Budgeting and forecasting are essential financial practices for any business. However, they are different, and involve different individuals or teams in your company. A forecast is the big picture of achievements and the factors involved, whereas a budget is a plan showing revenue expectations and expenses over time.
Larger businesses use these processes and see revenue and cost savings increase, but not all small businesses take advantage of these tools to achieve success. Here are some of the things you need to know about creating budgets and forecasts that are accurate and actionable.
Budgeting
Budgeting is planning a company's finances across critical areas like payroll, leased office space and equipment, software and hardware, and vendor payments. To properly create a budget, you need to create an outline that includes your projected cash flow, estimated revenue, and expenses for daily operations over a specific period (usually annually).
The first step of creating a financial budget is preparing a detailed financial outline and visualizing what is achievable. Once you have an outline and a goal for budgeting, you can make changes to further target your spending and income.
Types Of Budgets
There are six common types of budgets. Of course, which one you use depends on your business model, but these techniques help you organize your budget and execute it.
- Incremental Budgeting: You add or subtract a percentage of income and expenses against the previous budget.
- Value Proposition Budgeting: You ensure every list item in the budget creates value for your business.
- Zero-Based Budgeting: You create a budget based on cutting costs and justifying all expenses.
- Cash Flow Budgeting: You account for potential lines of credit to increase business cash flow.
- Activity-Based Budgeting: This budget maps out a specific input volume needed to achieve the projected business output.
- Surplus Budgeting: You budget to account for excess revenue.
Using these six budgeting types helps you plan for the future and realize the funding necessary to grow your business.
Forecasting
In contrast to budgeting, forecasting involves high-level projections of future business outcomes based on existing data and informed opinions. A forecast looks beyond direct factors that influence your business and macroeconomic factors like social and political climates that can sway your market.
Budgets are generally short-term and put in place annually to realize actual gains and expenses. However, a forecast is both short-term and long-term and requires more time to collect data, create a future growth plan, and adjust your operations accordingly. Therefore, most companies develop multiple forecasts to predict current and future business conditions.
Forecast Types
There are many dimensions and aspects of business activity, and each requires a forecast built to analyze current health and predict future growth in each area. Four primary types of forecasting are utilized when creating a plan for the future of your business.
- Demand Forecasting: This forecast helps determine the consumer interest for a specific product or service across the entire market. It differs from a sales forecast because it focuses on the external environment and uses data from past sales.
- Sales Forecasting: The planning process starts with projecting sales for the upcoming year. Because sales capture a business's main activity and the sales level, it tends to drive expenses, assets, and liabilities. Demand and sales forecasting go hand-in-hand because they are interrelated.
- Cash Flow Forecasting: This forecast shows how much money will come in and go out. This is a key forecast to accurately plan for income and expenses in your business's short- and long-term.
- Inventory Forecasting: Predicting levels of inventory for a future period is critical for businesses to ensure they have enough products on hand to fulfill orders. However, you must be careful not to overstock items, take past product sales performance and plan accordingly.
Key Differences Between Budgeting & Forecasting
While budgeting and forecasting appear similar, a thorough analysis reveals the differences between these concepts:
- Budgets outline planned business expenses and revenue for a specified period. Forecasting is a detailed projection of future business outcomes.
- A budget is usually created for the short-term (quarterly, bi-annually, or annually). Forecasting covers both short- and long-term business projections.
- Budgets are more static than forecasts. Financial forecasting undergoes several iterations as business situations and economic conditions change.
Budgeting & Forecasting Challenges
Every organization approaches budgeting and forecasting differently. How you approach both depends on your business model and the scope of processes based on your company size, structure, and industry.
A manufacturer evaluates its budgets and forecasts differently than a brick-and-mortar store. Each has specific financial targets and expenses that change the planning process. Common challenges hold back your budgeting and forecasting.
Disconnected Data
Data silos are a challenge for 57% of finance teams because they spend too much time gathering numbers from your ERP, CRM, HRIS, and other data sources. Collecting all this data keeps you from creating and analyzing the story the numbers tell you.
Without the story, budgeting and forecasting cycles slow, and it's harder to plan when business conditions change proactively.
These silos also discourage collaboration with cross-functional departments, which leads to unreliable budgets and forecasts that don't capture a complete picture of your business.
Manual Processes
The 2020 Pulse of Performance Management Survey found that 82% of finance teams still use Excel spreadsheets for budgeting, forecasting, and other core financial activities. But the same study found that 54% of those teams aren't happy with the processes.
Using Excel is labor-intensive, takes too long to complete, and is challenging to manage across the business. Excel is a comfortable and familiar tool, but when our company grows to a certain level of maturity, spreadsheets don't provide the processing power necessary for advanced budgeting and forecasting.
In addition, using Excel alone leads to version control issues, data integrity issues, and formula errors from manually entering data.
No Defined Workflows, Audit Trails, or Data Validation
There are many moving parts in budgeting and forecasting, which means keeping teams aligned is critical to success. You create stress and frustration with key stakeholders if you're searching for files, spreadsheets, and colleagues to gather numbers. You need workflows, audit trails, and data validation processes in place.
Budgeting & Forecasting Benefits
Now that we've covered the essentials of budgeting and forecasting, let's finish with the benefits of both:
- Financial Control – Easily track underperforming business areas or overspending.
- Risk Management – Different forecasts give insight into what to expect in the short term and the changes necessary to generate additional profits in the long term.
- Identify Opportunities – Budgeting and forecasting provide opportunities to review your listings or launch a new product or service.
- Goal Setting & Progress Monitoring – Sticking to your budget helps keep your business organized and reach goals faster.
Don't Leave It To Chance
Budgeting and forecasting take a lot of time and energy, especially if you have inefficient processes and procedures to collect the financial information needed to make better decisions.
Not everyone has the staff or resources to properly budget and forecast your business. Don't leave your future chances. Find the right finance and accounting firm to manage your financial operations and never miss out on an opportunity for growth.
ROARK is a Finance and Accounting consulting and executive search firm. We provide solutions for any size of business. From outsourced finance and accounting to executive search practice specializing in placing finance and accounting professionals like CFOs, Controllers, and Accountants in great companies to help manage and maintain your financial health.
Our consulting practice allows companies to undertake significant projects like mergers and acquisitions, ERP implementations, GAAP compliance, and audit support. Although we understand finance and accounting, our team of CPAs, MBAs, and executive search consultants have helped hundreds of businesses like yours streamline operations, provide guidance to meet your financial goals, and keep your business running smoothly.
Contact us if you're interested in setting a budget and putting processes in place to compare how you're doing against your established budget and develop new monthly forecasts to understand your current and future business goals better.