Budgeting vs Forecasting: Definitions

Budgeting

Budgeting is the process of creating a plan using prior period historical numbers to estimate and predict your future.

A budget can be prepared for 6 months or a full year, and it’s static.

Ideally, you want to start your budget in the last Quarter of the year, and plan your budget for the following year.

As part of reviewing your financials, you should compare your actual revenue and expense numbers vs. your budget to evaluate how the results vary from the expected performance.

Forecasting

Forecasting is the process of predicting future behavior based on anticipated changes.

For example, if you’re planning on releasing a new product or introducing a new service, you would forecast your sales numbers for the launch, based on customer demand, marketing dollars spent, and your expected ROI.

Forecasting should be updated on a regular basis, as your plan changes. It can be done for a short or long period.

Budgeting vs Forecasting in Laymens Terms

To summarize, a budget uses your previous performance to estimate the future.

For instance, we made X amount of dollars last year, and based on the trajectory, I think we will make X this year.

It’s static – meaning it doesn’t change. And it can be prepared for 6 or 12 months.

Alternatively, forecasting uses real data to predict future behavior.

For example, your business will have to shorten its hours for 3 months due to a global pandemic. Based on the shortened hours and consumer reaction, you forecast that sales will be down by 30%.

It summarizes revenue and expenses, and should be updated regularly. Variance analysis is not required.

Do You Need a Budget?

Here are a few questions we like to ask our clients.

• Do you make good money, but it’s not in your bank account?
• Do you struggle to pay your taxes?
• Do you struggle to put enough money into retirement?
• Are you wanting to take on more business, but you don’t have the capacity, and can’t hire because you have a negative cash flow?
• Do things feel a bit out of control in your business?

If so, it’s likely because you don’t have a budget.

A budget is the most fundamental tool you should use to manage your business finances.

How-to Make a Budget

A budget is simply a financial plan that helps you utilize the resources derived from your sales.

Having a budget helps you to stay focused on your mission, stay lean, and achieve profitability.

And to get started, you don’t need a fancy templates or even a spreadsheet.

It starts with forecasting your sales, then estimating your operating expenses and resources required to achieve your projected revenue.

Like David Ramsey says, every dollar should have a destination in your business.

And our biggest tip? Make sure you account for your own salary in the budget.

Remember, track your budget on a regular basis, examine it, and evaluate any variances. This will help maintain profitability.

How-to Do Budget Forecasting

The goal of business forecasting is to predict changes and trends in the future of your business, and develop business strategies to eliminate potential failure or losses before they happen.

So, forecasting helps your business to be proactive instead of reactive.

In order to forecast your business’s future, start with your sales numbers.

Forecasting your sales numbers doesn’t have to be complicated – here’s a simple formula you can use.

Jot sales numbers on your board for:

A.      Best case scenario

B.      Most likely case scenario

C.      Worst case scenario

Then take the average of the three figures above, and that will be your starting point.

Next, you will need to figure out the impact of your projected revenue on your operating cost by allocating a percentage of anticipated changes to your major expense categories.

Things like, accounting, marketing, labor cost and software expenses. Will these need to be adjusted based on your projected sales?

Remember, forecasting is rarely perfect.

You do the best you can, but there is always something unexpected.

Keep in mind, forecasting needs to be adjusted on a regular basis.

If you’d like help formulating your annual budget, or forecasting scenarios for your business, we strongly recommend finding an experienced accountant to help. 

If you don’t have one you’re happy with, we’ll be glad to help anyway that we can.

You can book a quick 15-minute call with Samy Basta, CPA anytime here.

Until next time!