Budgeting vs Forecasting
The budgeting vs forecasting process has been a good discussion between financial professionals. The argument of whether they serve the same purpose or if one is better than the other has lead to some interesting debates. The term has been used several times interchangeably. However let’s explore why this is incorrect by identifying the budget vs forecast difference. When it comes to planning and grading the company’s financial health, they are both tools that can be used by companies. Their managers to do just that. However, the proper way to use them both is in concert with one another and not particularly as a substitute for one another.
What is budgeting, definition-wise? It is the process used to compose a plan or create an estimate during a prior year or at the beginning of a current year to help manage and control the income and expenditures of the company for that year. Some have even defined a budget to be a road map or financial guide that recognizes the income of the company, while detailing the expense allowances with a not-to-exceed expectation for that given year. Now let’s examine the definition of forecasting to compare the differences between the budgeting and forecasting process.
Forecasting is another financial tool commonly used to help determine the financial status of a company. The meaning of financial forecasting is quite different from that of budgeting. Where the budget is used as a financial planner, the forecast uses this plan and compares it to the current financial direction of the company. They do this to predict where the company will end up by the end of that year. In other words, use the forecast to see if the company will meet or exceed the expectations from the budget allowing the managers and controllers to set future goals. They also use forecasts to identify trends that are used to grade the company’s financial position. They both seem to be very resourceful tools. Instead of comparing financial forecast vs budget, the more important discussion should be which tool is more effective.
Which is More Important?
So which tool in the financial forecast versus budget debate is more important? Let’s answer a few questions first. Can a business run productively without a budget, a plan of action for each year? Some do. However, to run a successful business without monitoring your financial status throughout the year to predict its financial grade by the end of the year can be very difficult. Budgeting can be a good tool to use to help plan the future of the business; however a greater predictor of future behavior is past behavior. The purpose of investing time to create a financial forecast is to predict the future based upon certain assumptions. In addition, use the past to defend those assumptions. Both tools are necessary for a business to be successful. In short, a budget sets the company’s goals while a forecast defines its expectations.
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