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Budgeting vs Forecasting: Key Differences You Should Know
Published on Tuesday, January 22, 2019
Similar to the way that sales forecasting and revenue forecasting are often confused, there is commonly also a misunderstanding about the differences between budgeting vs forecasting. But not to worry, all will become clear soon.
While both budgeting and forecasting are very useful instruments for businesses to use to devise plans for growth and management, it should be noted that they are not the same thing.
The two processes are commonly used in conjunction with each other, and this is where the confusion comes from. Since they are often made use of together, the terms are used interchangeably. However, to ensure that we’re using each tool correctly and getting the optimal value out of each, we first have to understand the differences between them.
Read on to get the details on budgeting vs forecasting, so you can make the most informed plans and decisions for your company, and ensure that your business is going in the right direction.
What Is Budgeting?
A budget is essentially a synopsis or a configuration of goals a company has. In other words, it is an idea of what a business hopes to accomplish, or what business goals they want to realize, in a set period of time, usually a year.
Elements of budgeting often include how much the business expects debt to reduce, expectations of cash flow, and approximations of expenses and revenues. Budgets are contrasted with actual outcomes, to determine the variances between the two.
To put this another way, budgeting is a representation of a business’s goals, cash flow, and current financial standing. The budget is commonly re-assessed every fiscal year, however, this is dependent on how those in management prefer to do things. Nevertheless, budgeting forms a standard, guideline, or criterion which can be used to compare to actual outcomes, to determine how a company has performed.
Often, budgets are formulated annually, however, this time frame is not set in stone as flexibility is necessary since business conditions may be altered through the course of the year.
What Is Forecasting?
Forecasting is essentially a determination of where your company may be headed in the future, particularly in terms of finances. This prediction or estimation is made through the use of historical data. In other words, it is a calculation of your future outcomes based on the results in your past over a certain period of time.
It is a way to gauge the areas in which your company will grow, where your revenue streams will come from, and where your expenses will be. In most cases, forecasts are geared toward determining revenue and spending.
Forecasts are usually updated more regularly than budgets are, and these updates can occur monthly or quarterly. It all depends on when there may be changes in the business plan, or operations, or inventory. They can also be designed for either a long-term period or for the short-term.
Forecasts are used to decide where and how to construct budgets for the future. Forecasts also assist management to decide how production and inventory should be dealt with, and how to make adjustments to the business plan.
Budgeting Vs Forecasting: A Summary Of Differences
So, based on the definitions of each, what are the actual differences in budgeting vs forecasting? Here is a list of all the differences, to make it easier to understand which is which. This will also help you to grasp what each tool is better for, so you can decide if you need to do both budgeting and forecasting, or just one of the two.
A key difference in the budgeting vs forecasting explanation is that they each serve a different purpose. In other words, they are used to calculate different things for your organization.
Budgets are used to get an idea of what the goal or target is for the upcoming year or quarter, in other words they quantify what exactly a company wants to achieve in the time period.
In contrast, a forecast is used to determine whether the target will be met in time or not. The forecast predicts what the company will achieve in the specified period.
Breadth of Analysis
When it comes to budgeting, there are many more things that are taken into account. For example, budgeting considers items including profits, revenues, expenses, cash flow, and more. Conversely, Forecasting deals with a much narrower analysis, typically including only revenue and expenses.
After the specific time period for which the budget was set out, the actual results are contrasted with the goals laid out in the budget. This is called variance analysis, and its purpose is to determine whether budgets in the future need to be more realistic. For forecasting, there is typically no such comparison that takes place.
Forecasting is done more frequently than budgeting is. A budget is usually updated only once a year, and it is updated so that it may remain in line with the current conditions of the market. On the other hand, a forecast can be updated as frequently as every month or even every two weeks, as it incorporates real time data.
This also means that the forecast is comparatively more flexible. Your forecast can change but your budget most commonly cannot.
In terms of the uses of budgeting vs forecasting, the two are also quite different. Using the former, management makes alterations in the business to try to ensure that the actual results become more aligned to the budget. They may use the budget to decide that some expenses need to be cut down, for example.
Also, after the budget versus actual comparison is made, there may be an impact on employee compensation – many companies have incentive plans based on company’s performance against budget.
The forecast, on the other hand, is often used for more operational type considerations. These may include changes in the levels of inventory or what the production plan looks like.
Budgeting Vs Forecasting: Which Should You Do?
In most cases, it is best to perform both budgeting and forecasting to ensure that your business is running optimally. However, this is not always possible due to several constraints which may include time and finances. In this case, you want to ensure you’re getting the most out of the time and money that you put in.
Budgets are quite time-consuming and take a lot of effort. Forecasting might be a better option because it can guide your business in the direction you want it to go in strategically. This is likely to be more beneficial in the long-term.
The results that you acquire from a forecast can be used to make immediate changes and decisions, that might not be possible with a budget. Furthermore, there are services and products that can be used to automate your forecasting, which makes the entire process both easier and more accurate.
By using a forecasting software like revVana, you can plan and maximize your revenue and get better forecasts to meet budget targets. You’ll gain valuable insights into what you are doing, how to do things better, and how to ensure that your growth potential is realized to the fullest extent.
To summarize the key idea about budgeting vs forecasting, essentially, the former is a devised plan which indicates where the organization hopes to go, whereas the latter is the calculation of where it is actually going. Both tools are quite useful for businesses and often are used in conjunction with each other.
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