When you’re putting together a business plan or a strategic plan for growth, you’ll hear people talk about budgets and forecasts. Sometimes it seems like the terms are used interchangeably, but there are some key differences between budgeting and forecasting.
What’s the difference between budgeting and forecasting?
The primary difference between a budget and a forecast is that a budget is a quantified plan for what a business would like to achieve within a fiscal year. A forecast, on the other hand, is an active summarized statement based on actual expectations over a period of time.
In other words, a budget represents where a business would like to go, while a forecast is an active representation of where a business will likely go, based on historical data and market predictions. Both are vital pieces of business planning and help inform you of your businesses’ overall health, profitability and potential for growth.
What is a Forecast?
A forecast is a high-level, strategic view of where you want your business to go in the future. It is a prediction of where you think your company will grow that’s often based on historical data—your past results over a period of time. A forecast will predict key, high-level revenue streams and major categories of expenses. Forecasts tend to focus on revenue and help determine spending predictions.
The key to a successful forecast is not to get into the granular details. You don’t want to create a forecast that accounts for every last item that you sell, or every detailed expense that you have.
Instead, focus on bigger categories of sales and expenses. For example, if you run a bike shop, you might forecast sales for bikes, clothing, accessories, and service. You don’t need to predict exactly how many bike shorts you’re going to sell.
How to Use a Forecast to Build your Business
A forecast is one of the most useful things you can create to develop your business strategy and help you make key decisions about where you will focus. For example, if you want to grow your revenue from service in your bike shop, you’ll probably want to forecast increased marketing spending and perhaps increased headcount.
To get the most out of your forecast, you’ll want to do a few things:
- Compare your actual results to your forecast on a regular basis. With a tool like LivePlan, you can create automated high-level reports that summarize how your business is doing. You can then make adjustments to your forecast based on past results and changes in the business landscape.
- Create multiple financial forecasts, or scenarios, to explore different strategic outcomes. For example, what will your business look like if you can grow service sales by 20 percent? What happens if you can cut expenses by 10 percent?
- Include your team in the forecasting process. Even small businesses should have their core team participate in the forecasting process to ensure that everyone’s on the same page and understands what the company goals are.
What is a Budget?
Budgets typically refer to detailed guidelines of how much should be spent in different areas of your business. Most commonly, budgets are considered spending guidelines. Budgets are typically detailed, setting limits for spending in things like travel, office supplies, fuel, insurance, etc.
Some businesses will also create detailed revenue budgets, developing detailed budgets for the sales of specific products and services. This is very different than a revenue forecast that focuses on the big picture and doesn’t get into the granular details. For example, forecasting sales of “bikes” is very different than budgeting the number of bikes you plan on selling from each specific manufacturer.
Businesses typically have an annual budgeting process that starts a month or two before the end of the fiscal year. Larger businesses will create budgets at the department level and then roll up all the department budgets into a master budget.
Smaller businesses typically use a faster, simpler process. The budget is typically driven by the business owner and key managers in the business.
How to get the most out of a budget
Budgets can be used as a tool to give some level of spending control to department managers or other leaders in a business. Instead of the owner or CEO having to make all spending decisions, budgets allow spending to be delegated since the budget acts as a guideline that dictates how much to spend in particular areas.
Tracking spending compared to your budget gives you deep visibility into where the money is going in your business. You’ll see what categories you’re overspending in and where you have room to spend more.
You can also use the budget to reallocate spending. For example, if you overspent on travel, you could consider reducing the budget for marketing.
Should you do a budget or a forecast?
If you’re like most business owners, you have very limited time and need to make sure that you’re investing your time in the things that will have the biggest impact on your business.
Since budgets can take a significant amount of time and effort, I recommend starting with a forecast that guides your strategic direction. This means looking at the big picture for your revenue and expenses. Determine the major sales and expense categories that you should pay attention to and then create forecasts for those.
This type of forecasting takes less time and doesn’t require that you dive into granular detail. For example, you may forecast an amount to spend on “marketing.” You don’t then need to specify exactly how much you plan on spending on online advertising compared to print advertising.
The final word
While budgeting and forecasting go hand in hand, small businesses shouldn’t get mired in the process and the terminology. Instead, if you’re running a small business, you should focus first on creating a forecast. Once you determine your sales goals and broad categories for expenses, you can dive in and add additional detail where it’s necessary.
At the end of the day, you want to focus on systems and tools that help your business grow. Create financial projections that meet your business needs, and then use them on a regular basis to measure your performance and adjust course as necessary.
If you’re looking for more guidance on how to manage your business with regular financial reviews, check out our guide on how to run a monthly review meeting.