In a recent survey by Prophix and CFO, we asked, “which standard financial processes present the greatest challenge, the ones that keep you up at night?”
The responses were unsurprising– 21% of respondents identified forecasting as one of their most challenging processes. Yet, for most companies, forecasting and budgeting are a critical part of financial planning & analysis (FP&A).
Organizations all over the world have been budgeting for decades, solidifying its position as a foundational financial process. Conversely, forecasting is a relatively new process, supported by the proliferation of finance software, such as Corporate Performance Management (CPM).
For those companies interested in improving their forecast, it’s beneficial to understand the key differences between budgeting and forecasting, and how to utilize both processes to benefit your organization.
So, let’s get started…
What is Budgeting?
For many organizations, the budget is the most critical part of their strategy, guiding the way towards what they want to achieve.
Educba defines a budget as, “a detailed statement of expected revenues and expenditure which quantifies the tactical plans of the management to reach a desired goal for the company during a specified period.”
Steven Bragg from AccountingTools outlines the characteristics of a budget:
- A budget is a representation of desired results, financial position, and cash flows
- A budget specifies a time period in which the business hopes to achieve the results
- A budget compares actual results to determine variances from expected performance
- The finance department can take remedial actions to bring results back in line with the budget
- A budget provides guidelines for resource distribution in line with the company’s long-term strategy
These characteristics can translate to wider benefits for your company including planning, profitability, and performance.
Budgeting encourages your leadership team to sit down and discuss its long-term strategic vision for the company. This exercise is beneficial because it encourages executives to consider the company’s competitive and financial position (AccountingTools).
Budgeting is also an opportunity to identify the most profitable areas of a company and make decisions about where to allot resources in the upcoming fiscal year. Cash allocation is a key part of the corporate budget, as it forces management to consider whether to invest in fixed assets or working capital. These are only a few of the benefits of budgeting, but broadly speaking, assembling a budget is an opportune time to take a long view of your business and discuss strategic objectives.
However, one of the challenges of budgeting is that corporate budgets can become quickly outdated, as they are often assembled at the beginning of the fiscal year. For this reason, many companies choose to create and maintain a forecast, which better reflects their finances in real-time. So, let’s take a moment to understand what goes into a forecast.
What is Forecasting?
Forecasting has garnered a lot of attention in recent years, predominately as a complement to budgeting. To put it simply, forecasting estimates revenues to be achieved in a future period, whereas budgeting quantifies the revenues a business wants to achieve.
Educba defines a forecast as, “an estimation of future outcomes which quantifies where the company is headed during the forecasted period.”
AccountingTools outlines the characteristics of a forecast:
- Forecasts are typically limited to major revenue and expense line items
- Forecasts are updated regularly (monthly or quarterly)
- Forecasts can be used for both short- and long-term considerations including staffing, inventory levels, and production plans
- Forecasts are not compared to actual results
There are many benefits forecasting offers to businesses. Forecasting, done at regular intervals through the year, can help companies adjust their goals to reflect company or market changes, as originally set out in their budgets. Given the diversity of business forecasting requirements there existing a growing number of forecasting methods such as:
- Rolling Forecasting that predicts the future performance of a business over a continuous period, based on historical data
- Dynamic forecasting uses the value of the previous forecasted value of the dependent variable to compute the next one versus static forecasting that uses the actual value for each subsequent forecast
- Real-time forecasting is the practice of updating probabilistic predictions about future events by assimilating new information as it appears
The diversity of forecasts also means that companies can focus only on what matters to their business such as cash flow, production, sales, or finance, and use a timeline that’s right for their business, whether that’s in days, weeks, months, or years. These forecasts can be quickly adapted to account for rapidly changing factors like interest rates, currency rates, production levels, and payment terms.
What’s missing from many forecasts, however, is a focus on long-term strategic goals. Inherent in the budgeting process is time for various departments, teams, and leadership to sit down and discuss their vision for the company in the next year. Without this strategic vision, it can be difficult for staff to regularly make knowledgeable decisions that support the company’s growth.
What Are the Differences?
Educba’s infographic does an excellent job of summarizing the differences between budgeting and forecasting, as discussed above.
In short, a budget reflects where management wants to take the company; a forecast is indicative of where the company is headed in the future.
No matter your organization’s preference, there are benefits and considerations to both budgeting and forecasting.
If your finance department relies primarily on a budget to guide their decision-making, it should be updated more than once in a fiscal year so that it accurately reflects changing market conditions and company objectives.
If you conduct forecasting, your management team should be aligned on their long-term goals and strategic vision for the company, so that everyone can make decisions with the same end-goal in mind.
Regardless of whether your company prefers budgeting or forecasting, your processes are only as good as the data used to compile them. Organizations that utilize Corporate Performance Management (CPM) software are better positioned to automate their budgeting and forecasting processes. With reliable data centralized in one location, companies can trust both their budget and forecast, and they can spend more time analyzing the results.
This blog is syndicated from our ISV partner Prophix and originally appeared at https://blog.prophix.com/beginners-guide-budgeting-forecasting/.