Both a budget and a forecast are financial tools. Companies use these tools to plan their growth, income, expenses. These tools are vital to companies as they help the management in decision-making.
Budgeting and forecasting are similar, and some companies owners don’t understand the difference between these two tools. This article explains the topic in detail, so keep reading to learn more.
What Is a Budget?
In accounting, a budget outlines a business’s expectations for the upcoming financial period. Typically, accountants set budgets for each fiscal year, but periods may be shorter.
A budget summarizes a company’s goals that describe where the business should be by the end of the fiscal period. Typically, a budget consists of the following parts:
- estimated income;
- estimated expenses;
- estimated unpredicted expenses;
- expected debt reduction;
- expected cash flow.
At the end of a period set in a budget, the management can compare actual results and a predetermined budget to determine the extent to which the company varies from the expected performance. The best type is a flexible budget.
How To Prepare A Budget?
Some companies operate without a budget, but it’s still recommended to develop one every period. The key takeaway when planning a budget is understanding your business needs. Answer the following questions to determine where to start with budgeting:
- What is your company’s current state?
- What is the bigger picture for the future?
- What are the most important current goals?
Answers to these questions give businesses a clear idea of where to begin and what decisions to make. Follow simple steps to create a budget:
- Determine all income sources.
- Calculate how much a business earns annually.
- Estimate fixed, variable, and one-off expenses.
- Add up mentioned above expenses and income to determine the cash flow and total revenue.
Such components are essential to a business.
What Is a Forecast?
A forecast is a prediction or estimate of what a company should achieve in reality. Forecasting is a more strategic tool than budgeting. A forecast provides a company with a roadmap of where it’s expected to land, based on collected analitical data and business drivers.
Typically, a forecast consists of revenue and expenses. Moreover, contrary to budgets, accountants should update forecasts regularly — every month or at least quarterly.
Typically, forecasting is a tool used for short-term planning. It’s common for new businesses to create forecasts weekly. However, you can also use forecasts for longer periods to help guide a business’s long-term strategic goals.
Forecasts rarely go into details, but they plan where a company is expected to be in the future months or years. Experts recommend creating several forecasts on different potential results.
Such a method helps predict what will happen to a company’s financial resources if it meets specific economic conditions. A forecast needs adjustments if a business doesn’t meet specific conditions, such as not reaching a sales plan.
Types of Forecasting
Two main types of forecasting exist in accounting:
- judgment or qualitative forecasting;
- quantitative forecasting.
Let’s dive into more detail about forecasting types.
According to judgment forecasting, the business should rely on its knowledge of the market and the informed opinion of its target audience to complete financial projections.
Logically, knowledge may be false, so this method should be applied only when there is no historical data to make decisions. Here’s an example: when launching a startup, you have no actual data to make decisions.
Quantitative forecasting is focused on producing data-backed predictions. It consists of gathering and analyzing data to determine economic patterns, specific market conditions, industry trends, customer behaviors, etc.
This forecasting tool uses data sets to forecast changes and possibilities for a business. Many companies use a combination of judgment and quantitative forecasting to determine potential expenses and predict market demand and possible sales.
How To Prepare A Forecast?
Preparing a forecast is a fairly simple process. An accountant has to examine existing business records from month to month. Pay extra attention to cash flow, revenue, expenses. Then follow the instruction:
- Define the objectives and goals of a forecast.
- Pick a forecasting method — prefer a quantitative method if you have data, and judgment forecasting if your project is new.
- Prepare financial statements, such as a balance sheet, cash flow statement, and income statement.
Ensure you update the forecast regularly. When the project is new, make weekly updates, while companies with data can make monthly updates.
Main Differences Between Budgeting And Forecasting
Now that you get the general idea of a budget and a forecast let’s check out the main differences between the two concepts.
- The budget reflects planned business expenses and income over a current period. A forecast aims at projecting the results of a business for the future.
- The budget is aimed at a short-term period of a year, while the forecast can be prepared as both short-term and long-term plans.
- A budget is less flexible than forecasting. It’s possible to make adjustments to forecasts as economic conditions change.
Even though it does seem that a budget and a forecast are similar concepts, they have a few significant differences mentioned in the list above.
Author: Charles Lutwidge