Corporate Finance for Beginners: Forecast vs. Budget
Financial planning techniques help your team make decisions that align with the company’s overall goals. At the same time, you’ll ensure that you’re also making fiscally responsible choices.
Financial forecasting is crucial for businesses. Your business’s financial forecast and budget can help guide most business decisions, regardless of the circumstances.
These They offer essential snapshots of the organization’s financial history while revealing areas that need improvement. They also help management make quick decisions without sacrificing accuracy or derailing the company’s forward movement.
Budget or Financial Forecast? What’s the Difference?
There’s a connection between budgeting and forecasting; the two are equally important, but there are also some key differences.
A budget offers an easy-to-understand estimate of a company’s future expenses and income. It has predetermined categories and covers a clearly defined period. Typically, a company sets up its budget once each year and uses it as a reference point when making necessary purchases during everyday business. It clearly shows the company’s financial position, goals, and cash flow.
A financial forecast uses historical data to make projections about a company’s future performance. A thorough financial forecast helps the management team decide how to update the budget.
When the business plan changes, management updates financial forecasts, as well. Significant changes in operations and inventory may also trigger changes to the financial forecast.
A Secret to Financial Success: Budgeting
The budget is a universal financial tool that isn’t just used to manage your household finances. Businesses need budgets too. A company’s basic budget is the framework that states how much money it has and how much it plans to spend. It is a projection that details the company’s financial goals.
This static budget is just a guideline. Like in a household, unplanned events and unexpected expenses are difficult to put in a budget. Companies use their basic budget to decide how to handle unexpected expenses and financial emergencies.
A company’s budget is subject to change, of course. It requires regular updates to remain relevant. When the predetermined budget period ends, the accounting department, management team, and the company’s owners may set aside time to compare the static budget to the actual income and expenditures. Using this information, they can make a new budget that better reflects the company’s recent activity.
Financial Forecasting: Planning for Future Growth
Forecasting helps companies predict their future and direct their growth by using data from their past financial performance. For example, if a business wants to understand what the next three months may look like where sales, income, and expenditures are concerned.
While there’s no guarantee that the future will mimic the past, using past performance gives analysts a solid platform to build their ideas about the company’s future performance. When factors such as the economy’s overall health affect a company’s sales, it can be nearly impossible to forecast very far into the future with accuracy.
Successful forecasting relies on a set of steps that are consistent no matter the size or type of business. The process begins with a question. For example, “How much product will we sell in the next three months?”
The forecast is typically a spreadsheet of financial data categorized by specific time periods. The forecaster lists variables that may impact sales in the next three months using an ideal data set. During this process, it’s necessary to make assumptions or predictions that help to cut down on the time it takes to make the set of forecasts. These assumptions may include the expected tax rate, gross margin, and revenue growth rate.
They may take the sales numbers from the same three-month period during the previous three years and check them for consistency from year to year. If there’s between a 3 and 5% increase in sales each year, they may assume that this year’s sales will show a 4% increase over the same time period in the previous year.
A Potential Downside of Financial Forecasting
It’s widely understood across all industries that forecasts are rarely 100% accurate. While the process allows the business to plan for potential financing needs, anticipate production schedules, and even create goals for the sales team, it’s impossible to predict unexpected events.
Outside forces like the political environment, weather patterns, and changing customer preferences may all affect how a company performs financially from one period to the next. Forecasters can easily fall into the trap of focusing on the past to predict the future. While it’s a valuable tool, a forecast can be a limiting factor if company leadership allows it to steal the show from present-day events.
There are better ways to use this valuable financial tool than allowing a forecast to serve as a fortune-teller in a company. Business forecasting enables a company to plan ahead enough to remain somewhat stable as it grows. Understanding that it’s an imperfect system is vital.
