long-term forecast. This might span several years and feed your strategic business plan, including adjustments to your production, planning, stock levels, and head-count. A solid forecast also comes in handy when you’re looking for funding or loans to grow your business.
Budget vs. forecast: Breaking down the differences
A budget and forecast are closely linked, but they’re not the same thing. The main difference is that a budget is what you’d like to happen, while your forecast is a reflection of what might actually happen.
Because budgets are often set at the start of a fiscal year and reviewed annually, the targets and assumptions can quickly become outdated as market conditions change. In some cases, events or economic trends could lead to your business earning less than expected, which means your budget is no longer realistic and suited to the new conditions. If you continue to go along the same path, you might compromise your financial position — or even your business.
Forecasts provide a short-term representation of the actual circumstances your business finds itself in. Because forecasts are done more regularly and grounded in recent performance, they can be used to take immediate action. You can adjust, adapt, and modify your plans accordingly.
How do budgets and forecasts work together?
Budgets quantify your business goals, and help you plan for the short, mid and long term. It’s essentially the end-goal for your business: it provides the big picture and direction you want it to go in. However, these goals might not be attainable because of changing market conditions or internal shifts within the business. That’s where the forecast comes in.
Your forecast reveals how your business is actually tracking, in relation to your budget. This information can feed the development of a sound budget, and help you readjust your goals and expectations throughout the year.
Budgets and forecasts should be used together to accurately plan and adjust to meet changing business conditions.
Simplify your budgets and forecasts
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.