Nearly 38% of businesses fail because they exhaust their cash reserves or fail to secure additional capital.
As the business grows, owners may find themselves stuck in managing everyday business operations. They might fail to plan financially resulting in stagnation or declining growth over time.
Well, this can threaten your business success. To succeed in a competitive world, businesses need proactive and flexible financial planning.
But how do you achieve this?
Through budgeting and forecasting, the two most important financial planning tools.
While most people consider budgets and forecasts to be the same, they are quite different.
In this blog post about budgeting vs forecasting, we’ll understand the core differences between these two financing strategies.
However, before that…
What is budgeting?
Budgeting is the process of setting your financial goals typically for a year. It provides a framework for businesses to prioritize their expenses and allocate resources.
Budgets are typically set at the end of a year to serve as a roadmap for the next fiscal year. At the end of the year, businesses can evaluate their performance by comparing budgets with the actual results.
Budgets are conservative and rigid. However, they’re the first essential step to enable strong budgeting planning.
What is forecasting?
Financial forecasting predicts the future financial outcomes of your business based on assumptions, market trends, and historical data. Forecasts can be short-term or long-term, depending on whether they fulfill operational or strategic needs.
Unlike budgets, forecasts get a regular periodic review. Businesses can identify potential opportunities and financial challenges early on, devising strategies to address the changing market conditions.
The key components of any forecast include 3 financial statements: cash flow, profit and loss, and balance sheet offering a thorough financial outlook of any business.
Budgeting vs forecasting: Key differences
Most people and even professionals use the terms budgeting and forecasting interchangeably. Well, apart from a few similarities, budgets and financial forecasts are quite different.
These key differences show a clear distinction between both.
1. Purpose
Budgets are built to set financial goals and track the performance of your business. Their primary goal is to stop businesses from overspending by setting spending limits based on income expectations.
Financial forecasts, however, predict the future financial outcomes of your business. Their core objective is to identify potential gaps in financial performance. As a result, you can take proactive measures to correct the course of the business’s future.
2. Time-frame
Businesses set budgets for one year, usually from one fiscal year to the next. Once defined, budgets are often set in stone for that specific period. At the end of the period, budgets are evaluated by comparing the set financial goals with actual performance.
Forecasts, on the other hand, can be long-term or short-term typically ranging between 18 months to 5 years. Unlike budgets, forecasts are updated monthly and quarterly to reflect the changing market trends and economic conditions.
3. Focus
Budgets focus on planning your desired outcomes by establishing clear spending limits. They offer a framework for financial goals to help you control and maintain the company’s finances. Budgets focus on resource allocation and maintaining optimum cash flow in the business.
Forecasts, however, focus on what will happen to your finances under changing market conditions. They help businesses test different scenarios and study their impact on business finances. The role of forecasts is to assist businesses in long-term strategic planning and building financial resilience.
4. Metrics
Budgets track planned expenses and revenue to monitor financial performance.
Forecasts, however, track projected financial outcomes to anticipate revenue fluctuations. Forecasts analyze historical data, market trends, and actual performance to help you make informed projections.
Here’s a quick rundown of the differences between budgets and forecasts for a more thorough insight.
| Factor | Budget | Forecast |
|---|---|---|
| Type of document | Budgets are static documents with a fixed start and end date. | Forecasts are living documents that adapt regularly and sometimes even in real-time. |
| Handled by | Budgets can be handled by individual contributors. | Forecasts are handled by company leaders and senior-level management. |
| Purpose | Budgets are prepared to reach a financial goal. | Forecasts determine whether a goal would be met or not. |
| Preparation time | It takes about 2-3 months. | It can be prepared in 1-4 weeks. |
| Detailing | Budgets are more detailed and granular. | Forecasts are aggregated offering an overall financial overview. |
| Flexibility | Budgets are rigid. | Forecasts are adaptive. |
| Disclosure | Budgets don’t need to be disclosed. | According to the SEC, publicly traded companies must disclose their high-level forecasts to investors. |
Those are the differences that separate these financial tools from each other. However, it’s time for some practical and thorough insights.
Examples of budgeting vs. forecasting
Let’s now understand budgeting and forecasting through a fictional example of “Celine” fashion house
Budgeting
Celine generated a revenue of $3M in 2023. For this year’s budget, they’ve set a SMART goal of a 30% revenue increase, i.e. $3.9M.
After considering their operating expenses and debt reduction goals, this is what the budget for 2024 would look like.
| Expected Revenues | |
|---|---|
| Revenue from physical store sales | $2.5 M |
| Revenue from digital store sales | $1.4 M |
| Total expected revenue | $3.9 M |
| Budgeted expenses | |
| Sales and Marketing expenses | $1 M |
| General and administrative expenses | $1.5 M |
| Debt reduction | $0.5 M |
| Total expenses | $3 M |
| Operating income | $0.9 M |
As the budget template indicates, revenue projections for 2024 are expected to be $3.9 M. This revenue will be generated from physical and digital sales.
This budget also offers insight into where Celine’s financial resources will be used, i.e. expenses. The budgeting process sets spending limits to $3 M.
If Celine maintains the expenditure and manages to meet the figures of revenue forecast, its operating income would be $0.9M.
However, businesses operate in a rapidly changing world. They cannot always predict exact expenditures and revenues for a specific period (usually a year). There would be variances and only a performance review can show whether the goal you set was met or not.
Forecast example
As the budget indicates, Celine plans to achieve $3.9 M in revenue by the end of December 2024. However, is it feasible to achieve this goal?
Let’s find out.
Let’s say after analyzing Celine’s revenue for the past year, it revealed that the revenue grew by 2% month over month (MoM) during the past year.
Assuming the same growth rate over the next year, this is how future revenue might look like in 2024.
Note: The revenue in December 2023 was recorded as $280,000.
2% MoM revenue growth in 2024
| Month | Projected revenue |
|---|---|
| January | $285,600 |
| February | $291,312 |
| March | $297,138 |
| April | $303,081 |
| May | $309,143 |
| June | $315,325 |
| July | $321,632 |
| August | $328,065 |
| September | $334,626 |
| October | $341,318 |
| November | $348,145 |
| December | $355,108 |
| Total revenue | $38,30,493($3.8M) |
As the forecast predicts, if Celine’s revenue continues to grow by 2% MoM, its revenue will be $3.8M by December. That’s still, $0.1M short of the goal it wants to achieve, i.e. $3.9M.
To reach the $3.9M revenue goal, Celine needs more than 2% MoM growth. By leveraging forecasts in decision-making, Celine’s team can explore various strategies to boost growth.
For instance,
- Increase their product pricing
- Reduce operational costs
- Generate more sales
By adopting these strategies, Celine can meet their year-end revenue goal.
Now these are just the predictions set during the beginning of the year. Situations may change and these figures may fluctuate drastically due to changing market conditions.
By updating the forecasts with changing market conditions, Celine would get a more realistic overview of their revenue projections.
How to prepare a budget and forecast for startups?
Budgeting and forecasting work together to help businesses achieve their goals. We’ll now discuss how you can create solid budgets and actionable forecasts for your business.
1. Set clear financial goals
Begin by establishing a clear financial goal to guide your budgeting and forecasting efforts
A SMART goal framework can help you set actionable goals relevant and achievable for your business.
The goals could be in terms of how much profit you want to earn or the revenue you expect to generate.
You need historical data and data from the current market scenario to get a specific idea. Businesses with no historical data can set their goals using industry averages.
A clear goal will form the foundation upon which your budgets and financial forecasts will be based.
For instance, Celine aims to achieve a 30% increase in revenue by the end of December 2024 by increasing sales.
2. Create a detailed budget
A detailed budget should include 3 components: expense projections, revenue expectations, and cash flow.
Expense projections
Expense projections outline all the expenses your business will incur during the budget period.
Here you create a detailed list of expenses essential to running your business. This can include fixed and variable costs, administrative and marketing expenses, debt reduction expenses, and any other costs associated with your business.
Be aggressive and include every expense category to keep your budgets relevant.
Revenue expectations
Elaborate on your revenue expectations by estimating your income from different sources. For instance, revenue from physical stores, digital stores, third-party platforms, royalties, etc.
The historical data can help in setting realistic revenue goals. Unlike expenses, be conservative with your revenue expectations.
Cash flow management
Map out the inflow and outflow of cash to ensure you have enough liquidity to meet the expenses. Leave room for contingency funds as no business is 100% risk-proof.
Use your budget as a benchmark and strive to meet the expectations within it consistently.
3. Develop a financial forecast
Once your budget is set in stone, you need something more practical and adaptive to work with. Something like financial forecasts.
While creating your financial forecasts, be it for the short or long term, prepare for worst, best, and working case scenarios.
Advanced financial forecasting software make this process extremely easy with their automation and intuitive features.
Now, what should you include in your financial forecasts?
- Profit and loss statement
- Cash flow statement
- Balance sheet
To make these financial statements, you need sales forecasts, revenue projections, and expense projections.
Once your forecasts are ready, update them regularly to meet market changes. Evaluate the forecasts to see if everything’s moving as planned
and test different scenarios to form strategic decisions.
Tips to improve budgets and forecasts
As easy as the steps to form budgets and forecasts sound, there are some tips to help you get the maximum benefits of these financial tools.
- Feed highly relevant data to your forecasts to help with strategic planning.
- Choose real-time data integration tools to make accurate forecasts.
- Learn from the previous forecasts by studying where they went wrong.
- Experiment with different scenarios to get the true value of forecasting.
- Conduct market research instead of relying entirely on historical data.
- Be pragmatic with your projections. Don’t be overly optimistic and keep room for contingencies.
That’s a wrap on tips. Time to get involved and put these concepts to use practically.
Strengthen your financial planning with Upmetrics
While budgeting and forecasting serve different purposes, a business requires both for a sound financial plan.
A reliable forecast assists in building a realistic budget. Comparing the forecast with a budget can help businesses adjust to changing market conditions and achieve their financial goal.
Now, all this is quite easy when you have a highly intuitive financial planning tool with easy accounting system integrations. Tools like Upmetrics can help you prepare highly detailed and visual financial forecasts for up to 7 years with utmost ease.
