Businesses deal with uncertainty every day. Things outside their control, like supply chain issues, labor trends, and market shifts, can impact nearly every aspect of business operations.
A lot of strategic planning involves anticipating what the future might hold and then deciding on the best plan to maximize performance in that anticipated future. It's an attempt to eliminate the guesswork and switch from reactive to proactive planning.
This is where budgeting and forecasting come into play.
Using a combination of the two, you can create a data-driven strategy that helps you hit your goals while maximizing profits and cash flow.
To do that, you need to understand the basics and use cases—and this guide will help you do just that.
What is budgeting and forecasting?
Budgeting and forecasting are ways of anticipating and planning for the future.
While similar and often confused, these are two separate tools in your arsenal for financial planning. You need budgeting for making specific plans and goals and use financial forecasting to think about the long term and prepare for larger economic conditions.
Budgeting is the action plan of finances driven by managers and goals for the company. Financial forecasting is predicting the company's economic conditions and future performance.
Let's get into the distinction between budgeting and financial forecasting, and how you can use each tool to improve your business performance.
Budgeting
A budget is a set of expectations of what a business will earn in a given period and plans for how to use that money to accomplish its goals most effectively. It includes estimates of revenues and expenses the business tries to adhere to over that period.
A reasonable budget is like a financial planning roadmap that should tell you:
- Where you are
- What matters right now
- Where you want to go
If your business is budgeting correctly, you'll be able to identify issues before they become significant problems (such as fraud or overcharging) and make dynamic budget changes in the moment.
You may also need current budgets or profit-and-loss statements to acquire financing or investors.
Check out our guide to creating a business budget.
There are five types of business budgeting that executives use to direct financial operations, but the right one is the one that works best for your company.
- Incremental budgeting: adjusting budgets by increments across the board.
- Activity-based budgeting: working backward from a desired goal.
- Value proposition budgeting: line items assessed for value to the company.
- Zero-based budgeting: justification for each purchase before allocation.
- Cash flow budgeting: facilitating the cash flow to your business.
Key features of budgeting
Some core features of budgeting include:
Estimating future revenue and expenses
Look at historical data to get a general feel for how the future will unfold. Then, start making descriptive and prescriptive changes.
Descriptive changes are how you expect the state of affairs to differ from the prior period. For example, if you're on a high-growth trajectory, you'll need to adjust budgets to accommodate an increase in production.
Prescriptive changes are how you want to shape your future spending. Say you want to reduce software costs and unnecessary subscriptions that should be reflected in your budget.
Tracking and reducing debt
A reasonable budget incorporates a game plan for paying down liabilities, from long-term ones like loans and lines of credit to short-term ones like credit card debt and accounts payable.
Check with an amortization schedule to see upcoming payments and how much you need to budget.
Comparing budgets to actual results
Routinely check in on how effectively the business is sticking to the budget, but remember that variance isn't necessarily bad. If you've overspent somewhere, it could have been the right thing to do given the situation, like spending money to promote a sale to open up inventory space for a new product line.
Financial forecasting
Financial projection and forecasting involve predicting the future using present and historical data. Forecasting allows executives to determine economic conditions and prepare for business changes.
Unlike budgeting, which focuses primarily on your business operations, financial forecasting should consider the macroeconomics, including social and political factors.
Financial forecasting is ongoing and fluid as circumstances and data change. If budgeting is steering the ship, financial forecasting is the map.
Financial forecasting comes in two varieties: qualitative and quantitative.
Qualitative forecasting uses knowledge and informed opinions to make estimates or predictions. Quantitative forecasting is a complex analysis of all available data to predict future outcomes.
Both styles attempt to provide insight into business futures so executives can make strategic, informed decisions for the company.
Typical forecasts used by businesses include:
- General business forecast: overall market conditions.
- Sales forecast: predicting future sales.
- Demand forecast: determining market demand.
- Capital forecast: available capital at a future date.
- Accounting forecast: predicting future costs.
- Financial forecast: the trajectory of your business.
What type of business forecasting should you use? Read up on each type of business forecasting.
Key features of financial forecasting
Some core features of financial forecasting include:
Changing with real-time information
You should update a forecast regularly based on the data coming in. Very rarely does everything play out exactly as expected.
For example, maybe a product goes viral and demand skyrockets. Then, the forecast is completely out of line with what's happening and no longer suitable for planning.
To help you make the best decisions, consider rolling forecasts that continually update with real-time data and adjust if new trends are identified.
Building on assumptions
To paint a picture of the future, you need to make assumptions about how things will turn out. For example, you might make assumptions about market trends or economic conditions to measure how they impact financial performance.
Sometimes, you can test different assumptions to get foresight into multiple possible outcomes. This is called scenario planning or scenario analysis.
Mixing historical information and current trends
Most forecasts start with historical data as a starting point. Then, they start to adjust the numbers based on assumptions.
Assumptions can be quantitative or qualitative. Quantitative assumptions are based on data, while qualitative assumptions are based on human judgment, like expert predictions or industry expectations.
How often should you budget and forecast?
Generally speaking, budgeting is done more often than forecasting.
Firm budgets can be set annually, quarterly, monthly, or even weekly, depending on the company's size and reach. However, budgets should be updated with actual spending levels to analyze variance.
Forecasting is typically conducted once per year or when there's economic upheaval. Forecasts are then routinely updated and adjusted based on how actuals compare to projections.
Like a sales forecast based on historical data, simpler forecasts might be made frequently, like for each quarter.
What is budget forecasting?
A budget sets a financial plan for achieving future goals, while a forecast models the future.
Budget forecasting synthesizes these two practices into one financial planning practice. You set the budget and then perform a forecast to see if it achieves the goal.
If a business wants to increase profits by 10% in the next quarter, a budget forecast would set spending levels and incorporate assumptions about external factors like market trends. They end up with a test of whether the business would accomplish that goal or whether the budget needs to be adjusted.
What's the difference between budgeting and financial forecasting?
We've compiled the essential differences in a table below to help you understand budgeting and financial forecasting at a glance. Read on for a deeper breakdown.
Purpose
While budgets and forecasts are ways of trying to understand the future, they're different approaches based on their purpose.
A forecast is a description of how the future could look. Using historical data, trends, and assumptions, finance teams present a picture of a possible future that leaders use to create strategies.
A budget is one of those strategies. They're a way of working backward from business goals to determine how finances should be allocated to achieve them.
While forecasting describes the future, budgets are focused on how spending can be planned to shape the future around a business's goals.
Inputs
Budgets are primarily focused on what a business can control. The starting point for most budgets is past financial reporting, like income statements and cash flow statements.
With this information, the finance team sets expectations about future revenue. Then, they start examining where they can increase or decrease spending to help the business achieve its financial goals.
Financial forecasting involves a wider array of information. Both quantitative and qualitative information are considered to complete a forecast.
This means a forecast incorporates data-backed assumptions (quantitative) and expert opinion (qualitative) to create conclusions.
For example, a business that makes single-use paper cups might see that data shows demand is increasing year over year. Still, if an expert says laws are being introduced to ban paper cups, the qualitative insight is that demand would decrease. Both factors are essential to consider when creating a forecast.
Time horizon
Budgets are made for as short as a week and as long as a year. If a budget looks too far into the future, it doesn't adapt to changes in circumstances or economic booms or busts.
Forecasts can be made for long periods—up to years in the future. In particular, startups are forecasting up to five years in the future to try and set their strategy.
Level of detail
A complete budget requires planning expenses down to the last penny. Every expense type and dollar needs to be accounted for.
A forecast is more relaxed when it comes to how detailed it needs to be. While you could spend countless hours plotting out every possible trend and potential change, most forecasts focus on key variables to measure the impact on a business's financials.
For example, suppose a coffee roaster hears that the cost of raw beans will likely increase by 30% in the next year. In that case, they'd create a forecast incorporating that information to see how it impacts their profitability. They don't need to include every other possible change to learn something from this forecast.
Incorporating external factors
Budgets examine what a business can control, mainly its expenses. The purpose is to determine what the business should do to achieve its goals.
In contrast, forecasts try to account for as many external factors as possible. Information about market trends or economic indicators is used to create a picture of the business's future prospects.
Frequency of updates
Budgets don't often allow for flexibility. They're set to be followed and if a business aims to be adaptable, it typically uses a shorter time frame.
Forecasts are updated regularly as data comes in that could reshape the projection, whether it's weekly, monthly, or quarterly. Set times to update forecasts because how things change could completely reshape your strategy.
Gain clarity and control with cash flow forecasting software from BILL
To understand where you want to go and exactly how to get there, you need visible, actionable budgets and financial forecasts. BILL Cash Flow Forecasting helps plan for the future by leveraging your historical accounting data to automatically generate forecasts up to 13 months in the future. It also empowers you to model how various scenarios—such as hiring a new employee—could impact cash flow
BILL also provides the tools to help businesses track expenses, create budgets, and meet goals. See how with a BILL demo.
Budgeting vs. forecasting FAQ
Should you do a budget or forecast first?
If you're completing a budget and a forecast, it's best to do the forecast first to build a budget based on it. Once you've completed a forecast, you get a rough estimate of what kind of revenue and expenses to expect, then plan an optimal path that connects the two.
If you complete a budget first, you might see something in the forecast that makes you second-guess the budget you put together.
How are budgets and forecasts connected?
Budgets and forecasts are both lenses for looking into the future. While they can be completed independently, budgets often use information from forecasts to help set spending levels.
These two practices come together in budget forecasting, which is the practice of testing a budget within a forecast to see if it accomplishes the business's goal.
What are examples of forecasting and budgeting?
Forecasting often focuses on an aspect of a business that it's projecting the future for. Examples include sales, demand, and financial forecasts.
Budgets vary depending on the strategy a business uses to inform its budget. Examples include incremental, zero-based, and activity-based budgeting.
