Finance teams generate many insightful reports for business leaders, and each one serves a distinct purpose. Two such tools that are often referred to interchangeably but are actually very different are budgets and forecasts. Read on to learn about these differences and why forecasts provide additional insight that budgets cannot.
What Is a Budget?
A budget is a statement that outlines a business’s expected revenue and expenditure in detail. This allows business leaders to create a financial plan for their operations for a specific accounting period. These plans are always short-term and are rarely changed to reflect changing market conditions. Finance teams look back on their budgets to evaluate whether the strategies they used were effective in helping them meet their goals.
When Should You Use a Budget?
Since budgets help business leaders lay out specific financial plans, they are prepared in advance of an upcoming accounting period. Budgets aid leadership teams in goal setting and help them communicate these goals to operational and administrative teams easily and consistently. Various departments can then use these budgets to allocate funds and manage operational performance in the short term to ensure that they are on track to meet their goals for the immediate future.
What is a Financial Forecast?
While budgets are used to set a baseline for short-term performance, financial forecasts use historical data to estimate future financial performance. These estimates are usually done both in the short and long term. Unlike budgets, businesses can have multiple forecasts based on a variety of scenarios and strategic decisions made by top level leaders. Financial forecasts also inform data-based assumptions about future financial performance that are then used in budgets for realistic and accurate goal setting.
When Should You Use a Financial Forecast?
Budgets are usually developed at fixed intervals for specific accounting periods, but financial forecasts can be created at multiple time intervals or when changing market conditions demand a reevaluation of past financial assumptions. Forecasts can use near real-time data to predict whether a team’s strategy will allow them to meet the goals set out in their budget. Forecasts clearly outline what a company is expected to achieve in a predetermined period. This makes them highly reliable as an indicator of performance that can be presented to investors and other stakeholders.
4 Ways to Maximize the Effectiveness of Financial Forecasting
1. Ensure That Financial Data Is Complete, Accurate, and Reliable
Despite the insights financial forecasts can provide to internal and external stakeholders, business leaders don’t always make full use of them. More than half of business leaders disagree that they have high confidence in the accuracy of their forecasts. This is often a result of unavailable or unreliable financial data. Businesses should always ensure that the financial information they collect and analyze for forecasting is complete and accurate and that any new data is held to the same standard of quality.
2. Keep Abreast of Changing Market Conditions and Business Strategies
Financial forecasts often consider market conditions and business strategies to estimate the future financial performance of a business. However, market conditions change regularly and business strategies must be adapted as a result. Since financial forecasts are more dynamic than budgets and can change depending on these conditions, finance teams should use them to assess how evolving business landscapes will affect sales, revenue, and profitability.
3. Outline the Financial Impact and Performance of Every Business Division
Business leaders use financial information as a basis for decision-making, goal-setting, and strategic planning. However, insights generated and contained within operational silos impede decision-makers from having a holistic view of financial performance. Financial performance can be affected by operational issues such as hiring, operational efficiency, and more. This makes it extremely important for executives to collect data across information silos and departmental boundaries.
4. Create Forecasts Using Different Scenarios and Prepare for the Worst
While creating forecasts, business leaders can sometimes be tempted to use the most optimistic market conditions and business assumptions. This temptation is often stronger when creating forecasts to present to investors. However, business leaders should always recognize the importance of preparing for challenging market conditions. Multiple financial forecasts using different financial assumptions can help businesses lay out plans for every possible business scenario in advance.
How Fully Integrated Finance Software Can Improve the Insights Delivered by Critical Financial Functions
Budgeting and forecasting are both important processes for modern finance teams. Each is useful for business leaders at different stages of planning and reporting. Finance teams that understand how each of these processes assists in the creation and maintenance of a profitable business model can use them to great effect.
Business leaders can improve how these functions are performed by building strong information pipelines that deliver financial data to key stakeholders effectively. Almost three-quarters of finance teams prefer a centralized and tightly governed source of financial information. Fully integrated finance software can help finance teams effectively collect important data, organize them in the appropriate format, and deliver them to stakeholders in an effective and timely manner.
To learn how Place’s solution can help you improve key financial forecasting, budgeting, and planning processes, schedule a demo with us today.