The term "budget forecasting" has been getting a lot of awareness lately. However, the term and practice are confusing. Many mistakenly use the term interchangeably, describing adjacent financial planning and analysis processes and leaving room for finance operators to interpret those as budget forecasting. This post will provide a general view of a budget forecast, how it differs from a budget, why it is crucial, and the basics of creating one.

What is Budget Forecasting?

Budget forecasting is the process of estimating future revenue and expenses. Budget forecasting aims to provide a quantitative assessment of an organization's financial position at a specific point in time, using the budget of the forthcoming period as one of its data sources.

It can give you, for example, an idea of whether your company will have enough money to cover its expenses and debts and how much profit it might make.

A budget forecast is made primarily to simulate what the budgeted values should accomplish when a budget is produced and expectations for the following year are established. The budget prediction is used to try and forecast how the budget will turn out if followed precisely.

Budget vs. Budget Forecast

Finance operators might refer to a budget as a financial road map when making choices because it highlights the organization's objectives for the upcoming fiscal year. It frequently includes a variance analysis to explain any differences from expected outcomes and is then compared to the actual results. A budget is often a static financial plan, which is often only annually revised.

A forecast predicts what the company will accomplish using data from the past. Forecasts typically don't go into great detail and tend to lump revenue and expenses together.

Hence, the main difference between a budget and a budget forecast is that a budget is static, while a budget forecast is dynamic.

Budget vs. Actual Analysis

Once the budget period is over, it's time to see how your company actually performed. This process is called Budget vs. Actual analysis. Budget vs. Actual analysis compares the income and expenses that were budgeted for with the actual income and expenses of the company.

This analysis is vital to see if the company stuck to its budget and achieved its financial goals. If not, Budget vs. Actual analysis can help you determine where the company went over or under budget and why.

Scenario Planning

Often Budget Forecasting is wrongly used to describe scenario planning. While also used to plan ahead, scenario planning is a process of creating hypothetical future situations and estimating their consequences. Scenario planning, sometimes known as "what-if" planning, simulates various financial outcomes depending on a set of presumptions. One example may be very similar to a company's annual budget, which uses past performance and projected income to create a strategy.

Another scenario might be developed to show finances in a "worst case" scenario, for as, when a significant anticipated contract fails, sales are below expectations, or manufacturing overruns cannot be sold off. A "best case" scenario, which is the opposite of the worst case, might be the third scenario.

These "what-if" scenarios combined could produce a roadmap or budget estimate for a business to follow. Finance teams essentially perform a form of budget forecasting when they create what-if scenarios and present a plan or budget for each one.

Why Is A Budget Forecast Important?

A budget forecast is special because it offers a financial outlook for the future, assuming that the budget is strictly adhered to.

Typically, previous data is utilized to predict the future based on certain assumptions. Because the budget forecast predicts budgeted values, past data is not directly referred to in this instance. Most budgets typically call for the utilization of historical data and some degree of assumptions. Therefore, even if neither are being used as direct inputs in the model itself, it can be said that the budget prediction comprises both assumptions and historical data.

Variance analysis, which compares actual results to predicted budget amounts, is based on budget prediction.

Because of this, a budget forecast is a beneficial tool for monitoring and is frequently used in corporate performance management.

How To Make A Budget Forecast?

Establishing the budget is the task that needs to be finished first to start working on a budget prediction. The forecast will be built on top of the budget, giving the model's essential inputs. Once a budget is in place, creating a budget projection is not too difficult. This is so because the budget is comprised of the forecast's results.

Making assumptions about the timing of revenue and expenses is all that is needed for the actual financial model. At its core, the procedure consists of two steps.

Step #1: The Budget Should Be Divided Into Time Periods

The budget itself serves as the model's foundation because the budgeted amounts are the results of the forecast.

Expectations for revenue and expenses are often annualized because most budgets are set annually. The fact that most revenues and expenses are cyclical is not considered in this.

Use the budgeted amount and spread it out over the course of the following year to generate the prediction. Keep in mind that the sum of all the individual time periods should match the annual budget amounts.

There are a few ways to do this, one of which is straight-line, where revenue is distributed equally across each predicted time.

Consider the past trends from prior years and use those trends for the allocated amounts would be another, more accurate strategy.

Step #2: Create KPIs using the Budget Forecast

Utilize the forecast to develop key performance indicators after the budgeted amounts are projected for each of the following months. This will help to guarantee that operations get as close as feasible to the budget prediction.

Step #3: Carry Out Variance Analysis

The budget prediction culminates in a thorough financial blueprint for the following year. It incorporates the budget and produces a helpful set of critical metrics that can be used to assess the company's performance.

By conducting variance analysis on such KPIs and the forecast directly, management is given insightful information that may be used to reduce risk or change objectives.