Budgeting & forecasting - Comparison

Budgeting

A budget is a spending plan based on income and expenses. It is a financial plan that outlines the expected income and expenses for a defined period. In other words, it's an estimate of how much money you'll make and spend over a certain period of time, such as a month or year. In business context, Budget can be a roadmap guiding resource allocation to achieve organizational goals and objectives efficiently.

A budget is an outline of expectations for what a company wants to achieve for a particular period, usually one year. Characteristics?of?budgeting include:

• Estimates of revenues and expenses
• Expected cash flows
• Expected debt reduction
• A budget is?compared to actual results to calculate the variances between the two figures.

Forecasting

Forecasting involves making predictions about the future by taking into consideration events in the past and present. It is a decision-making tool that helps businesses cope with the impact of the future's uncertainty by examining historical data and trends. Forecasting in accounting refers to the process of using current and historic cost data to predict future costs. Forecasting is important for planning purposes – it is necessary to estimate and plan for costs that will be incurred prior to actually incurring them.

In short, financial forecast is a framework that presents estimates of past, current, and projected financial conditions.

Characteristics of Financial forecasting include:?

• Used to determine how companies should allocate their budgets for a future period. Unlike budgeting, financial forecasting does not analyze the variance between financial forecasts and actual performance.
• Regularly updated, perhaps monthly or quarterly,?when there is?a change in operations, inventory, and business plan
• Can be created for both the short-term and long-term. For example, a company might have quarterly forecasts for revenue. If a customer is lost to the competition, revenue forecasts might need to be updated.
• A management team can use financial forecasting and take immediate action based on the forecasted data.

Planning

Planning provides a framework for a business' financial objectives — typically for the next three to five years. A budget is done over a short-term horizon, generally for 12 months, while a business plan is a medium-long term document looking at the next 3 to 5 years. The level of depth and detail for each document also varies significantly. Creating a financial plan requires building a long-term strategy for getting you where you want to go, while building a budget means money management for the day-to-day operations.

Although?budgeting and financial forecasting are often?used together, distinct differences exist between the two concepts. Budgeting quantifies?the expected revenues that a business wants to achieve for a future period. In contrast, financial forecasting estimates the amount?of revenue or income achieved in a future period.

• Budgeting is the financial direction of where management wants to take the company.
• It helps quantify?the expectation of revenues that a business wants to achieve for a future period.
• Financial forecasting tells whether the company is headed in the right direction, estimating the amount of revenue and income that will be achieved in the future.
• Budgeting creates a baseline to compare actual results to determine how the results vary from the expected performance.
• Financial forecasting is used to determine how companies should allocate their budgets for a future period.

Comparison between Forecast and budget

A budget outlines the direction management wants?to take the?company. A financial forecast is a?report illustrating whether the company is reaching its budget goals and where it is heading in the future.?

Budgeting can sometimes contain?goals that may not be attainable due to changing market conditions. If a company uses budgeting to make decisions, the budget should be flexible and updated more frequently than one fiscal year,?which is a?relationship to the prevailing market.

Budgeting and financial forecasting should work in tandem with each other. For example, both short-term and long-term financial forecasts could?be used to help create and update a company's?budget. A budget may not always be necessary during a fiscal year, although many companies make them. However, a financial forecast is relevant because of the information it provides because it can highlight the need for action. In contrast, a budget may contain targets that cannot be accomplished if the budget is an overreach.

The Key Differences

1. Purpose: Budgeting is the process of creating a financial plan for a defined period of time, usually a fiscal year. Forecasting is the process of predicting future financial outcomes based on historical data and trends.
2. Inputs: Budgeting starts with setting financial goals and allocating resources to achieve them. Forecasting uses past financial data and market trends to make predictions.
3. Time Horizon: Budgeting is typically a long-term planning tool that covers a fiscal year or more. Forecasting can be done for any period of time, from the next month, quarter, 1 year, 3 years.
4. Precision: Budgets are often detailed and precise, with specific revenue and expense targets. Forecasts are less precise, due to the uncertainty of future events.
5. Flexibility: Budgets are static and sometimes set in stone, making it difficult to change them during the year. Forecasts, on the other hand, can be updated as new information becomes available.
6. Level of Detail: Budgets are usually more detailed, covering all expenses and revenues. Forecasts are often high-level and less granular.
7. Use: Budgeting is used to guide financial decision-making and measure performance against goals. Forecasting is used to anticipate future events and adjust plans accordingly.
8. Decision-Making: Budgeting is a key tool in the decision-making process, as it helps managers allocate resources and prioritize initiatives. Forecasting is used to inform and support decision-making, by providing a view of potential future outcomes.
9. Role of Management: Budgeting often involves input and approval from upper management, while forecasting may be done by finance teams with individual departments.
10. Accuracy: Budgeting is based on well-researched assumptions and estimates, but may still be subject to significant deviations from actual results. Forecasting accuracy can be impacted by unpredictable events and market changes.
11. Relevance: Budgeting is important for companies that need to plan and manage their money, while forecasting is important for companies that want to know and prepare for future market conditions.
12. Compliance: Budgeting is sometimes tied to regulatory requirements and financial reporting standards, while forecasting is not necessarily subject to the same level of compliance.
13. Complexity of Financial Models: Financial modelling plays an important role in both Budeting and forecasting. However, in general budgeting may utilize less complex financial models, while forecasting often relies on models and algorithms to predict future outcomes.
14. Emphasis: Budgeting places emphasis on controlling costs and managing resources, while forecasting focuses on anticipating future financial outcomes.
15. Continuous Process: Budgeting is a process that is typically done annually or semi-annually. While forecasting is a continuous process that is updated as needed to reflect changes in market conditions.
16. Real-time vs Historical Data: Forecasting typically uses real-time data and market trends, while budgeting may use historical data and assumptions.
17. Iterative Process: Both Budgeting and Forecasting are iterative processes. Budgeting may involve an iterative process, with multiple rounds of revisions and updates. While forecasting may involve a more dynamic and ongoing process.
18. Basis of comparison: Budgeting provides a basis for comparing actual performance against planned results. Forecasting provides a basis for evaluating potential risks and predicting future results.
19. Dynamic vs Static: Forecasting is a process that changes over time, while budgeting is a process that is set for a certain period of time.
20. Input from Other Departments: Budgeting may involve lots of inputs from other departments, such as marketing and sales. While forecasting may involve fewer inputs and may be primarily done by finance and data analytics teams.

Budgeting and forecasting both serve different purposes. And are important tools for financial planning and decision-making.

Article credits for key differences #asif masani