The difference between a Forecast and a Budget
The other day I was sitting on a zoom session and I noticed a lot of business owners were getting confused about budgets and forecasts.
Both are similar in that they attempt to predict the financial future of a business. But where they differ is in how you use them.
To me a budget is usually done once a year. In it you attempt to predict the future and set up annual financial and non-financial targets for the business to aim for.
But the reality is very shortly after you have set the budget, in the real world something changes. Any one or more of the assumptions you used to predict the future are no longer valid.
Unless you adapt to this, and change something, it is highly unlikely you will achieve your budget or your financial and non-financial targets.
And that’s where a forecast comes in.
Into your budget you now roll in the impact of these changes and create a new set of predicted financial and non-financial outcomes. If these outcomes don’t meet the budgeted targets, then you need to start looking at what other changes you can make to the business to bring you closer to these budgeted targets.
This becomes your forecast.
For example, you may need to delay hiring a person because the planned growth is not as fast as you budgeted. So even though you budgeted to employ someone in August, it does not mean that you do. Instead, you wait a bit longer.
Your forecast is helping you make timely business decisions.
And when circumstances change again, you revise your forecast again. And you revise what you are going to do in your business.
That way, during a financial year, you would have one budget, but you could have many different forecasts prepared at different times.
So even though budgets and forecasts attempt to predict the financial future of a business:
- Think of a budget as a strategic tool setting up where you want to be in a year or two. Don’t do something because it was budgeted, but is no longer viable under current business conditions; and,
- Think of your current forecast as a tactical tool to help you make timely business decisions as you aim for your targets in an ever changing world. That is the real benefit of a forecast and why a regularly updated forecast is much more important than a once a year budget.
Every one of my clients has reforecasts done throughout the year. Often with multiple different what-if scenarios to give you another perspective.
And here is another real world tip. In some businesses, conditions have changed so much that comparing actual performance to budget is irrelevant. 2020 was a great example with COVID significantly changing how many businesses operated. In those businesses, I throw out the budget and start to measure:
- actual performance to the previous forecast.
- full year current forecast to the previous forecast.
This way you can see how current business decisions are working (or not).
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Wayne Wanders, A Real CFO
wayne@aRealCFO.com.au
