The key difference between a budget and a forecast is that a budget lays out the plan for what a business wants to achieve, while a forecast states its actual expectations for results, usually in a much more summarized format. In essence, a budget is a quantified expectation for what a business wants to achieve. Its characteristics are:
- The budget is a detailed representation of the future results, financial position, and cash flows that management wants the business to achieve during a certain period of time.
- The budget may only be updated once a year, depending on how frequently senior management wants to revise information.
- The budget is compared to actual results to determine variances from expected performance.
- Management takes remedial steps to bring actual results back into line with the budget.
- The budget to actual comparison can trigger changes in performance-based compensation paid to employees.
Conversely, a forecast is an estimate of what will actually be achieved. Its characteristics are:
- The forecast is typically limited to major revenue and expense line items. There is usually no forecast for financial position, though cash flows may be forecasted.
- The forecast is updated at regular intervals, perhaps monthly or quarterly.
- The forecast may be used for short-term operational considerations, such as adjustments to staffing, inventory levels, and the production plan.
- There is no variance analysis that compares the forecast to actual results.
- Changes in the forecast do not impact performance-based compensation paid to employees.
Thus, the key difference between a budget and a forecast is that the budget is a plan for where a business wants to go, while a forecast is the indication of where it is actually going.
Realistically, the more useful of these tools is the forecast, for it gives a short-term representation of the actual circumstances in which a business finds itself. The information in a forecast can be used to take immediate action. A budget, on the other hand, may contain targets that are simply not achievable, or for which market circumstances have changed so much that it is not wise to attempt to achieve. If a budget is to be used, it should at least be updated more frequently than once a year, so that it bears some relationship to current market realities. The last point is of particular importance in a rapidly-changing market, where the assumptions used to create a budget may be rendered obsolete within a few months.
In short, a business always needs a forecast to reveal its current direction, while the use of a budget is not always necessary.
If you’d like help creating your budget or forecast and understanding the related financial statements … we can help. We specialize in helping businesses create comprehensive financial plans, monitor their financial activity and understand their financial statements. So, if you don’t have the expertise or resources, click here to contact us.
For more on small business budgets, check out the other articles in the series on the Key components of the financial and operational planning process for small businesses: