But what is financial forecasting? How does it differ from budgeting? And how can companies improve both of these critical financial functions?
Understanding the Difference Between Forecasting and Budgeting
Financial forecasting is an estimate of a future financial outcome for an organization. By analyzing an organization’s current financial position and other factors, a properly developed financial forecast presents an assumption of how the organization will perform in the future. A forecast is monitored and updated on a regular basis, typically monthly. Forecasting takes place, ideally, each month so that the business leaders can more frequently analyze monthly actual results and forecast out revenues and expenses for the remaining months of the year based on their real-time observations of the current market conditions.
Budgeting is the one-time creation of a financial plan in advance of a particular fiscal year. Company leadership works closely with department managers to set revenue expense targets based on the strategic goals of the company for the upcoming year. The annual budget, once finalized and approved by company leadership, becomes the benchmark against which enterprise performance is measured throughout the year. Department managers and business leaders are held accountable to meet their budget, and generally their performance-based compensation is tied to their ability to do so. Actuals are then tracked against the final budget as the year progresses so business leaders and operational managers can track their performance and make necessary adjustments to meet the financial and operational objectives defined at the start of the year.
Budgeting and forecasting methods can vary by industry. For example, future interest rates are fundamental to forecasting in banks and credit unions, whereas predicting consumer demand is key to retail forecasting. Appropriate forecast time horizons and update frequencies also differ. Weekly forecasts are useful for apparel companies whereas quarterly forecasts are typically sufficient for commercial aerospace businesses. Regardless of industry though, the fundamental principles and activities of budgeting and forecasting apply to every organization.
Examples of Forecasting Methods
Examples of Budgeting Methods
|Quantitative Methods apply mathematical and statistical methods ranging from straight line or linear regression, to multiple models and machine learning.||Incremental Budgeting takes the previous budget figures and is adjusted up or down to get the current period’s budget.|
|Qualitative Methods take into account factors that are difficult to measure, capturing opinions of knowledgeable personal and executives.||Zero-Based Budgeting is a method were all department budgets are set to zero and are rebuilt based on justified expenses.|
Organizations often combine quantitative and qualitative methods in developing forecasts, for example by using quantitative forecasting methods as a starting point and augmenting those results with input from executives or other experts. This has the advantage of involving business operations in the forecasting process and increasing accountability.
A wide variety of data is required for financial forecasting and budgeting, not the least of which are estimated revenues and expenses. The accuracy and timeliness of that supporting data is reflected in the accuracy of the resulting forecasts.
Teams frequently need to make adjustments to forecasts due to changing business conditions and new information. New data is always being collected and created that can better inform business decisions and outcome. It is best practice to implement a monthly forecasting process, where each month the business updates a new forecast scenario with the most current actual results, and re-forecasts updated revenue and expense targets based on the most current information and assumptions available. This results in more accurate predictions of future financial performance, more insightful decisions about how to manage the company, and avoids unpleasant surprises after the books have already closed.
Tools for Financial Forecasting and Budgeting
Unfortunately, many companies still rely on Microsoft Excel spreadsheets for financial forecasting and budgeting. Those excel-based forecasts and budgets are frequently stored in multiple versions, spread across corporate networks, collaborated on via email, and managed with other ad hoc tools not purpose-built for financial forecasting and budgeting. This is manual, tedious, error-prone, and risky. The finance team spends almost all of their time manually wrangling and validating data, and almost no time analyzing it.
The good news is there is a better way. Cloud-based planning software is purpose-built to automate and accelerate the budget and forecast process.
These applications eliminate manual data collection and aggregation efforts, allow financial and non-financial users across an organization to collaborate in a more efficient and meaningful way when building budgets and forecasts, and enable powerful and easy reporting so everybody in the organization can quickly analyze the data and make better decisions in real-time. They provide global security, workflow, and a single source so that everybody is working from one trusted version of the data. Finally, they are easy to use so that they can be owned by business users, and fast to deploy so that business years realize fast time-to-value at a lower cost of ownership.
To get all the best practices for financial planning and forecasting – download the white paper for five tips for a smooth and insightful planning, budgeting and forecasting process.