Budgeting and forecasting are the two most common topics people consider when thinking about financial planning for a business.
Throw in "budget forecasting" and things just get too confusing.
But these terms mean different things.
Not having accurate budgets can cause overspend.
Bad forecasting can mean missed opportunities.
Poor financial planning can create difficulty keeping up with a changing business landscape.
That's why we’re going to clear up the confusion in this blog post.
- Budgeting is a detailed, static financial plan and expectations laid out in advance.
- Forecasting is the dynamic, flexible process for assessing current performance and predicting future potential.
- Budget forecasting is a specific type of forecasting that takes its inputs from the budget for the upcoming fiscal period.
- Planning is a general term that refers to budgeting or forecasting
- Budgeting and forecasting are not synonymous, but they are closely aligned.
- There are distinct steps you can take to improve both your budgeting and forecasting.
- What is budgeting?
- What is forecasting?
- What is a budget forecast?
- Difference between budgets and forecasts
- How are budgets and forecasts connected?
- Six steps to a strong budget
- Five steps to build and update your forecasts
What is budgeting?
Budgeting is the process of planning, including income (revenue) and spending (expenses) for your business over a set period of time. Budgets most commonly look at the next 12 months of the business and track finances over a calendar or fiscal year.
It helps to think of a budget as a financial roadmap for your business. The budget describes what management wants the business to do going forward and how it intends to get there. That said, a budget is not a plan.
Budgeting can follow either a top-down or a bottom-up approach.
- Businesses develop budgets using internal historical financial data. To build next year’s budget, they look at prior budgets, compare them to prior actuals, and gather other internal and external data. This results in a budget that reflects company goals and expectations going forward.
- Budgets are “static.” Unless something drastic occurs, the budget you set in January (or the beginning of the fiscal year) doesn’t change over the next 12-month period. For every month of budget, you’ll compare actual performance (“actuals”) against the budget. This determines how closely the business is following the plan, and if it lines up with expected outcomes.
- Budgets require a lot of detail, and they take time to complete. “Budget season” planning starts at least three months before the budget takes effect. For calendar year budgets, this means planning begins no later than October 1. Larger organizations with more extensive budgeting may begin the process even earlier.
At the end of the budget process, you’ll have a detailed plan for the financial life of the business, including:
- Detailed income statements, balance sheets, and cash flow statements
- Capital expenditure timelines for large projects
- Fixed and variable expense outlines (for example, compensation and raise details)
- Metrics for evaluating the performance of budgets
Now that you understand budgets, let’s take a look at forecasts.
What is forecasting?
Forecasting is the higher-level, more flexible cousin of the static budget. It looks at the bigger picture—major revenue and expense items—and can change over time due to reviews and changes in the economic landscape.
- Unlike a static budget, forecasts get regular updates—at least every six months, although different industries revise their forecasts every quarter or month. Forecasts that add future periods as the previous periods close are known as “rolling” forecasts.
- If a budget is a roadmap for where the business wants to go, the forecast provides data on where it’s actually headed. Forecast information changes based on real-world changes with new info. They may change based on the economy, the supply chain, or the competitive landscape.
- Forecasts rely on some historical data such as financial statements to make predictions. But largely, they focus on what’s currently happening in the business and the larger economic picture.
What is a budget forecast?
If a budget summarizes a company's goals and a forecast models what those goals should achieve, then a budget forecast predicts the outcome of the budget.
In other words, the budget forecast answers this question: "if followed exactly, what end state does this budget create?"
- A budget forecast is a projection of the budget. This means it's a key component of variance analysis or any P&L budget vs actuals model.
- The budget forecast references the budget instead of historical values, so it's especially helpful for organizations that have inconsistent historical performance.
- Because it measures the future state of the budget, the budget forecast is a great tool for measuring performance and for Corporate Performance Management (CPM).
Differences between budgets and forecasts
It helps to remember these defining differences when discussing forecasts and budgets:
- Budgets are used to form strategies and define business goals over the coming year.
- Forecasts aid decision-making based on the most recently available information. They help teams understand progress toward budgetary goals.
- Budgets require detailed preparation to enable the most accurate detail for roadmap planning and funds allocation. Preparation should take 3-6 months.
- Forecasts rely on historicals, short-term data, or imagined situations. Preparation should take a few hours to a month, depending on the quantity of data you're using and the scope of the forecast.
- Budgets look at the next 12-month period, whether a calendar or fiscal year.
- Forecasts may look at a range of periods depending on business needs. Common forecasting periods are monthly, quarterly, or semi-annually.
- Budgets are static. Once set, they shouldn’t have big changes. You should compare budget assumptions to actuals on a regular (usually monthly) basis to ensure accuracy.
- Forecasts are dynamic tools. Changes in data and trends will require updates to your forecasts.
- Budget reliability declines over time as actual performance deviates from expected performance.
- Forecasts maintain reliability as they change based on the latest available data.
How are budgets and forecasts connected?
Though budgeting and forecasting are separate activities, they are connected. Each informs the other, and both contribute to an accurate and actionable financial outlook.
Budgeting is the root of your planning process. Creating an annual budget should come before any forecasting activities. Once an annual budget is in place, you can use the information to create forecasting for the following month, quarter, or year.
As the year progresses and actuals become available, forecasts and associated KPIs may adjust. They will reflect changes in business performance or outside forces. You can then use this forecasting data for the next budget planning process.
6 Steps to build a strong budget
To start your planning process off right, use these steps to create a strong, accurate budget:
- Look at revenue: Examine your existing revenue streams to find all available income sources. Add these together to understand the total revenues flowing into the business.
- Understand fixed costs: Look at the expected costs for your business today, such as rent, supplies, payroll, taxes, and insurance. Total these to get a picture of total fixed expenses.
- Estimate variable costs: Total other expenses you expect over the next budget period. Include things like supplies, equipment, owner/partner salary, marketing, utilities, etc.
- Create a rainy-day fund: Every business runs into roadblocks. Building contingency funds into the budget gives you some flexibility.
- Draft financial statements: Use the previous data to create your P&L. This is the big picture financial performance.
- Build your budget: Use the historical data and P&L info to outline your path to profitability over the future period. Review these numbers against actuals as you progress through each month-end close.
Want a more comprehensive list? Head over to our strategic budgeting guide.
5 steps to build and update your forecast
Now that you have your budget roadmap, you can begin to forecast probable outcomes over the next period(s).
- Specify time horizons: How often does your business plan need to adjust to remain competitive? Choose a forecasting interval to reflect the speed of change.
- Determine financial objectives: What are you trying to do with your forecasts? What KPIs will you use to determine on-target performance? Define any assumptions and what outcomes you expect.
- Pull together information: Gather the necessary data for detailed forecasting, including:
- Previous period financials for historical perspective
- Current and historical statistical data
- Cross-departmental, expert, and/or consultant advice
- Trend reporting and external event data that could impact the forecasting process or its outcomes.
- Potential disruptors or outliers (changes in the supply chain, natural disasters, economic fluctuations such as inflation, etc.)
- Determine forecasting model: Consider the four commonly used forecasting methods. Each has different levels of complexity and required data. Choose which method works best for your particular situation.
- Implement and refine: Put your forecast to work. Refine the forecasting with new and emerging data over each succeeding reporting period. Use the data derived from forecasting to make data-driven decisions and strive for the outcomes outlined in the budget.
Conclusion: budgeting, forecasting, and the budget forecast
Now you know the basics of budgeting and forecasting. You also know where the budget forecast fits into the bigger picture.
If you'd like to get started on creating a budget forecast, download and play around in our free P&L budget vs. actual template for Excel and Google Sheets.