In today’s dynamic business environment, improving the efficiency of internal processes is a top priority for any business. The budgeting and forecasting process is no exception as it provides strategic insights that support decision making and goal setting which are critical elements for a company’s success.
The primary purpose of these processes is to support the company’s strategy through planned initiatives, ensuring the optimize allocation of resources. Budgets are formulated for setting a target for the coming month or a quarter or a year and forecasting is performed to understand whether the budgeted target will be timely met or not.
Both budgeting and forecasting should be used together as complementary. It is therefore very important to understand what budgeting and forecasting are, the common challenges, how to improve and streamline the process, what are the advantages and differences between the two processes and how these factors assist considering finding solutions.
What is Budgeting?
Budgeting is the process of building an estimate of an organization’s revenue and expenses, investment and cash flow based on the current business environment, creating plans or estimates using the prior period items, adjusting the numbers for any future projection for the upcoming period. It is a structured format of goals and objectives that a company wants to achieve in a selected time frame.
The budget process followed would depend on the size of the company, with inputs from various departments of the company. Smaller businesses sometimes shy away from the budgeting process as they believe they do not require such or due do a lack of know-how, however every business irrespective of the size, should have a budget as it is the foundation or the roadmap of the company’s vision.
Budgets are static, with the resulting budget an initial outlining of a company’s expectations for the next 12 months up to 5 years. It is the summary of where you want your company to be by the end of the given period. The budgeting process is a strategic exercise, that assists the management team setting goals for the company.
What is Forecasting?
Forecasting refers to estimating what actually will be achieved by the company. It is a periodic observation of the proportion of budgeted goals achieved and how much is remaining for the remainder time frame. Forecasting can be done for both short term and long term.
A financial forecast is a compilation of projected sales forecast, expense budget, income projection, cashflow statement, and assets and liabilities that estimate the financial future of a company based on historical data, actual data, comparing it against the budget and the analysis of future trends. It an assessment the company’s performance measuring if the company is meeting the financial goals as outlined in the budget.
Benefits of budgeting
- The budget process results in a clearly defined plan that’s reflective of your company’s financial and operational goals.
- As budgets are typically prepared annually, budgets provide important guidance regarding what your business can expect to accomplish that year.
- The budgeting process assists and “forces” you and or management to examine the company’s financial activities and assess the viability of each individual expense.
- Budgeting requires detailed documentation of all the sources and uses of cash, ultimately enabling you and or management to anticipate cash flows with accuracy.
- Budgeting often starts from the bottom up, involving many cross-functional stakeholders ain the process, which instils a sense of ownership among employees and motivates them to meet their budgeted goals.
- You can periodically, weekly, monthly, and quarterly, compare the budget with up-to-date financial results, providing real-time insight via a variance analysis into how your company is performing.
- Budgeting makes it clear exactly where and when financial resources are needed so you can allocate them accordingly and keep the business on track.
Budgets are however prepared so far in advance and are based on a fixed set of assumptions and circumstances known at the point in time, which can quickly become outdated as soon as those assumptions and circumstances change and this is where forecasting takes over, when the budget no longer meets certain time-sensitive needs.
Benefits of forecasting
- Forecasting is performed regularly after financial statements are released, usually right after a month-end or quarter-end close cycle, with key performance metrics updated, providing insight into how your business is performing.
- Comparing your actual data, your budget and your past results, forecasting gives you the insight you need to reallocate resources proactively and help you and or your managers make data-driven business decisions.
- Forecasting reveals business trends that help you determine if you need to adjust your course.
- It’s easier to manage cash flows and capital requirements if you have a well-informed forecast prediction of where future expenses are likely to fluctuate.
- Reliable forecasting assists with financing and investment opportunities.
- Forecasting allows you and or your managers to focus their attention to where it’s needed, especially in the short term.
- You can use your forecasted numbers as the logical starting point for your next budget.
Difference Between Budgeting and Forecasting
Your budget is your road map, highlighting key financial checkpoints for every phase of the business journey, however once that journey has started, it’s common for circumstances to change, ultimately outdating the original assumptions that were made when the budget was created. Best practices involve regularly reviewing your budget against the changing business environment, forecasting accordingly to determine where the numbers are and will be going.
Budgets are formulated to set a target for the coming month, quarter, year, up to five years. It is the setting of an operational and financial plan.
It is performed weekly or monthly to understand whether the financial budgeted target will be timely met or not.
It contains absolute values that the company aims to achieve, which may include the number of units it has to sell or the amount of revenue it must generate and the cost and selling pricing of products and or services. It is about expressing the financial plan in quantitative terms.
The forecast expresses expectations, it does it better through percentages comparison against the actual results, last year results and the budget results, implying what proportion of budgeted values has been accomplished and how much of it can be reasonably achieved in the remainder of the period. It is about trend analysis.
It observes the past trends and tries to set a realistic target based on these after smoothening or excluding once-off or extraordinary incidents, for example a sale in a specific month
It analyses the changes in the current circumstances and tries to estimate and conclude that in the light of such changing events, whether the budget will be met or not.
A budget is formulated once per period; for example, if we have budgeted the revenues and expenditures for the upcoming year, it will remain so until the year is completed, budgets are not changed, once accepted
Forecasting is done on a more frequent basis, weekly or monthly and in certain times it may even be done on a daily or real-time basis so that appropriate measures and actions can be timely undertaken to meet the budgetary requirements or deal with the circumstance changes.
Once the budgeted period gets over, the actual results are compared to the budgeted goals and last year’s performance to see how they have varied and whether the budget was realistically achievable or not in order to improve future budget setting and planning accordingly.
Forecasting are interim numbers and is a variance analysis technique, measuring actual results against budget and last year, to address changes in trends and circumstances timeously.
Budgeting is a broader analysis, and it includes a larger number of items such as revenues, costs, cash flows, profits, items of financial position, basically a full profit and loss statement, balance sheet and cash flow statement.
Forecasting is a variance analysis as it deals with the actual performance compared to the budget and the expected numbers are adjusted for the remainder period in accordance with the actual results.
Strategy / Area changes
This is more about fixed targets a company wants to achieve, including investment, capex, and debt structuring.
This is more about an estimate which a company may achieve.
Budgetary goals and objectives which are shared and communicated to all departments and relevant stakeholders, including the shop floor levels in manufacturing companies, so that the targeted production is achieved.
Forecasted numbers are mostly for the business owner, shareholders and or management and the team of supervisors so that they are aware of how to manage the work to meet the targets.
Both budgeting and forecasting are important tools of management and actuals, budgets, last year results and forecasts should be compared and evaluated on a consistent basis. Both techniques are essential and form an integral part of the short term and long-term decision making. It allows for a more accurate budgeting and forecasting process and can highlight potential risks as well as opportunities that lie ahead. If budgets are not formulated, the company may become directionless and at the same time, if forecasting is not conducted, there can be a chance of oversight and piling up of wrong decisions and actions taken.