The Difference Between a Budget and a Forecast

If you’ve ever heard the phrase, “the budget has been slashed,” then you’re on your way to knowing what the difference is between a budget and a forecast. The reason budgets get slashed in businesses is because forecasted profits are usually down, meaning that a company has to cut its cloth accordingly. 

Budgeting and forecasting are standard financial tools that businesses use to help guide their financial future. Specifically, a budget is an expectation of a company’s performance during the next financial period, usually a year or a quarter. Broadly speaking it summarizes the company’s financial goals.

These can be broken down into a number of different categories including: 

• Revenue estimates
• Estimated expenses
• Expected debt reduction 
• Estimated profit

The Primary Use of a Budget

As a budget is not set in stone but rather just an estimate, it has to continually be monitored and measured against a company’s performance. In order to plan successfully, a company, or even a household, regardless of the size, needs to have a budget to set out its expectations.

It serves as a baseline to compare actual results and can be modified as the company sees fit. It’s essential to keep expenditure in check.

Difficulties in Budgeting

Budgets become difficult to adhere to when actual income and expenses deviate from what was originally budgeted. This is particularly true for businesses that invoice customers who do not pay on time.

It doesn’t mean that the business won’t ultimately receive revenue but if it drags over the budget's timeline it becomes difficult to maintain a coherent budget. 

Different Types of Budgets

It’s common for most companies to start with a Master Budget which is usually reflective of the entire fiscal year. It will include projections for every aspect of the company including revenue, expenses, operating costs, sales, and capital expenditures. 

A static budget is usually the starting point for any company and shows how much a company has, how much it will spend and what its fixed expenses are. These numbers — such as a rent or mortgage payment — are firm and cannot be changed.

An operating budget is far more fluid and includes the expenses and revenue generated from ongoing business operations. If a company’s budget to buy more goods, is determined by the number of goods it has sold, its operating budget can fluctuate from week to week or quarter to quarter.

There are budgets for every aspect of a business. A cash-flow budget is similar to an operating budget and monitors the profit coming in versus the expenses going out. A flexible budget adjusts the activity or volume levels of a company and is a more sophisticated form of budgeting than the others mentioned.

Primary Use of a Forecast

A (financial) forecast allows a company to predict a financial outcome by examining previous financial data and key business drivers. It can then allocate its budgets accordingly.

One of the key differences between a budget and a forecast is that a forecast is usually limited to revenue and expenses and is updated on a regular basis (monthly or quarterly), whereas budgets may be allocated on an annual basis.

Key Components of a Financial Forecast

• To determine how budgets should be allocated within a company.
• Updated regularly by using data from operations, inventory, and changes in a business plan.
• Can be crafted to suit both short-term (ie. immediate) and long-term planning based on incoming data.

Examples of a Forecast in Action

In real estate, a potential buyer of an investment property may want to know how much profit a building is likely to make based on its income and expenses. Expenses would include its mortgage, utilities, taxes, insurance, and repairs. Income would mostly include rents and possibly storage and washer and dryer usage (if coin-operated).

When the expenses versus the income are calculated, a forecast, also known as a Pro Forma can be created.

However, if any of the elements should change — rents go up or down if a tenant moves out, expenses increase due to a sudden repair, then these numbers will change and the buyer will have to alter their budget accordingly.

Key Differences Between a Budget and a Forecast

A budget is a broad outline of the direction management wants to take the company. In the real estate example above, they may budget on spending a certain amount of money each month on improving the building with the goal of increasing the rents and making the property more profitable. A financial forecast is a report detailing whether these financial goals are being met.

A sudden expensive repair may put the ongoing cosmetic improvements on hold and the rent increase might be delayed while the more urgent repair is dealt with.

Budgeting may contain unrealistic goals due to fluctuating market conditions. The shut down of a local factory may decrease the revenue for the local businesses around it and thus, the budget may have to change.

Conclusion

Budgets and forecasts are essential tools in a business's financial armory and should work in sync with one another. A forecast is an on-the-ground commentary on a company's long and short-term performance which is then used to help create a budget for the next financial period.