Budgeting versus forecasting: what’s the difference?
Budgeting and forecasting are two of the key financial activities for any business owner. They are often linked together, which is fine, but it’s important to remember they aren’t the same thing. So what are the differences and how can they each help you develop your business?
What is budgeting?
A budget is a detailed outline of what the business predicts will happen financially over a specific period of time (usually a year). This includes revenues, expenses, cash flow and overall financial position.
Larger companies often have a budgeting process which brings together input from various departments and profit centres, and is usually managed by the head of finance. In smaller companies, the budget might be handled by the business owner themselves with the help of a few key employees, a business advisor or accountant. The timeframe to complete the process is likely to be shorter for smaller businesses.
Once a budget is established it usually remains set and unchanging for the financial year. Some organisations do use a ‘continuous budget’, which is adjusted during the year based on changing conditions. While this can be useful, it also requires closer ongoing attention and repositioning, with no guarantee of a better result.
What is a budget for?
A budget is one of your key management tools and helps you to run the business effectively.
You can compare your actual financial income to the budgeted amounts, and analyse any differences between the two. Similarly, you can see where expenses in any given area are higher than what was budgeted for, and get to the bottom of why that is.
With a solid budget in place, you can easily check in on whether revenues and profits are on track with your predictions, whether you have brought in additional revenue or lost business that was included as a source of income. This all helps you to manage your business.
Top tips for creating a useful budget:
- Start with a realistic cash-flow projection. Your revenue forecasts will inform this, but the expected income might not always continue, so it is better to be cautious.
- Make a distinction between essential expenses for things your business cannot function without (e.g. electricity, internet) and other, non-essential expenses.
- If you have debts, build debt reduction into your budget.
- Try to include cash reserves in your budgeting so any extra profits can serve as a cushion against a downturn in business.
What is a forecasting?
A forecast is a higher level ‘big picture’ projection of how a business will manage either in the short-term or as part of longer-term planning. Forecasts usually include informed predictions on key sources of revenue and overall expenses. A longer-term forecast might look ahead several years and inform a strategic business plan, whereas shorter-term forecasts are often completed for more immediate operational decisions. A forecast might be used to inform adjustments to staffing levels, production planning and inventory. A convincing forecast might also help secure financing or bank loans.
What is a forecasting for?
Both short-term and long-term forecasting are tools to help your business make adjustments in spending and focus during the year as conditions change. For instance, if an important customer will be reducing or adding to their volume of business with your company, this will have a major impact on operations and cash flow.
Top tips for effective forecasts:
- Update your forecasts on a regular basis. When things change significantly, so should your predictions for your business.
- Consider preparing more than one forecast: one that reflects an optimistic position, one pessimistic and one most likely. This allows you to prepare for any eventuality, whether that is growing the business or adjusting to some bad breaks.
- Involve key members of your team, who are likely to be well aware of what is happening on the ground day to day. Keep them involved and giving you updates as you review your forecasts.
While budgeting and forecasting serve different functions, they are related to some extent. A good forecast can feed into the development of a sound budget. During the financial year, using your forecasts and budget together can help you make adjustments to meet changing business conditions. These financial predictions and plans can be challenging for business owners but advice is always available from a business advisor or an accountant. Contact us today to arrange a free consultation and find out how we can help!