Budgeting vs Forecasting
Budgeting refers to the process of projecting the revenues and costs of the company for the future specific period of time that business wants to achieve, whereas, forecasting refers to the estimate of what actually will be achieved by the company.
Budgeting is a structured format of goals and objectives that a company wants to achieve in the selected time frame most commonly a year; however, it can be different too. Forecasting is a periodic observation of the proportion of budgeted goals that have been achieved and how much is remaining for the residual time frame.
The primary purpose of these processes is to support the enterprise strategy through planned initiatives, budgeted resource allocation extent to which changes in the environment are impacting the capacity of the business to meet objectives.
What is Budgeting?
Budget is a detailed statement of an enterprise’s financial activity, which includes revenue, expenses, investment, and cash flow for a particular period (often a year).
While preparing the budget for large companies, the budget statement may comprise input from the company’s various functional departments and profit centers (Business units). It is a time-consuming process.
Generally, budgets are static and prepare for the company’s financial year. However, some organizations use a continuous budget, adjusted during the year based on changing business conditions. While this can add accuracy, it also requires closer attention and may not necessarily yield a better outcome.
For example, An enterprise provides $ 75 million for interest (@10% pa) cost in its budget. But during the year, suddenly, The Central Bank of the country increases interest rate instigating the banks to raise their lending interest too. Which shall result in higher interest cost to the company, and hence the company needs to reinstate its budget according to the new projected interest cost.
What is Forecasting?
A forecast is an assessment of possible future events. At the initial planning stage, it is compulsory to prepare to forecasts possible actions for the business in the future. Forecasts are prepared for sales, production, cost, procurement of material, and financial need of the business. The forecast has some flexibility, whereas the budget having a fixed target.
Generally, budgeting and forecasting used interchangeably or understood as the same activity (budgeting includes forecasting). However, there is a thin line between both. A forecast is a projection of what will happen during the budgeting period at an organization level, generally include significant incomes and expenditures. A forecast may be for long term or short term period or using the top-down or bottom-up approach.
A long-term forecast will provide valuable output to the management for their strategic business plan. In contrast, short term forecast is generally is done for operational and day to day business needs.
Budgeting vs. Forecasting Infographics
Key Differences
- The purpose of the two techniques underline the critical difference between the two as budgeting is a detailed sketch of the aims and objectives of the company in a set upcoming period whereas, forecasting is the regular monitoring of the same so that the company is aware whether it is reasonable to think that the target will be met
- The relevance of the conclusions is also different; forecasting is used to take interim measures in an attempt to meet the targets set by the budget while the variance analysis is used to take up critical decisions of the company such as expansion activities required, compensation policy outline and components and so on
- Budgeting is also essential to understand whether a company can break-even or not. Therefore, whether it should continue operations or start an attempt to gradually take an austere measure of liquidating assets or finding an interested buyer who may buy the company in part or whole.
- Constant revisions to the budget make it meaningless because it can lead to a lot of confusion, however, a continual review of forecasted numbers is a necessity to understand what changes are required in the current techniques for incorporating interim changes.
- Budgeting is conducted for all financial statements such as Income statement, and Cash flows statement and the Balance sheet. However, the forecasting is done only for revenues and expenses because other items involve more significant uncertainty and forecasting them may seem like a futile exercise as it will amount to nothing.
Budgeting vs. Forecasting Comparative Table
| Criteria/Item | Budgeting | Forecasting |
|---|---|---|
| Purpose | Budgets are formulated for setting a target for the coming month or a quarter or a year. | It is performed to understand whether the budgeted target will be timely met or not. |
| Content | It contains absolute values that the company aims to achieve; therefore, it may include the number of units it has to sell or the amount of revenue it has to generate. | As the forecast expresses expectations, it does it better through percentages, implying what proportion of budgeted values has been accomplished and how much of it can be reasonably accomplished in the residual time. |
| Methodology | It observes the past trends and tries to set a realistic target based on these after smoothening for one-off or extraordinary incident. | It analyses the changes in the current circumstances and tries to conclude that in the light of such events, whether the budget will be met or not. |
| Frequency | A budget is formulated once per period; for example, if we have budgeted the revenues and expenditures for the upcoming year, it will remain so until the year is not completed. | Forecasting is done on a more frequent basis, and at times may even be done on a real-time or a constant basis so that appropriate measures can be timely undertaken in an attempt to meet the budgetary requirements. |
| Variance Analysis | Once the budgeted time frame gets over, the actual results are compared to the budgeted goals to see how they have varied and whether the budget was realistically achievable or not so the future budgets are revised accordingly. | No such analysis is conducted for the forecasted numbers as they are only interim numbers; in fact, forecasting in itself is a variance analysis technique. |
| Areas covered | Budgeting is a broader analysis, and it includes a larger number of items such as revenues, costs, cask flows, profits, items of financial position. | Forecasting is a narrower analysis as it deals with only revenues and expenses and not with cash flows or financial position. |
| Structural changes | As a budget is a long term phenomenon, variances are looked at through a stricter lens. It may lead to structural changes such as R&D upgrades or CAPex changes. | Forecasting is a short term measure, and therefore it doesn’t lead to drastic changes. It may allow the management to make decisions as to increasing the shifts of workers as per change in demand; however, it won’t lead to changes such as increasing plant capacity. |
| Awareness level | Budgetary goals and objectives are conveyed to all levels, including the shop floor levels in manufacturing companies, so that the targeted production is achieved. | Forecasted numbers are mostly for the management and the team of supervisors so that they are aware of how to manage the work to meet the targets. |
Conclusion
We can draw a simple analogy that budget is like seasons, which are for a certain period, the maximum time of which can have a particular type of weather. At the same time, forecasting is an interim announcement of the number of rains or sun that can be expected on any given day. It can’t be predicted for a more extended period as it will get affected by changes in the daily weather and therefore, may not bring out a truer picture if predicted from long before.
Both techniques are essential and form an integral part of the short term and long term decision making. If budgets are not formulated, the company may become directionless. At the same time, if forecasting is not conducted, then there can be a chance of oversight and piling up of wrong decisions and inaction.
(Article source from: https://www.wallstreetmojo.com/budgeting-vs-forecasting/)
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