Companies plan for their future activities using various tools. Usually, this process falls under the managerial accounting process. This process involves creating and communicating information for internal use. Companies do not share their plans with external parties. Instead, these plans are for internal use only. Planning allows companies to understand how to operate to achieve an objective.
Planning for the future is crucial for several reasons. This process begins when a company gets incorporated. At this stage, companies prepare a business plan which details their activities, finances, etc. Similarly, it helps set the goals and objectives for those companies. Consequently, companies make plans on how to achieve those goals.
Companies may use various tools in managerial accounting to create plans. One of the most prevalent ones includes a budget. Usually, companies prepare a budget for every period. However, companies may also use forecasts, which are similar. Most people confuse between budgets and forecasts. However, they differ in various critical aspects.
Before discussing the difference between budgets and forecasts, it is crucial to understand them individually.
What is a Budget?
A budget is a financial plan that companies prepare and use for a specific period. It includes estimates for income and expenses for an entity. Usually, companies use it to plan for their future activities. However, other entities, such as individuals, organizations, etc., may also budget their finances. On top of that, companies can also use budgets for resources, assets, liabilities, and cash flows.
A budget allows companies to prepare a plan for their activities. Usually, companies prepare them annually or quarterly. On top of that, some companies may also budget for their operations every month. Companies prepare budgets for various areas within their operations. Later, they combine those budgets to create a master budget. However, the process may differ from one company to another.
Companies also prepare various types of budgets. These types differ based on whether they consider income or expenses. On top of that, they also vary based on the underlying function they cover. For example, companies prepare budgets for sales, production, capital, cash flow, project, marketing, etc. Together, they can help set the objective for those companies during a future period.
Budgeting allows companies to determine whether they have enough resources to operate in the future. If they don’t, they can create a plan to obtain finance to fund operations. Sometimes, companies may also get a surplus on their budgets. In those cases, they can plan to use that surplus to benefit further. In rare cases, companies may also reach a balanced budget.
What is a Forecast?
A forecast is a method to estimate future finances based on predictive techniques. Usually, companies use it to determine the direction of future trends. It requires historical data as input. Based on that data, forecasts make estimates for future figures. In a way, forecasting is similar to budgeting as it involves predicting future amounts. Although the process may include similarities, it differs significantly from budgeting.
Companies usually prepare forecasts for internal use. However, they may also distribute them to third parties. For example, creditors may require a forecast for future operations before providing finance to a company. Forecasting is also essential in determining how to allocate budgets for predicted expenses. It sets the base for the budgeting process used within most companies.
Essentially, forecasting involves predicting what will happen in the future. However, it still considers data from the past and present to make those predictions. Forecasting also incorporates uncertainty within planning. This process sees how it impacts financial decisions based on historical data and trends. Usually, companies use forecasting as a base for their future decisions. Based on that, they can also create budgets.
Furthermore, forecasting allows companies to use other tools to predict future outcomes. It may include straight-line forecasts, moving averages, line regression, time series analysis, and projects. Usually, companies use two methods for forecasting. These consist of qualitative and quantitative forecasting methods. Each includes more types, which are crucial in predicting future outcomes.
Budget Vs. Forecast: What Are the Differences?
Budgets and forecasts are tools managers use to plan for the future. However, both serve a different role within any company. On top of that, they vary based on other features. Most people use budgeting and forecasting as interchangeable terms. However, they do not cover the same areas. The primary differences between budgets and forecasts include the following.
The primary difference between budgets and forecasts is their meaning. A budget usually includes a quantitative plan for a future period. For most companies, it concerns using an estimate to create that plan. On the other hand, forecasts provide that estimate. Essentially, forecasting involves predicting future trends based on historical information.
The purpose of a budget is to create a target for a future period. As stated above, these targets relate to income and expenses that companies obtain from various sources. On the other hand, forecasts do not create an expectation. They help companies understand whether they can meet their budgeted targets. Similarly, forecasts serve as the base for creating a budget.
Budgeting involves creating realistic targets for the future based on past trends. Usually, companies prepare their budgets based on the prior period’s data. However, it may also involve budgeting from scratch. On the other hand, forecasting uses a similar method. It uses historical information to predict future trends. However, it also incorporates uncertainty into the process.
A budget allows companies to set expectations on what managers want to achieve during a specific period. These expectations relate to the strategy that companies expect to work towards in that period. On the other hand, a forecast creates an expectation for what companies will achieve. While both may seem similar, they cover different areas.
Usually, companies create a budget for a short-term period. For most companies, budgeting covers a quarter or year. Based on their needs, companies may prepare budgets for even shorter terms. On the other hand, forecasts usually cover long-term needs. Companies can prepare forecasts for one year or several areas based on their requirements.
Budgets are more static and do not require significant changes regularly. Companies do not update these budgets unless at the end of the financial period. Usually, the underlying factors associated with the budgets don’t change. For that reason, companies don’t update them often. However, forecasts are more flexible. Companies can revise them regularly to reflect the most recent market conditions.
Companies use budgets as a control tool to manage their operational performance. On top of that, they may also use it to monitor actual performance. Budgets are an essential part of the planning process. On the other hand, forecasts serve as an input during the budgeting process. They also help provide the base when developing long-term strategic plans.
Budgeting and forecasting involve planning for the future. Although both sound similar, they differ significantly. Some of the primary differences between budgets and forecasts include the following.
|Meaning||Quantitative plan for a future period||Predicting trends based on historical information|
|Purpose||Creates a target for the future||Help companies understand whether they can achieve budgeted targets|
|Method||Creating realistic budgets based on past trends||Using historical information to predict future trends|
|Expectations||Sets expectations for what managers want to achieve for a period||Sets expectations for companies for the future|
|Time horizon||Covers a short term||Used for long-term purposes|
|Flexibility||Usually static with minimum changes required||More flexible to reflect recent market conditions|
|Usage||Used as a monitoring and control tool||Used in budgeting and long-term strategic plans|