Before you start developing your product for your startup business, you will need these two financial tools – budgeting and financial forecasting. They will help you create a business strategy and funding from the investors.
Projected financial statements are the basis for any business’s feasibility, so prepare budgeting and financial forecasting to create a sustainable business plan.
Budgeting and Financial forecasting are often confused, as they both more or less estimate the financial revenue. Still, there are specific key differences in its purpose, usability, duration, final outcome, and practical application.
This article will help you understand what is a budget, what financial forecasting is, why they are essential for your startup, and the critical differences between budgeting and forecasting, along with the steps to create effective budgeting and financial forecasting.
So, let’s start with understanding what is a budget.
What is Budgeting?
Budgeting is a process where you create a plan and expect your business to achieve it by estimating revenue, expenses, and cash flows along with the budgeted balance sheet.
A budget gives you an idea of what you have and, using those resources, what you should expect to achieve financially.
The budget can be your sales budget, operations or expense budget, or an overall financial budget depicting the financial projection of your business. Let’s learn which types of budgets you can prepare for your business.
Types of Budget Most Commonly Used for Startups
A master budget is an overall business budget, showing smaller and specified parts from the operational and financial budgets. It gives the management an idea of how they should plan their business activities.
The financial budget allows you to understand the overall financial position that you should expect your business to have in a specified duration, such as budgeted capital, budget sales, projected revenue, expected liabilities, and budgeted total assets for the company.
The operating budget will give you an idea of how much operating revenue and operating expenses you will need for a specified period. The operating revenue and cost refer to the income and expenses directly related to your business.
For example, if you manufacture paints, the revenue from selling color paints is your operating income, but the revenue from scrap is not your operating income.
Cash Flow Budget
A cash flow budget is prepared to know the money that comes into the business and goes out. The estimation of the cash flow is done using revenue and expense forecasts.
A static budget uses a fixed amount of revenue and expenses throughout the year. It gives you an idea of how much money you will receive and spend. Not-for-profit entities use it as they are given a fixed amount to use.
Apart from the above types, there are other types of budgets based on the requirements of the business startup, such as fixed cost budget, revenue budget, labor budget, expenditure budget, etc.
Don’t tell me what you value. Show me your budget, and I’ll tell you what you value.” – Joe Biden.
Why is Budgeting Important for Startups?
- Budget acts as an effective financial management tool for your business plan. It helps you understand where you will be in the coming years.
- The budget helps you compare your actual results with the budgeted outcome to understand your business financials against what you expected/planned.
- Budgeted numbers are critical components to preparing a variance analysis that will help you understand your actual performance against your budgeted targets.
- Early detection of any deviation from your budgeted plan will enable you to determine the reasons for the deviation and improve the performance.
What Is Financial Forecasting?
Financial forecasting refers to estimating the company’s financial performance based on projections of what your startup business will achieve in the specified period.
Financial forecasting helps you understand the trends, and it is not what you want to achieve. But it gives you an idea based on the predictions and projections of what your business will gain.
Typically, the financial forecasting is done for the revenue and expense items to understand the sales and expense projections. It helps in the allocation of the budget amounts accordingly.
Financial forecasts also include cash flow projections, but they generally do not forecast the financial position.
Types of Financial Forecasting Startups Use for their Businesses:
Below are the most common types of financial forecasting every startup business performs:
Revenue forecasting helps you understand your revenue trends based on the projections and historical information available. Entrepreneurs mostly use revenue dashboards to build data-backed forecasts.
Expenditure forecasting projects various expenses that need to be incurred to run the business based on the current business trends and historical data.
Cash Flow Forecasting
Cash flow forecasting how much money your business will have and how much cash will go out.
Why is Financial Forecasting Important for Startups?
It helps you understand how your business will grow considering the current market trends and allows you to consider the competition.
When you have a forecast, you will try to achieve or outperform the forecasted figure that sets a goal for your business.
It is the most flexible way to predict your finances as it can rapidly incorporate the changes.
But then budget and forecasting look similar; how are they different from each other? Let’s find out what are the key differences between budgeting and forecasting.
Budgeting Vs Forecasting: Key Differences
The budget tells you what levels of sales, expenses, and other assets and liabilities you want to achieve in a particular time frame. In contrast, forecasting will tell you what you will achieve considering the current trends and past data.
The budget considers past data to predict and set certain levels for sales, expense, capital, assets, and liabilities so that you can compare your actual performance against the budgeted plan. On the other hand, forecasting considers market trends and analysis to understand how your business will achieve the forecasted revenue for a specified period.
Flexibility for Revision
The budget is generally not revised once it is made as it, later on, compares the actual performance to find out the variance; hence it is not very flexible. In contrast, the forecasting is quite flexible and revised as specific trends change in the market to consider them in your forecasted revenue and expenses.
A budget is a tool to control your financial and operational performance, whereas a forecasted revenue can be used to develop your budgeted financials.
The budget is mainly prepared for 12 months or less, whereas a financial forecast could be 3 to 5 years. Sometimes, financial forecasting is also done for three months or six months.
Budget prepares budgeted financial statements, while forecasting provides projected financial trends for revenue and expenses.
Budget gives you an overall business plan for capital, assets, liabilities, revenue, expenditure, cash flow, etc. Whereas, forecasting gives a business plan primarily for income, expenditure, and cash flow.
Forecasting is an integral part of budgeting. It provides inputs to prepare an overall budget. In comparison, forecasting does not cover budgeting as it is done independently.
How to Prepare an Effective Budget and Forecast for Startups?
- Collect historical details and current market trends and align them with your business goals.
- Analyze the product market, and related trends and consider them for forecasting.
- Make assumptions and forecast the revenue, expenses, and cash flows based on the details gathered.
- Use the forecasted numbers to prepare overall budgeted financial statements.
- Revisit the underlying assumptions and market trends for any changes.
The Bottom Line
Budgeting and financial forecasting are the two pillars to understand and estimate your company’s financial performance. An effective budget and forecasting can help you achieve your targets and make it possible for you to go as planned.
Request your free demo at Upmetrics, where you can customize your financial forecasting with simple steps. It will automatically create effective financial forecasts and simplified financial summaries for your business.