Budget vs. forecast: 3 key differences
Budgets and financial forecasts — you’ve heard the terms before. But, there’s often a lot of confusion around the difference between budgeting and forecasting and the roles these essential tools play in financial planning and startup growth.
In this guide, we’ll drill down into budgeting and forecasting and learn the differences, when to use each, and how to create budget forecasts for your business.
What is a budget?
A budget is a plan for spending based on estimates of expenses and income (or available funds) over a period of time. Budgets can be created for an individual, group, single project, or an entire business. They can be created for a fiscal year, a single year, or on a monthly or weekly basis (more common for personal budgets).
Purpose of a budget
A budget helps your business plan out its cashflow — a critical task to ensure your money is going to the most effective places and you’re not spending more than you have. It can also determine the following:
how much money you need to cover anticipated costs
how much you’ll have leftover in case of emergency
the point where your business breaks into profit
the right price points for your products or services.
Every business should have a budget — the insights, information, and guidance it provides are invaluable.
Budgeting mistakes to avoid
Creating a budget can be a difficult task, particularly for those who are new to it.
Here are some of the most common mistakes to avoid:
forgetting to deduct sales and income taxes from your revenue
failing to allow a buffer for shrink and lost inventory
not factoring in interest on loans and credit accounts.
Finally, don’t forget other costs, such as insurance or healthcare coverage, that are essential but not necessarily immediately obvious. Taking time to consider all of these angles at the start can help avoid issues down the road such as insufficient funds for a project.
What is a forecast?
What is forecasting in business, and how is it different from budgeting? While a budget outlines your company’s expectations for the given period, a forecast attempts to predict what you’ll actually achieve. In practice, this means budgets tend to be more detailed, while forecasts are usually more strategic and high-level.
Purpose of a forecast
A financial forecast plays an important role in helping businesses put together realistic goals and plans. Forecasts are also highly useful as showpieces for investors and lenders.
Types of forecasts
There are 3 main types of financial forecasting your business might want to take advantage of: general forecasts, sales forecasts, and financial forecasts.
General forecasts cover a broad range of elements, like projected revenue and expenses, data regarding the demand for your product, and market trends.
Sales forecasts, as you'd guess, are all about sales. These forecasts cover the number of products and services expected to sell, the projected costs of those products and services, and the profit that they’ll generate.
Financial forecasts are higher-level forecasts that look at the overall financial picture of the company. They might include revenue data, expenses, comparisons to industry averages, and more.
Each forecast type serves a distinct purpose, although there’s naturally some overlap between them.
Forecasting mistakes to avoid
If you’re ready to create a forecast, first take a look at these mistakes to avoid:
Being too optimistic
While you certainly don’t want to discount your business, you need to be realistic, otherwise the forecast will serve little purpose.
Making the scope of the forecast too narrow
When creating your forecast, rather than only looking at your primary products or services, take a holistic approach and include the entire company. You’ll get a more accurate picture and end with a stronger plan of action.
Budgets vs. forecasts: What’s the main difference?
While budgets and forecasts are certainly similar, there are a few key differences that dictate when you’d use one over the other.
Budgets are usually static
Budgets tend to be static documents. While they may be changed in some exceptional circumstances, this tends to be the exception, rather than the rule. This is because a budget is used to determine financial needs and available resources, and it’s hard to plan based on constantly changing numbers.
Forecasts, on the other hand, are often updated quite frequently. Since forecasts are intended to provide a strategic overview and guidance on the direction of the business, they need to be kept current to be useful.
Budgets are based on reality vs. expectation
The first major difference between a budget vs. forecast is that a budget is based on reality, while a forecast is based on expectations. If your business is currently selling an average of 500 units per month, that’s what you’ll most likely base your budget on. But, if you know that this number has been trending upwards for the last several quarters, your forecast for the next quarter is likely to take that into consideration.
Budgets are tactical vs. strategic
Another difference between budgeting and forecasting is purpose. Put simply, a budget is a tactical tool intended to inform your day-to-day operations. A forecast, on the other hand, is a strategic tool designed to help your business chart its course in the future.
How to accurately forecast your budget
Now that we’ve got the basics covered, it’s time to learn how to accurately create a budget forecast for your business. The process is fairly straightforward, but the work can be daunting if you’re new to it, so we’ll walk through each step one by one.
1. Gather data
Your first step is to gather the information you’ll use to create your forecasted budget. A common source is your Profit and Loss statement from the past year. You should break this data down as granularly as needed — revenue by source, and expenses by type or recurrence.
2. Perform an analysis
Next, perform a preliminary analysis of that data. This analysis helps make sense of the raw numbers and get a better idea of trends in your business. Watch for increases or decreases in revenue or expenses and find your averages. As a general rule, you also want to be conservative with your numbers; take the higher end of your average expenses and the lower end of average revenue or profit. This gives some built-in buffers.
3. Establish a time frame
A properly forecasted budget should focus on a specific time frame. There’s no right or wrong here, it just depends on the needs of your business. Common time frames are monthly, quarterly, and annually.
4. Set expectations
Alright, now we’re getting to the good stuff. This step is where you take the data from your analysis and project estimated revenue based on earning history. This becomes your revenue goal and is the income benchmark you’ll use to make financial decisions over the forecasted period, so it helps to be a little conservative.
5. Project expenses
Next, project your estimated operating expenses for your chosen time period. These budget projections should cover everything from mortgage payments to payroll to cost of goods sold. Expenses should be calculated aggressively, using the top end of your estimates (the opposite approach to projecting revenue). You effectively assume the worst-case scenarios to give yourself some wiggle room.
6. Establish a contingency fund
As we’ve all learned over the last couple of years, it’s important to have a plan in place for unexpected occurrences. So, take those projected expenses and determine the monthly total operating cost of your business. This will be used to create a contingency fund.
Generally, you want this fund to cover at least 2 months of operating costs. In other words, if all revenue stopped tomorrow, you’d be able to continue as normal for 2 months before experiencing interruptions. Once you’ve got a suitable amount, set it aside somewhere accessible.
7. Implement the budget
The final step is to implement your budget. With your revenue and expenses forecasted and your contingency fund set up, you now have what you need to create a budget document to guide your business moving forward. Refer to this document when making financial choices or evaluating changing market conditions.
Improving your budgeting and forecasts with MYOB
As you can see, budgets and forecasts are an essential part of operating a business. They help set expectations for future performance and guide decisions at both a high level and during the day-to-day grind.
However, these reports can also be highly involved and time-consuming to put together. MYOB can help. Our accounting software can enable you to put together more accurate budgets and forecasts in less time. Try MYOB FREE for 30 days today.