A strategic approach to your financial future should include both budgeting and financial forecasting. While similar and often confused, these are two separate tools in your arsenal for business money management. You need budgeting for making specific plans and goals, and use financial forecasting to think about the long term and prepare for larger economic conditions.
Budgeting is the action plan of finances driven by managers and goals for the company. Financial forecasting is predicting the economic conditions and performance of the company in the future.
Let’s get into the distinction between budgeting and financial forecasting, and how you can use each tool to improve your business performance.
Budgeting includes the following
- Estimating future revenue and expenses
- Preparing for projected cash flow
- Tracking & reducing debt
- Comparing budgets to actual results
When you prepare a budget you’re steering the ship in the direction you want to travel. Your budget also creates the baseline that will allow for comparison and analysis as you progress. Budgets are an actionable step, and are always accompanied by specific spending and tracking habits.
There are five types of business budgeting that executives use to direct financial operations, but the right one is the one that works best for your company.
- Incremental budgeting: adjusting budgets by increments across the board
- Activity-based budgeting: working backward from a desired goal
- Value proposition budgeting: line items assessed for value to the company
- Zero-based budgeting: justification for each purchase before allocation
- Cash flow budgeting: facilitating the cash flow to your business
How often should you be budgeting?
Firm budgets can be set annually, quarterly, monthly, or even weekly depending on the size and reach of your company. However, budgets should be updated constantly to reflect the spending that has occurred and any other changes to the company’s economic situation.
A budget is a roadmap of priorities and destinations. If you aren’t budgeting, you aren’t laying out the priorities and strategies for your business, and you have no idea where you’ll end up.
A good budget should tell you:
- Where you are
- What matters right now
- Where you want to go
If your business is budgeting correctly, you will be able to identify issues before they become major problems (such as fraud or overcharging) as well as make dynamic budget changes in the moment. You may also need current budgets or profit-and-loss statements to acquire financing or investors.
Check out our guide for creating a business budget.
Financial projection and forecasting is the act of predicting the future using present and historical data. In business, forecasting allows executives to determine economic conditions and prepare for changes.
Unlike budgeting, which focuses primarily on your own business operations, financial forecasting should take into account the macroeconomics at play—including social and political factors. Financial forecasting is ongoing and fluid as circumstances and data change. If budgeting is steering the ship, financial forecasting is the map.
Benefits of business forecasting:
- Better grasp on in-house financial data and business performance
- Competitive advantage
- Setting and enforcing effective budgets
- Faster response to cyclical or seasonal changes
- Ability to identify larger patterns and relationships
- To assist in creating a long-term financial plan and goal-setting
Just like budgets, financial forecasts can be created for specific purposes—sales, capital, demand. The needs of your company and the goals you’re pursuing dictate the data you use and formulas you construct to create meaning for your business. It’s recommended that you utilize a few different types of forecasting so that you’re prepared for any of the realistic futures that lie in wait.
Common business forecasts include:
- General business forecast: overall market conditions
- Sales forecast: predicting future sales
- Demand forecast: determining market demand
- Capital forecast: available capital at a future date
- Accounting forecast: predicting future costs
- Financial forecast: trajectory of your business
What type of business forecasting should you use? Read up on each type of business forecasting.
Financial forecasting comes in two varieties: qualitative and quantitative. Qualitative forecasting uses knowledge and informed opinions to make estimates or predictions. Quantitative forecasting is a complex analysis of all available data to predict future outcomes. Both styles attempt to provide insight into business futures so that executives can make strategic, informed decisions for the company.
A widely recognized example of financial forecasting is a pro forma financial statement, which is a prediction of likely and optimistic business performance that is often used for investment proposals, marketing purposes, or simply for internal calculations.While there are limitations on what a pro forma can predict and how it can be represented to potential investors, a pro forma statement can be a helpful benchmark for anticipating future needs.
How often should you be forecasting?
Some forecasting methods take intensive data collection and analysis, and are usually conducted once per year, or when there is economic upheaval (such as a global pandemic). Simpler forecasts, such as a sales forecast based on historical data, might be conducted each quarter.
Essentially you should always have a forecast that helps you see where you’re going and what to expect in the short- and long-term financial future.
What’s the difference between budgeting and financial forecasting?
There are a few key differences between budgeting and financial forecasting, but smart business owners understand and use both to increase profits. Budgeting and financial forecasting should impact one another for maximum effect.
|Outline of spending and goals||Projection of where the company is headed|
|Current status of the company||Future status of company, economy-at-large|
A well-constructed financial forecast can inform your budget by showing which areas to emphasize for growth or reduction. An updated and strategic budget can help you adjust a financial forecast to reflect increased savings or mitigated losses. Both are needed for a healthy future perspective in a growing company, and both should be frequently updated.
You need both
You need both visible, actionable budgets alongside informed financial forecasts to understand where you want to go and exactly how to get there. It begins with collecting data and ends with creating strategies to meet your financial goals—and we can’t wait to see what you do next.
Divvy provides the tools to help businesses of all sizes track expenses, create budgets, and meet goals. See how with a Divvy demo.