The two tools that the companies use to establish their plans for the company are budgeting and financial forecasting. Often these two terms are used together but are two different concepts -Budgeting quantifies the expectation of revenues whereas forecasting estimates the numbers that will be achieved. Forecasting is where the company wants to be in long term (say 3 or 5 years from now), whereas, budgeting is short term planning to achieve those results (say next 12 months). Forecasting is strategic planning whereas budgeting is tactical planning.
Budgeting is the process of creating a plan to spend your money which helps in determining in advance for what you’ll have money and for what you won’t be having money. It’s all about maintaining the balance between expenses & income. This spending plan for your money ensures that you will always have enough money for the vital operations of your business and at times of need.
For corporates, budget is indispensable when it comes to functioning at optimum level. It helps in planning for exigencies. Budget is an estimate of revenues and expenses; it talks about the expected cash flows and goals. It outlines the expected debt reduction. Budgets can be classified on various basis i.e. capacity(fixed/flexible), function (sales/ production/ purchase) or time (long term/ short term). A periodical re-evaluation of budget is always required based on which updates are done.
A budget is compared to real results to compute the variances between the two figures. Budgeting creates a reference point to compare actual results to work out how the results differ from the anticipated performance. Budgeting can occasionally have unattainable goals due to dynamic market conditions. When decisions are grounded on budgeting, the budget needs to be flexible and its regular updating is required to make it relevant to the market conditions that you are working in.
Financial forecasting is critical for business success. For effective management of working capital and cash flow, a company must have a rational idea of how much revenue it plans to receive over a given period of time and what are its necessary expenses over the same time period. Developing appropriate staffing and operational plans depends heavily on the financial forecasts of expenses and revenues eventually leading to a successful business. Forecast is estimation of future trends and outcomes, grounded on the past and present data.
Business forecasts envisage the forthcoming financial inflows and their sources by assessing current and previous data and trend analysis. It is used to determine how companies should allocate their budgets for a future period. Unlike budgeting, financial forecasting does not analyze the deviance between financial forecasts and actual performance. It is regularly updated, perhaps monthly or quarterly, when there is a change in operations, inventory, and business plan.
Forecast can be both short-term and long-term. Management team uses the financial forecasting data to alter their course of action to suit the business conditions as and when required. Additionally, a company’s management team finds a long term forecast helpful in developing its business plan. Established firms that generate regular revenue find it easier to create accurate financial forecasts compared to firms whose revenue generation is subjected to seasonal / cyclical fluctuations.
A budget is the frame work which guides the management in taking their company to their desired goals/ direction. A financial forecast is a report exemplifying whether or not the company is reaching its budget goals and where the company will be heading in the future. Every twelve months budget is prepared for the accounting period. While a financial forecast is reviewed and fine-tuned frequently. Usually budget sets targets for the future. Whereas forecast only projects future outcomes and does not set ant target.
Budget is the plan prepared by the business for its future economic actions. While forecast is just an estimate about future inflows and outflows of the business organization. Both of them are financial planning tools that assist the senior management of the organization in the decision-making process. Budgeting and forecasting are inter-twined and should work as partners with each other. Both short & long-term financial forecasts should be taken into consideration while creating and updating a company's budget.
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