Cash Flow Management Guide

10. Budgeting vs. Forecasting: The Difference

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Business Finance

Budgeting vs. Forecasting: The Difference

Apr 27, 2023 • 5 min read
small business debt and financing
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      As a small business owner, you know how important it is to plan ahead, make informed decisions, and stay on top of your finances. Budgeting and forecasting are two crucial tools that can help you do just that. We’ll take a look at what budgeting and forecasting are, their differences, and how they can be used together to help you achieve your financial goals.

      What are budgeting and forecasting?

      Though the terms ‘budgeting’ and ‘forecasting’ are sometimes used interchangeably, it’s important to understand what the terms actually mean.

      Budgeting is the process of creating a financial plan for a specific period (usually a year) that outlines your expected revenues and expenses. Budgeting has the very specific goals of allocating your financial resources effectively, setting a standard that you can use to measure your progress, and helping you make adjustments.

      Forecasting, on the other hand, is the process of making predictions about future events, based on historical data, trends, and other relevant factors. The purpose of forecasting is to estimate what may happen in the future and plan accordingly. Forecasting may involve several scenarios to evaluate how different events may influence your business.

      Purpose of budgeting.

      There are different types of budgeting techniques that small businesses can use, such as zero-based budgeting or incremental budgeting. Zero-based budgeting involves starting from scratch and creating a budget from the ground up, without any assumptions from the previous year. 

      Incremental budgeting, on the other hand, builds on the previous year’s budget and adjusts it based on changes in revenue and expenses. The budgeting process usually involves setting financial goals, estimating revenues and expenses, creating a budget, monitoring progress, and making adjustments as the year progresses. Budgets are usually reviewed at least monthly to ensure that the company is on track with its financial goals.

      Purpose of forecasting.

      There are different types of forecasting methods that small businesses can use, such as quantitative and qualitative forecasting. Quantitative forecasting uses historical data and mathematical models to make predictions about the future. Qualitative forecasting, on the other hand, relies on expert opinions, surveys, and other non-mathematical approaches to make predictions. 

      Techniques used in forecasting include trend analysis, which looks at historical data to identify patterns, and regression analysis, which uses statistical methods to estimate relationships between variables. A small business can usually manage forecasting on their own, but as your business grows, you may need to employ accounting experts or data analysts to achieve more accurate forecasts for your business.

      Forecasting may involve projecting worst-case scenarios to determine how much cash your business needs to keep on hand or best-case scenarios to calculate potential employee bonuses. 

      Differences between budgeting and forecasting.

      While budgeting and forecasting involve predicting future events, they have different objectives, time frames, and focuses. 

      Budgeting is focused on creating a financial plan for a specific period and allocating resources accordingly. Forecasting, on the other hand, is focused on making predictions about future events that can inform decision-making. Additionally, budgeting is usually done on an annual basis, while forecasting can be done on a more frequent basis, such as monthly or quarterly. Forecasting may also involve longer time horizons, reaching several years into the future. 

      It’s also important to note that budgeting and forecasting have their limitations. Budgeting can be limited by unforeseen events that may affect revenues and expenses, making it difficult to accurately predict outcomes. Forecasting can be limited by the availability and accuracy of data, as well as the assumptions and biases of those making the predictions. However, despite their limitations, budgeting and forecasting should still be considered invaluable tools.

      A business will generally only have one budget, while it may have several forecasts. Multiple forecasts can be used to explore several possible future scenarios, while the company will generally want to set its budget in stone. Forecasting can be used to justify decision-making while budgeting is usually used to monitor past events.

      Despite their limitations, combining budgeting and forecasting can provide small businesses with numerous benefits. By using forecasting to inform the budgeting process, small businesses can create more accurate budgets and make better-informed decisions. Forecasting can also help small businesses anticipate potential challenges and opportunities, allowing them to proactively adjust their budgets and strategies.

      Final thoughts

      Budgeting and forecasting are essential tools for small businesses to effectively manage their business cash flow and plan for the future. By understanding the differences between the two and using them in tandem, small business owners can make more informed decisions, allocate their resources more effectively, and achieve their financial goals. 

      Because there is no one-size-fits-all set of rules for creating budgets and forecasts, you’ll need to tailor both your budget and your forecast to fit your company’s needs. Don’t hesitate to seek the guidance of a financial professional to help you develop a comprehensive budgeting and forecasting strategy tailored to your business’ specific needs.

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      About the author
      Casey Long

      Casey Long is a CPA with over 15 years of experience. She has spent her career explaining complex financial concepts to various audiences. She started as a bookkeeper and worked her way up, so she understands all aspects of accounting processes.

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