There are hundreds of different kinds of financial documents, so it’s easy to get mixed up about which is which. Two of the most common are budgets and forecasts, and you’re almost guaranteed to encounter these if you run a business (or are hoping to do so).
Both these documents deal with the future, so they could be mistaken for one another. To prevent you from making this mistake, we’ll look at both subjects in detail. This article will specifically look at:
- The definition of a budget
- The uses of a budget
- The definition of a forecast
- The uses of a forecast
- Using budgets and forecasts together
The definition of a budget
A budget is a way of presenting the financial expectations a business owner has for their company. A budget tends to be annual and contains a great deal of information — everything from projected sales revenue to estimated cash flow. A budget might also include the company’s current financial position (which is a list of what they own and what they owe — their assets and liabilities) as well as the position the company might be in by the end of the year.
The main point of a budget is that it’s a presentation of what a company’s directors hope to achieve, as opposed to a presentation of what will actually happen. That’s not to say a budget should be unrealistic, but it does mean a budget should act as a goal or target instead of an actual guideline for what’s happening to the company.
The uses of a budget
First and foremost, a budget exists to aid with financial planning. Whether you’re running an established company or only just starting a business, you’ll want to create a budget for the upcoming year.
A budget helps you present the aims of your business more clearly, which in turn helps you understand what to prioritise. For instance, the first budget you create when starting your business might set aside a large amount of money for advertising, so you can find more customers. As you grow over a year, this advertising amount might change. Still, you should have a budget to represent how much you want to focus on a particular area.
Budgets are also an important way of measuring success. If your company’s finances closely match the budget you set at the start of the year, you’ll know that your business is heading in the direction you wanted. Looking back at previous budgets and comparing them to your company’s actual finances is a great way of charting the progress of your business over the years.
The definition of a forecast
A forecast is an estimate of the future finances of a company. It uses existing financial data such as:
- Data from the business itself
- Figures from the performance of business competitors
- Financial information from market research
The data is then used to create a prediction of the company’s finances.
A forecast will usually only focus on one subject, as opposed to the general overview a budget provides. For example, you might have a forecast that only looks at a company’s cash flow or a sales revenue prediction. A forecast is generally created more regularly, i.e. monthly instead of annually. Finally, a forecast might get updated depending on circumstances within the company, whereas a budget would stay the same as it has little relation to the actual finances of the company.
The uses of a forecast
Forecasts tend to be of more practical use to a business than a budget. While budgets are good for outlining a company’s hopes and ideals, forecasts are a better tool for making actual business decisions.
A forecast is great for displaying the direction of your business to potential investors. If you’re trying to get some financial support for your business, potential investors will likely ask how much money your business is going to make. A forecast will provide them with a realistic estimate of the cash coming in and out of your business.
Forecasts are also a useful tool for setting sales goals. Budget can be less helpful for this task because they aren’t as focused on the current situation of your business — but a forecast can provide you with a relatively accurate idea of the sales your business could make within a given period of time.
Using budgets and forecasts together
You can actually get a lot of benefits from combining budgets and forecasts together.
This is because budgets and forecasts serve different purposes despite using the same sort of data. A forecast is for short-term decision making, while a budget manages the long-term direction of a business.
If you’re looking to combine the two, then combine those short-term forecasts into a single budget at the end of the year. Future forecasts might not align with the new budget, even if that budget was put together using previous forecasts. That’s okay — remember, your current budget doesn’t need to greatly resemble the existing financial direction of your company, it’s just a representation of how you hope the year will go.
Keep on top of your finances with a simple app
Once you understand the difference between budgets and forecasts, you should try to make some of your own. To do this, you’ll need to be able to access all of your financial data with ease. The best way to achieve that is by using financial management software, such as Countingup.
Countingup is the business current account with built-in accounting software that allows you to manage your financial data efficiently. With features like automatic expense categorisation, invoicing on the go, receipt capture tools, tax estimates, and cash flow insights, you can confidently keep on top of your business finances wherever you are.
You can also share your bookkeeping with your accountant instantly without worrying about duplication errors, data lags or inaccuracies. Seamless, simple, and straightforward!
Find out more here.