Forecasting can help your business set achievable goals. But where do you start? By creating your budget.
Forecasting models and budgeting are not the same. Budgets are what you want to happen, while forecasts reflect what you think will happen.
A budget is a static plan that covers a specific period and is usually based on the company’s past trends. A forecasting model is a dynamic projection based on historical results, economic impacts, and operational changes that occur throughout the year. Forecasting looks at the company’s current financial situation and uses that information to predict if a budget will be met.
Budget first, then forecast.
A budget is the projected revenue and expenses of a business for a given period, usually one year. Once the budget is finalized, it generally isn’t modified.
Budgeting may sound simple, but there are several approaches you can use. Each method has pros and cons, and whichever approach you take should be based on what will be most accurate and impactful in projecting the financial outcomes of the business.
Incremental budgeting. This is one of the most common approaches. This method starts with the prior year actuals and layers in the assumptions for the upcoming year.
Zero-based budgeting. A zero-based budget starts from scratch, not by using actual expenses incurred in the previous year. If an expense is not justified or approved, it is eliminated from the budget. A zero-based budget can be more time consuming, but it is ideal for decreasing costs.
Value proposition budgeting. This budget plans expenses based on the value it will bring to the company. This method could be used in government spending, allocating funds based on the services that are most needed. The end goal of value proposition budgeting is to spend more on expenses that are more valuable to customers, which in turn should result in an increase in revenue.
“Rolling” budgeting. This budgeting approach is continuously updated. When one month is completed, another month is added to the end of the budget to maintain the desired number of months the business would like to have in a budget at any given time.
The best practice in budgeting is to not change the budget once it is set. This will allow the business to assess the accuracy of the original budgeting assumptions.
However, goals may become unattainable if significant changes occur during the year. At this point, you will definitely need to create a forecasting model to fully understand where the business is headed in order to make the appropriate decisions.
