Ultimate Guide to Budgeting & Forecasting

Organizations around the world have been budgeting for decades, solidifying its position as a foundational process.

Complementing this, forecasting is another critical process for finance teams, which has been supported by the proliferation of financial performance platforms.

As such, it is essential to understand the key differences between budgeting versus forecasting, and how to use both processes to benefit your organization.

Was ist Budgetierung?

Let’s dive into the nuances of budgeting, so you can learn how to leverage this process to benefit your organization.

Definition of budgeting

Budgeting is the process by which organizations estimate revenue and expenses over a specific period and decide how to allocate that money.

Educba defines a budget as, “a detailed statement of expected revenues and expenditure which quantifies the tactical plans of the management to reach a desired goal for the company during a specified period.”

Key components of a budget

A budget provides a holistic view of a company’s financials, and as such, incorporates a wide range of financial data. The five key components of business budgets are:

• Estimated revenue: The money you anticipate earning from selling goods or services.
• Fixed costs: Expenses essential for business operations, like rent and utilities.
• Variable costs: Fluctuating expenses tied to business performance, such as raw materials and production labor.
• One-time expenses: Significant costs like equipment purchases, technology upgrades, or furnishings.
• Cash flow: The movement of money into and out of your business.
• Profit: The remaining funds after deducting fixed and variable costs from revenue.

Types of budgets

Depending on your company’s needs and the amount of financial data you have available, there are many different types of budgets, including:

• Master budget - A master budget combines all financial aspects of your company, allocating funds to each area. It serves as a comprehensive plan that departments refer to throughout the year to ensure their spending aligns with corporate goals.
  
  
• Operating budget - Operating budgets offer a high-level overview of business performance and a way to monitor revenue, variable costs, fixed costs, non-cash expenses, and non-operating expenses. Typically updated monthly or quarterly, operating budgets primarily focus on revenue and expenses.
  
  
• Financial budget - A financial budget provides a detailed projection of a company’s income and expenses over a specific period. It encompasses all aspects of the business’s financial activities, including cash flow, capital expenditures, and long-term liabilities, ensuring that resources are effectively managed to achieve corporate objectives.
  
  
• Cash flow budget - A cash flow budget forecasts the inflows and outflows of cash within a business over a specific period. It helps manage liquidity by ensuring that the company has enough cash to meet its obligations while identifying potential cash shortages or surpluses.
  
  
• Static budget - A static budget is a budget that remains unchanged throughout a specific period. Unlike dynamic or flexible budgets, a static budget is set and fixed. However, this doesn't mean it can be created, announced, and forgotten. Companies consistently refer to their static budget to monitor variances between the budgeted amounts and actual spending.

Was ist Forecasting?

Definition of forecasting

Forecasting estimates the revenue that your business will achieve in a future period. Forecasting takes into consideration your past performance, current performance, and additional relevant information.

Prognosen haben in den letzten Jahren viel Aufmerksamkeit erlangt, vor allem als Ergänzung zur Budgetierung, die den Umsatz quantifiziert, den dein Unternehmen erzielen möchte.

Key components of a forecast

Before creating your forecast, you need to compile the following components:

• Purpose: Determine the specific objectives of your forecast, such as predicting product sales or evaluating the financial impact of hiring decisions.
• Past financial statements and historical data: Collect data on revenue, expenses, cash flow, and other financial metrics to gain a comprehensive view of your business performance.
• Timeframe: Select a timeframe for your forecast, ranging from short-term projections to long-range planning.
• Financial forecast method: Decide whether your approach will be qualitative, based on opinions and sentiments, or quantitative, relying on trends and data analysis.

Types of forecasts

There are three primary types of forecasts, which include:

• Qualitative forecasts: Based on judgment and intuition when historical data is limited. Qualitative forecasts involve market research and cross-functional collaboration to explore potential outcomes.
  
  
• Quantitative forecasts: Utilizes past data and trends to make evidence-based decisions, with a focus on numbers and analytics tools to project future outcomes.
  
  
• Causal forecasting: Involves a detailed mathematical approach, using regression analysis and statistical models to understand cause-and-effect relationships between variables, offering insight into complex scenarios like supply and demand predictions.

How do budgeting and forecasting relate?

Next, let’s explore how budgeting and forecasting relate to each other.

Differences between budgeting and forecasting

Budgeting captures your company’s spending allocation for a given period and is based on your current financial position. In contrast, forecasting is an estimate of your financial future, typically based on historical data and trends. Forecasts are often used to determine how you should allocate your budget. In summary, the key differences between budgeting and forecasting include:

• Function: Budgeting involves planning for future periods using numbers, while forecasting estimates future performance based on judgment.
• Purpose: Budgets outline management's goals for a specific financial period, while forecasts predict what the company is likely to achieve.
• Time period: Budgets typically cover a fiscal year, while forecasts look further ahead and can be updated regularly.
• Flexibility: Budgets are rigid and updated less frequently, whereas forecasts are adaptable and incorporate new data and trends regularly.
• Application: Budgets help manage short-term finances, while forecasts assist in long-term strategic planning.

How budgeting and forecasting complement each other

Budgeting and forecasting work hand in hand as forward-looking approaches. While budgets help you prepare for the upcoming fiscal year, forecasts project how future performance may unfold. By utilizing both budgeting for short-term planning and forecasting for long-term insights, companies empower their finance teams to make informed decisions and set strategic organizational goals effectively.

Importance of using both in financial planning

No matter your organization’s preference, there are benefits to using both budgeting and forecasting in your financial planning process.

Budgets can be updated more than once per fiscal year so that they accurately reflect changing market conditions and company objectives. Simultaneously, forecasts help align your management team with long-term goals and strategic vision for the company, so that everyone can make decisions with the same end-goal in mind.

By incorporating both budgets and forecasts into your financial planning process, you gain insights into your short-term and long-term performance metrics, allowing you to make the necessary changes to ensure your business is successful.

What are the benefits of budgeting and forecasting?

Now that you’re familiar with the components and differences between budgeting and forecasting, let’s explore their benefits.

Improved financial management

By compiling and validating your financial data, including revenue, expenses, and cash flow, you can improve your financial management practices with a comprehensive overview of your business performance. Regular updates to your budgets and forecasts can also help facilitate effective risk management and ensure you can make changes to better align with your business objectives.

Better decision-making

Budgets and forecasts empower your team with insights into your short- and long-term business performance, enabling strategic decision-making based on a deep understanding of market trends, business objectives, and financial considerations.

Increased accountability

Since departments often submit financial data to the finance team to create budgets and forecasts, this can increase accountability across the organization, promoting a culture of responsibility and shared commitment to organizational success.

Enhanced strategic planning

With robust budgeting and forecasting practices in place, you can enhance your company’s strategic planning capabilities. By leveraging the insights gained from budgets and forecasts, companies can develop informed strategies that align with long-term goals, optimize resource allocation, and adapt proactively to market dynamics for sustained competitive advantage.

How to budget and forecast effectively

Setting clear financial goals

Before creating your budget or forecast, you need to have a clear financial goal in mind, so you can collect the necessary data, consult with relevant stakeholders, and use the right budget or forecast method. Examples of corporate goals include:

• Short-term goal (budgeting): Setting a monthly sales target to increase revenue by 10% within the next quarter.
• Long-term goal (forecasting): Projecting market trends to anticipate growth opportunities over the next five years.

Short-term vs. long-term goals

As discussed above, budgeting is well suited to short-term goals, and forecasting is better suited to long-term planning. Choosing the correct approach for your goals, whether budgeting or forecasting, comes down to what information you’d like to generate, and how you plan to use it to inform your decision-making.

Gathering accurate financial data

Perhaps the most important part of budgeting and forecasting is your financial data. Establishing a single version of data truth will ensure everyone works from the same assumptions, minimizing confusion about the latest figures.

Ensuring that your financial data is accurate and up to date is also crucial for making informed decisions. Consistency in data sources and regular validation processes can significantly enhance the reliability of your budgeting and forecasting outcomes.

Sources of financial data

To effectively budget and forecast, you should compile financial data from all your source systems including your ERP, CRM, and HRIS software. This will improve the relevancy and validity of your budgets and forecasts by giving you a holistic view of your business.

Robust data validation processes to detect discrepancies, automated data integration tools to streamline collection, and a software solution like a Financial Performance Platform can significantly improve the accuracy and efficiency of your financial data.

Using the right tools and software

The right tools and software can make all the difference in your budgeting and forecasting process by improving accuracy and efficiency. Let’s explore some popular budgeting and forecasting tools, and how to create realistic projections for your business.

Popular budgeting and forecasting tools

When researching budgeting and forecasting tools, you will come across three distinct types of vendors:

• Process-specific vendors: Process-specific vendors offer software for one finance process like budgeting, planning, consolidation, or financial close. Many businesses gravitate towards process-specific vendors because they want to address their immediate needs (e.g., forecasting), but it’s important to choose a solution that future-proofs your business by letting you expand your use case as needed.
  • Vendor example: Cube is a spreadsheet-native platform that’s ideal for financial planning.
• Industry-specific vendors: These vendors provide solutions that are tailor-made to meet the unique needs and challenges of a specific industry - be it healthcare, manufacturing, retail, or others. However, these types of solutions can limit your ability to grow, as they may not be flexible or adaptable enough to accommodate changes as your business evolves.
  • Vendor example: Sage offers business management and accounting software specific to the healthcare industry.
• Excel add-ins: These vendors offer a custom-built tool that enables users of Microsoft Excel to leverage additional functionalities that are not available in the standard Excel application. This functionality typically includes sourcing, visualization, analysis, and reporting of financial data. However, relying solely on Excel add-ins may fall short in meeting the multifaceted demands of modern companies, and impact your ability to adapt and thrive.
  • Vendor example: Vena Solutions is an Excel-based solution for finance teams who want to stay in a spreadsheet-based environment.
• Financial performance platform: A financial performance platform is the most multi-faceted finance software. A platform offers a comprehensive suite of applications for everything from budgeting and forecasting to consolidation and financial close. If you’re seeking a holistic solution, a financial performance platform is your answer.
  • Vendor example: Prophix One, a Financial Performance Platform, empowers your finance team with applications for every area of finance, including budgeting, forecasting, reporting, analytics, consolidation, financial close, and more, so you can be prepared to tackle trends, changes, and challenges, ensuring your business remains resilient and competitive.

Overall, a Financial Performance Platform, like Prophix One, is best suited to handling your budgeting and forecasting processes. By centralizing access to your financial data in one platform, everyone can work together to drive growth.

Check out the 21 best business budgeting software for CFOs (in 2024) in our blog.

Creating realistic projections

There are several steps to keep in mind when creating realistic projections, including:

1. Establish your baseline – Your forecast is only as accurate as your baseline. Before creating your forecast, you need to assess the current state of your business, including your revenue, expenses, cash flow, profit, and margin. The more detailed your baseline, the more valuable your forecast will be.
2. Focus on key metrics – Before creating your forecast, you need to be clear on what metrics and variables you plan to evaluate. If you want to compare your company’s performance against other organizations of a similar size or in a similar industry, make sure to collect benchmark data only from your direct peers. You should also validate your historical data and ensure you’re only using the most reliable data sources.
3. Make a judgement call – In situations where complete data is unavailable or when forecasting for new products or services, relying on the expertise and judgement of your finance team is a common practice. Integrating qualitative insights alongside quantitative data can improve the accuracy of forecasts, especially in uncertain scenarios.

Methods for creating projections

There are two approaches to creating your forecasts – bottom-up or top-down. Each has its own unique challenges and benefits.

Top-down forecasts involve assessing the entire market that you operate in. By evaluating the demographics of your market, you can make predictions about how your business will perform. The primary benefit of top-down forecasts is that you can evaluate the revenue potential of your company by focusing on market capacity and growth potential.

In contrast, bottom-up forecasts focus on your business’s product lines, services, and activities. Bottom-up forecasting is less concerned with the overall market and more with what activities or actions the business needs to take to be competitive. This approach to forecasting can help you better understand how your money is spent and how it will impact your future financial reports.

Monitoring and adjusting budgets and forecasts

Now that you know what goes into an effective budget and forecast, and the methods for creating realistic projections, let’s cover how to monitor and adjust your financial plans.

Regular review processes

No matter your approach to budgeting or forecasting, it’s crucial to regularly review your historical data, projections, and results. Forecasts should be continually updated to reflect market changes, new product launches, or service offerings. Similarly, budgets should be updated when corporate goals change or when departments are faced with resource constraints.

Adjusting as needed

By regularly reviewing your budgets and forecasts, you can guarantee the relevancy and accuracy of your financial plans and align them with changing business conditions and goals.

Common challenges

Despite the extensive benefits of budgeting and forecasting, there are some common challenges faced by finance teams:

Dealing with uncertainty

It’s common to come up against uncertainty in your budgeting and forecasting processes, which can make it difficult to know which variables and metrics to change. This is why it’s important to be flexible in your approach by developing multiple forecast scenarios or by using the continuous method of budgeting where additional periods are added after a prior period ends. This way, you can pivot your strategy as the market evolves, ensuring that your decisions are responsive and resilient in the face of change.

Managing variability in data

Managing variability in data poses a significant challenge for finance teams. By incorporating robust data validation techniques and utilizing advanced analytics tools, finance leaders can navigate variable data sets effectively. Adapting to changing data patterns and implementing agile forecasting methodologies enables teams to make informed decisions, fostering agility and precision in financial planning.

Aligning budgeting and forecasting with business strategy

Budget and forecasts are more than just plans, they communicate to internal teams what the organization’s strategy and goals are. That’s why it’s important to circulate your finalized budgets and forecasts with the broader company including individual teams, leadership, and stakeholders or investors. It may also be helpful to distribute these plans in multiple languages, formats, and via different channels to ensure everyone is on the same page and pursuing their goals in such a way that supports business strategy.

Ensuring stakeholder buy-in

When it comes to resource allocation or what-if scenarios, it can be hard to get everyone on board with change. Make sure to involve stakeholders early in the process by encouraging them to contribute data and insights that pertain to their department. This can help generate more engagement and make employees feel like their contributions are valued. You should also meet regularly with your leadership team to ensure your budgets and forecasts reflect organizational priorities.

How to get started with budgeting and forecasting

Now that you’re knowledgeable about both budgeting and forecasting, here are some quick tips on how to get started:

Identifying your starting point

The first step of any budget or forecast is compiling and validating historical revenue, expense, cash flow, and profit data. This gives you a clear picture of where your business stands, so you can begin to identify where you’d like to go.

Establishing a process

Identify what approach to budgeting you’d like to take, such as zero-based, continuous, activity-based, static, rolling, incremental, value proposition or flexible. Similarly, choose which forecasting method you plan to implement, whether top-down or bottom-up.

Involving the right people

Work with stakeholders to understand their pain points from the prior fiscal year, establish priorities, gain their support, and identify opportunities for improvement. Ask stakeholders to contribute to data collection and validation, so that departmental priorities are included in your budgets and forecasts.

Setting up tools and templates

To streamline your budgeting and forecasting processes, set up dedicated tools and templates. Use finance software like a financial performance platform to create standardized templates for budget creation and forecasting. These platforms can help automate calculations, provide clear data visualizations, and ensure consistency in your financial planning efforts.

Regular review and improvement

Schedule regular check-ins to assess the accuracy of your predictions, track variances, and identify areas for adjustment. Use feedback from stakeholders and performance metrics to continuously refine your budgeting and forecasting processes, ensuring they align with the evolving needs and goals of your organization.

How Prophix can help

Regardless of whether your company prefers budgeting or forecasting, your processes are only as good as the data used to compile them. Organizations that use a Financial Performance Platform, like Prophix One, are better positioned to automate their budgeting and forecasting processes. With reliable data centralized in one location, companies can trust both their budget and forecast, and spend more time analyzing the results.

Unlock your potential for growth with accurate and comprehensive forecasts and budgets from Prophix One.