A common point of confusion in corporate finance is the distinction between a budget and a budget forecast. While there is some commonality between the two terms, taking the time to understand the difference between the two is beneficial.
This is because both of these practices are critical components of a healthy fiscal plan, but each do slightly different things.
In this FAQ we will provide a comprehensive view of a budget forecast and how it differs from a budget, why it is important, and the basics of creating one.
What Is A Budget Forecast?
A budget forecast is a type of forecast that takes its inputs from the budget for the upcoming fiscal period.
Once a budget is created and expectations are formed for the upcoming year, a forecast is created to model what the budgeted values should achieve. The budget forecast is used in an attempt to predict the outcome of the budget, if followed exactly.
Budget vs Budget Forecast
A budget summarizes the organization’s goals for the coming year and provides business leaders with a financial guide to reference when making decisions.
It is often compared to actual results and accompanied by variance analysis that explains any deviations from expectations. A budget is typically a static financial plan, meaning they are typically only updated once a year.
A forecast uses historical information to produce a prediction of what the business will actually achieve. Usually, forecasts are not very detailed and tend to broadly group revenue and expenses. Budgets are regularly updated and considered dynamic financial models.
The primary difference between a budget and a budget forecast is their intended uses. A budget is usually used as a roadmap, where a budget forecast provides a projection of the budget used for variance analysis.
Why Is A Budget Forecast Important?
What makes a budget forecast unique is that it provides a financial view into the future if the budget were followed exactly.
In a normal forecast, historical data is used to make a prediction on the future based on given assumptions. In the case of the budget forecast, historical data is not referenced directly because the budgeted values are being forecasted.
Usually, most budgets require the use of historical data and also utilize some level of assumptions. Therefore, it can be said that the budget forecast includes both assumptions and historical data, even though neither are being directly used as inputs in the model itself.
The budget forecast forms the basis for variance analysis, where actual outcomes are measured against the forecasted budget amounts.
This makes a budget forecast an extremely useful tool for performing monitoring and a common tool used in Corporate Performance Management (CPM).
How To Make A Budget Forecast
The most obvious activity that needs to be completed prior to beginning work on a budget forecast is the creation of the budget. The budget will form the foundation for the forecast and provide the model with its key inputs.
As a reminder, all financial models rely on inputs that are then used as a basis for the calculations in the model. There are several approaches to budgeting that can be used, adopting the best one takes thought.
Creating a budget forecast is fairly straightforward once a budget is in place. This is because the budget itself consists of the outcomes of the forecast.
The actual financial model only requires that assumptions be made on the timing of revenue and expenses. At a high level, the process is two-fold.
Step 1: Break The Budget Into Time Periods
Since the budgeted amounts are the outcomes of the forecast, the budget itself forms the basis for the model.
Most Budgets are created on an annual basis, therefore revenue and expense expectations are typically annualized. This does not take into account the cyclical nature of most revenue and expenses.
To build the forecast take the budgeted amount and allocate it across time periods over the upcoming year. Bear in mind, the end result of aggregating all of the separate time periods should equal the budget amounts for the year.
There are several approaches to doing this, one being straight-line, where revenue is spread out evenly across each forecasted period.
Another, more accurate approach, would be to consider the historical trends of previous years and apply those trends to the budgeted amounts.
Step 2: Use Budget Forecast To Create KPIs
Once the budgeted amounts are forecasted over each of the upcoming months use the forecast to create and implement key performance indicators to ensure operations result as close as possible to the budget forecast.
Step 3: Perform Variance Analysis
The end result of the budget forecast is a comprehensive financial roadmap for the upcoming year. It includes the budget and has resulted in a useful set of key performance indicators to measure the business against.
By performing variance analysis on these KPIs and the forecast itself, it provides management with useful insight that can be used to mitigate risk or modify goals.
Using DataRails to Build Budget Forecast
Every finance department knows how challenging building a budget forecast can be. Regardless of the budgeting approach your organization adopts, it requires big data to ensure accuracy, timely execution, and of course, monitoring.
DataRails is an enhanced FP&A solution that can help your team create and monitor budgets faster and more accurately than ever before.
By replacing spreadsheets with real-time data and integrating fragmented workbooks and data sources into one centralized location, you can work in the comfort of excel with the support of a much more sophisticated data management system behind you.
This takes budgeting from time-consuming to rewarding.