Budgeting vs. Financial Forecasting: What's the Difference? (2024)

Budgeting vs. Financial Forecasting:An Overview

Budgeting and financial forecasting are tools that companies use toestablish aplanfor where management wants to take the business—budgeting—and whether it is heading in the right direction—financial forecasting.

Althoughbudgeting and financial forecasting are oftenused together, distinct differences exist between the two concepts. Budgeting quantifiesthe expected revenues that a business wants to achieve for a future period. In contrast, financial forecasting estimates the amountof revenue or income achieved in a future period.

Budgeting

A budget is an outline of expectations for what a company wants to achieve for a particular period, usually one year. Characteristicsofbudgeting include:

• Estimates of revenues and expenses
• Expected cash flows
• Expected debt reduction
• A budget iscompared to actual results to calculate the variances between the two figures.

Budgeting represents a company'sfinancial position, cash flow, and goals. A company's budget is typically re-evaluated periodically, usually once per fiscal year, depending on how management wants to update the information. Budgeting creates a baseline to compare actual results to determine how the results vary from the expected performance.

While most budgets are created for an entire year, that is not a hard-and-fastrule. For some companies, managementmay need to be flexible and allow thebudget tobe adjusted throughout the year as business conditions change.

Financial Forecasting

Financial forecasting estimates a company's future financial outcomes by examining historical data. Financial forecasting allows management teams to anticipate results based on previous financial data. Characteristics of financial forecasting include:

• Used to determine how companies should allocate their budgets for a future period. Unlike budgeting, financial forecasting does not analyze the variance between financial forecasts and actual performance.
• Regularly updated, perhaps monthly or quarterly,when there isa change in operations, inventory, and business plan
• Can be created for both the short-term and long-term. For example, a company might have quarterly forecasts for revenue. If a customer is lost to the competition, revenue forecasts might need to be updated.
• A management team can use financial forecasting and take immediate action based on the forecasted data.

Financial forecasting can help a management team makeadjustments to production and inventory levels. Additionally, a long-term forecast might help a company's managementteam develop its business plan.

Key Differences

There are critical differences between budgeting and forecasting. For example, budgets are created to meet a goal, such as quarterly growth. Financial forecasting examines whether the budget's target will be met or not throughout the proposed timeline. The content of a budget and financial forecast is different—the former contains specific goals like the number of items to sell or the amount of money to earn. The latter shows the expectations of how the budget will be met.

A budget is made for a specific period and is usually based on past trends or experiences of the company. A financial forecast examines a company's current financial situation and uses the information to forecast whether or not a budget will be met. Financial forecasting may be done frequently while a budget is set for a specific time period and may not be done more than once, twice, or quarterly.

Special Considerations

A budget outlines the direction management wantsto take thecompany. A financial forecast is areport illustrating whether the company is reaching its budget goals and where it is heading in the future.

Budgeting can sometimes containgoals that may not be attainable due to changing market conditions. If a company uses budgeting to make decisions, the budget should be flexible and updated more frequently than one fiscal year,which is arelationship to the prevailing market.

Budgeting and financial forecasting should work in tandem with each other. For example, both short-term and long-term financial forecasts couldbe used to help create and update a company'sbudget. A budget may not always be necessary during a fiscal year, although many companies make them. However, a financial forecast is relevant because of the information it provides because it can highlight the need for action. In contrast, a budget may contain targets that cannot be accomplished if the budget is an overreach.