Budget vs. forecast: What's the difference?

Understanding the terms budget and forecast can make a big difference in how you manage your business’s finances. Though they might seem similar, they serve different purposes and can impact your financial planning in unique ways.

In this blog, we'll explain what a budget and a forecast are, outline their differences, and show you how to use both to strengthen your long-term strategy.

What is a corporate budget?

A corporate budget outlines how an organization plans to allocate funds for the coming year. Typically, a corporate budget specifies the funds per department and project, so stakeholders have a clear understanding of what’s available to them to achieve their goals. The objective of a corporate budget is to align revenues with the company’s strategic direction, ensuring enough funds are available to support a company’s operations and drive growth.

Why do businesses need budgets?

Businesses need budgets because they provide an overview of how resources and funds should be allocated throughout the year. Budgets help establish guidelines for stakeholders within the organization, so they don’t over- or under-spend. Budgets also help departments choose which projects to prioritize and what roles to hire for throughout the budget period.

Who creates the budget?

In many organizations, finance is responsible for creating the budget. They compile data, validate figures, and distribute the budget to the company. However, the most effective budgeting processes involve stakeholders from across the organization. All stakeholders should contribute, validate, and review data that pertains to their department, ensuring everyone is aligned with organizational goals.

How does the budget get made?

To create a budget, finance teams usually review the previous year’s budget to determine areas for improvement and refinement. Based on last year’s results, finance leaders then begin collecting the necessary data for the current year’s budget. This process typically involves validating data from different source systems to ensure it is accurate, complete, and auditable. Once the data is validated, it’s compiled into a budget template that’s circulated for review and approval among relevant stakeholders.

It’s worth noting that budget creation can vary depending on your organizations preferred method – whether its flexible budgeting, top-down budgeting, continuous budgeting, zero-based budgeting, activity-based budgeting, or capital budgeting. Each method has its own set of principles and processes, tailored to meet specific organizational needs and goals.

What is a forecast?

A forecast projects your organization’s financial health to some point in the future. Forecasts consider your past performance, current performance, and additional relevant information, such as market trends, economic conditions, and internal operational data. These projections help organizations make informed decisions about resource allocation, strategic planning, and risk management.

Sometimes, these forecasts will move forward into the future as time passes—known as rolling forecasts. Rolling forecasts continuously update the projection period (e.g., adding another month or quarter as one ends), providing an ongoing view of the financial outlook that helps organizations remain agile and responsive to changes.

How do companies use forecasts?

Companies use forecasts to understand how certain variables will impact future performance. For example, if a company knows that the summer months are typically slower for sales, they can forecast what it will take to recover lost revenue in the fall. Forecasts are primarily a forward-looking practice that can help companies better allocate their resources, plan strategically, and mitigate risks.

Many companies use forecasts in conjunction with or even in place of traditional budgets because forecasts are more agile and able to adapt to changing market conditions. This flexibility allows companies to make real-time adjustments based on the latest data and trends, leading to more responsive and effective financial planning.

How do FP&A teams create forecasts?

First, FP&A teams must identify the goal of the forecast. For example, is it to estimate how many products you’ll sell in a given period? Or is it to see if your current budget will be adequate to support your organization in six months?

Regardless of the purpose of the forecast, FP&A teams gather historical data and prior financial statements to better understand the status of revenue, equity, investments, and other financial metrics. With this data, FP&A leaders choose a forecasting method (e.g., rolling forecast) and a time period for the forecast.

Afterward, FP&A teams are responsible for analyzing the resulting data, documenting their findings, and monitoring results. This continuous analysis is a hallmark of forecasting and helps ensure that forecasts remain relevant and accurate, allowing companies to make informed financial decisions and adjustments as needed.

Forecasts vs. scenarios

The difference between forecasts and scenario plans is that forecasting is a quantitative exercise focused on predicting a desired future state based on current and historical data. In contrast, scenario planning is a qualitative exercise that considers multiple possible future states and how various factors might influence them.

Forecasting is focused on what it takes to achieve a specific goal in the future, often involving numerical projections and statistical analyses. In contrast, scenario planning explores how goals will be influenced by future trends, uncertainties, and potential disruptions, helping organizations prepare for a range of possible outcomes.

Forecasts and pro forma financial statements

The difference between forecasts and pro forma financial statements is that forecasts aim to predict the future financial state of your business based on historical data, current trends, and future assumptions. Pro forma financial statements are detailed projections that make these predictions more concrete by modeling the financial impact of specific events or decisions.

Pro forma statements typically involve hypothetical scenarios and are often used to present a "what if" analysis. They are created in advance and may exclude any information that a company believes skews their results, such as one-time expenses. This helps in providing a clearer picture of ongoing operational performance and potential future outcomes.

Is predicting cash flow a forecast?

Yes, predicting cash flow can be considered a type of forecast. Cash flow forecasting aims to anticipate operating cash flow (e.g., how revenue compares to operating expenses) based on future financial events so a business can see how much cash they have on hand and operate more profitability.

What's the difference between a budget vs. forecast?

Now that you’re familiar with the basics of budgeting and forecasting, let’s explore some of the nuances.

Key differences between budgeting and forecasting

There are five key differences between budgeting and forecasting that help to differentiate each process from the other:

1. Function – Budgeting is a quantitative process that leadership uses to plan for future periods. Forecasting is a qualitative process that estimates future performance.
2. Purpose – Budgets specify what management hopes to achieve during a specific financial period. Forecasts specify what a company is likely to achieve during the period.
3. Time period – Budgets are usually restricted to a fiscal year. Forecasts are created with longer time horizons in mind and can often be updated on a rolling basis.
4. Flexibility – Traditionally, budgets are not flexible and are updated much less frequently than forecasts. Forecasts can be updated regularly to incorporate new variables, trends, and real-time data.
5. Application – Budgets help organizations manage a financial period in the short term. Forecasts aid companies in developing their long-term strategy.

Cash budget vs. cash flow forecast

In much the same way that budgets and forecasts differ, so do cash budgets and cash flow forecasts. A cash budget specifies the available funds for a specific financial period. Cash budgets are not typically updated and provide a one-time view of a company’s cash position. In contrast, cash flow forecasts are created to anticipate a company’s future cash position to support long-term profitability.

Cash budget vs. forecasted income statement

As explained above, a cash budget outlines the resources available for a specific financial period. In contrast, a forecasted income statement, sometimes also referred to as a pro forma statement, typically involves hypothetical scenarios and is often used to present a "what if" analysis.

All about budgeting methods

Curious about budgeting? Let’s dive into the different types of budgeting methods and how they benefit your business.

Static vs. flexible budgets

A static budget is based on a fixed level of activity or output, whereas a flexible budget can be adjusted for changes in business activity like sales or production volume.

A flexible budget also offers a framework for a company to adjust its operations—such as investing in or discontinuing business practices—based on external factors, typically the revenue generated from those activities. In contrast, a static budget does not accommodate changes. It remains fixed, with outcomes that are more precisely defined and unalterable.

Top-down vs. bottom-up budgeting

Top-down budgets begin with senior leadership, allowing them to allocate resources to departments as they see fit. Bottom-up budgeting begins with each department and asks them to specify the resources they’ll need for the fiscal year.

Both top-down and bottom-up budgets assess the influence of historical performance and present market conditions. The key difference between these approaches is who identifies the impact of these trends. In top-down budgeting, leadership pinpoints external and internal factors, whereas in bottom-up budgeting, individual departments take on this task.

The 4 main budgeting types: activity-based, incremental, value-proposition, and zero-based

There are several other budgeting types, explained below:

• Activity-based - Activity-based budgeting (ABB) identifies and allocates resources based on activities required to realize the company's goals. It offers a granular perspective of costs, focusing on activities.
• Incremental - Incremental budgeting takes last year's budget and adjusts it based on anticipated changes in the upcoming year, usually by increasing or decreasing the budget by a certain percentage.
• Value-proposition - Value-based budgeting allocates resources based on the value to the organization, focusing on outcomes and results rather than just activities or costs. It aligns spending with the company's core values and strategic objectives, prioritizing investments that deliver the most significant returns.
• Zero-based budgeting - Zero-based budgeting (ZBB) is when you start each fiscal year with a zero-base. When you create a zero-based budget, each department accounts for its needs down to the line item, regardless of whether the amount is higher or lower than the previous budget.

Types of forecasting methods

Want to learn more about forecasting? Let’s explore the different types of forecasting methods and how they can benefit your company.

Judgment vs. quantitative forecasting

Judgment forecasts rely on a finance leader’s judgment when there is no historical data to reference. These forecasts are often created when there is a limited amount of prior data to reference, such as when launching a new product, or when market conditions are unprecedented (e.g., during COVID-19). In contrast, quantitative forecasting relies heavily on historical data and current trends to inform the forecast.

The 4 main forecasting methods: straight-line, moving average, simple linear regression, and multiple linear regression

There are several other forecasting methods, including:

• Straight-line: Straight-line forecasting estimates future values by extending a straight line from current data trends. It’s a simple method that assumes consistent growth or decline over time.
• Moving average: Moving average forecasting evens out fluctuations in data by calculating the average of different subsets of the dataset. This method helps in identifying underlying trends and patterns over a specific period.
• Simple linear regression: Simple linear regression uses historical data to establish a relationship between a single independent variable and the dependent variable. This approach is useful for predicting outcomes based on one influencing factor.
• Multiple linear regression: Multiple linear regression expands on simple linear regression by considering multiple independent variables to forecast a dependent variable. This method provides a more comprehensive analysis by accounting for various factors that may impact the forecast.

Conclusion: Evaluate your budget vs. forecast with Prophix

Understanding the difference between a budget and a forecast can greatly improve your financial planning. By using both methods, you can better manage your business's future and operate more efficiently.

Ready to get started? Prophix One can help you budget and forecast better, giving you actionable insights into your business’s future.