A budget is a detailed financial plan that shows estimated revenues and expenses for a specific period, usually a year. It lists all expenses and revenues, organizes cash flow, establishes a payment process, and provides specific plans for savings, borrowing, spending and investments that a business plans to undertake within a specified time. It is an administrative action that seeks to exercise control over the company finances and resources whereas forecasting is part of strategic management exercise, allowing managers and planners to set goals.
Budgets may be of many types, such as:
- Sales budget, or estimates of future sales for the given period
- Production budget, or an estimate of the number of units to produce, to meet forecasts or sales goals, and the costs involved in such production activity
- Cash budget, or a prediction of future cash receipts and expenditures
- Marketing budget, or an estimate of funds needed for promotion, advertising, and public relations
- Project budget, or an estimate of costs such as labor and materials required to undertake specific tasks
Business forecasting is making projections or predictions of expected revenues and sales. It involves the analysis of current and historical data and subjects them to statistical methods, managerial judgments, or other analysis to determine future trends. It sets expected results, which may or may not come to pass or be applied, and primarily finds use to increase profitability or sales rather than exercise control.
Both forecasting and budgeting are closely interrelated and inseparable. Very often, the forecast forms the basis on budgets, for the sales volume in budget depends on the forecast of expected sales. Conversely, forecasts can also serve as an updated budget or plan, revising the projections made in the budget owing to passage of time.
Both budgets and forecasts provide estimates, and construct models of how a business might perform financially if the expected events and plans play out as desired. The difference between forecasts and budgets is that forecasts gaze into an uncertain future whereas a budget bases itself on planned events. In a limited sense, forecasting is projecting past data into the future, and budget is deciding how best to use such projected financials.
A forecast makes predictions based on historical data, managerial foresight, predictions, benchmarking, and other factors. It is an expectation of what would happen in the future, to prepare for such eventualities. For instance, if forecasts predict a 20 percent increase in sales, the company would seek to expand production by 20 percent to match demand. Forecasts usually serve as a guide, and seldom become binding or impose on company operations.
A budget in contrast is passive, listing out the specific course of action and measuring the actual financial operation of the business based on the forecasts. Very often, the organization remains bound by the allocations made in budgets.
The methodology of preparing a budget and a forecast are similar; the difference between forecasting and budgeting is in the application of these tools and the data processed. Forecasts have an understanding of the possible opportunities and threats in the future, and budgets find use to make specific plans for such opportunities and threats.
The budget represents the course or path the organization sets to manage its finances. The forecast on the other hand sets the direction. For instance, the sales forecast by analyzing past trends may estimate a net positive cash flow or $300,000 by the end of the financial year. Based on such a forecast, the budget may make plans to spend a portion of such cash inflows on capacity expansion, make new investments, or other purposes. Again, while the budget makes similar estimates, a revised forecast, say six months down the road may predict reduced sales than initially forecasted, and a net positive cash flow of only, say $150,000 by the end of the year.
There is no hard and fast rule regarding the format or structure of forecasts and budgets. The methodology adopted to prepare these tools depends on the management style.
A budget relates to a specific financial period, usually a year, although quarterly and monthly budgets are common. Forecasting, in contrast is an estimation of uncertain future extending over flexible periods, which may be days, months, or many years. There is no hard and fast rule regarding the time-period in forecasts, and forecasts can be short-term (up to a week), medium term (a month or a quarter), or long-term (a year or more).
Budgeting is a mandatory administrative and compliance exercise for companies whereas forecasting is a voluntarily and often strategic management exercise. While there are certain accounting principles to follow when preparing budgets, there is no standard format. Forecasting is even more flexible, and companies may prepare forecasting in any manner, using any standards they like.
Whether the forecast depends on the budget or vice versa is similar to a chicken-and-egg story, with no conclusive evidence of what comes first. What is certain, however, is that one influences the other.
- BusinessBalls. “Financial Terms and Ratios.” http://www.businessballs.com/finance.htm. Retrieved August 17, 2011
- “Budget vs. Forecast | Financial Planning & Analysis.” http://www.asifism.com/accounting/budget-vs-forecast-financial-planning-analysis/. Retrieved August 17, 2011
- University of Stanford. “Key Definitions.” http://www.stanford.edu/dept/pres-provost/budget/pillar/basic/com/glossary.html. Retrieved August 17, 2011