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Forecasts Vs. Budgets

Forecasts Vs. Budgets

At times, you may hear the words budgeting and forecasting used as if they were interchangeable.  The object of this blog is to differentiate between the two terms and explain how these concepts work. 

While we utilize budgeting and forecasting together, they’re distinctive and serve different roles in your business. 

Forecasts

Forecasting is an estimation of future outcomes which quantifies what you expect your business to do during the forecasted period. Simply put, it is a well-thought-out projection of desired business outcomes for a future period.

How Can Forecasting Help?

Forecasting is an essential tool for your business.  It provides an insightful understanding of the actual circumstances your business is facing. Forecasts are strategic and help you to establish future goals for your business.

The use of financial forecasting in a budget will help you model various scenarios and better evaluate whether your company will meet your planned business goals.

Forecasting Vs. Budgeting

On the other hand, the budget acts as the financial plan that supports realizing those forecasted outcomes. In sum, forecasting develops the company goals. The budget is the operating and financial planning tool that management uses to attain its forecasted goals. 

Budgets

Our discussion focuses on a Master Operating Budget, which outlines planned business expenses and revenue. It is a comprehensive budget designed to provide an overall financial view of your business. It estimates future profit or loss over a period. And it is essentially a proforma Profit and Loss statement for the business, and it forecasts the future financial activity of the company, including sales, expenses, and profit.

What is a Budget Used For?

A budget is a tool used to plan and control the business. At the beginning of the budget period, it serves as the financial plan. While at the end of the period, it serves as a control device to help you measure performance and analyze variances to improve future performance. 

How Do I Create a Budget?

The budgeting process starts with defining objectives you wish to complete during the budget time period, usually a year.  Business objectives might be a dollar amount or percentage of profit. Similarly, a dollar amount or percentage of sales growth might be a business objective.  But it starts with objectives.

Your budget must reflect realistically achievable and measurable business objectives. Equally critical is the necessity to link those expectations to the resources required to achieve the planned objective(s) results.  

If you plan to evaluate individual performance against budget standards, those individuals to be responsible and measured must have input into the budgeting process.  You must ensure “buy-in” to the performance levels reflected in the budget.

How Do I Create a Forecast?

  1. Gather information and data. Examining your financial statements and additional information will help you gain accurate insights.

2.  Establish and document your goals using a “SMART” criteria:

  1. Specific
  2. Measurable
  3. Achievable
  4. Relevant
  5. Time-bound

3. Define and document all assumptions.

4. Select your forecasting methods. Some basic examples include

  1. Sales patterns: what products and/or services sell better than others
  2. Trend analysis: what products and/or services are in high demand
  3. Historical extrapolation: setting goals based on past experience and achievements.
  4. Seasonal forecasting: for existing or new products or services that sell well during seasonal periods

5. Implement your methods and use your forecasts. Implementing and utilizing your projections will help you substantially with decision-making.

Note – Forecasting and budgeting should work together.

Wrapping Up – Why Do I Need to Forecast?

Forecasting plays a pivotal role in the management and success of your business. It is an essential aid to planning. Planning is the backbone of effective business operations.

Forecasting allows you as a business owner or manager to identify risks and take advance preemptive action.  It also helps in spotting opportunities and capitalizing on them promptly. 

Many businesses have failed because of a lack of forecasting or faulty forecasting on which they based operational planning.

Wrapping Up – Why Do I Need to Budget?

The budget enables a business to accurately establish business objectives, priorities, and spending caps for the year. It lets you detail where funding originates and where new strategies or tactics might bring additional revenue into the company coffers.

Many small businesses have an accountant who prepares their tax returns. These business owners may think that a good accountant will be in charge of all their business financial management systems, processes, and practices.  The truth is most accountants are focused on recording what happened in the past rather than the future and forecasting. 

By forecasting, preparing, and utilizing a budget, business owners can improve the company’s management planning and control process. 

If you need help developing your financial management systems and want to learn more about budgeting and forecasting, contact Belfield and discover the Belfield difference today!