Budgeting vs. Forecasting: What’s the Difference?Chia-Li Chien, Ph.D., CFP®, PMP®, CPBC
Chia-Li Chien | Aug. 28, 2014
Investors behave differently depending on whether information is favorable or unfavorable with regard to the stock market. Information such as quarterly earnings report, unemployment rate, interest rate, or every move of the Federal Reserve makes waves in the stock market. Top management of these publicly-traded companies set their expected or forecasted quarterly earnings a year in advance. Each quarter they will be measured by how well they are performing against their forecast.
In the business world, public or private sectors tend to take ideas and run a forecast just to see how they stack up financially. Ultimately, they want to meet the stakeholders’ expectations. The stakeholders include equity or bond holders (or investors), customers, employees and suppliers, etc.
What is Forecasting?
Let’s take a look at the definition from Merriam-Webster dictionary:
verb -ˌkast; fȯr-ˈkast\
to say that (something) will happen in the future : to predict (something, such as weather) after looking at the information that is available
Every morning, I check the weather forecast to prepare for my day. Why? If it’s going to rain, I might need an extra ten minutes to get to the office on time. I might remind my daughter to put on an extra layer or jacket in case of windy or snowy conditions. The weather forecast helps us prepare for our day ahead. Before the business fiscal/calendar year ends, most businesses will prepare a budget for the upcoming year so that people know the target and how they will be measured and rewarded.
Forecasting is nothing more than a process to help us prepare for what’s ahead so we can be more proactive in achieving our business goals, instead of reactively putting out fires. I would venture to say that you and I both know that meteorologists might or might not be right about the weather forecast. With the latest technology improvements, I would say that their forecast is very close but still not 100% accurate. We factor that potential accuracy of the forecast into our day’s preparation and schedule as well. Your business forecast must allow for an expected accuracy range, too, so the management team knows what to expect and how to measure success.
The difference between budget and forecast.
|What are the intentions?||Where do you want to go? e.g., 15% increase in revenue by Dec. 2014||Where are we now? e.g., 5% ahead of the plan and on track to achieve the goal. It’s like a radar or GPS to show your current state.|
|When to prepare the numbers?||Once a year, typically year-end, prior to the upcoming year. e.g., Dec. 2013 for 2014 Budget||As often as needed. It depends on types of forecasts, for example, 13-week cash flow forecast, daily credit forecast, 8-week sales forecast, quarterly people capacity forecast, etc.|
What do businesses typically forecast? The Triple Bottom Line, according to my favorite author Ken Blanchard in his book, Leading at a Higher Level, Blanchard on Leadership and Creating High Performing Organizations.
Here is how the triple bottom line stacks up with forecast examples and common failures in business.
|The best place to work||The best place to do business with||The best place to invest|
Production Output Efficacies
|Common Failures in Business|
|Wrong people on the team||Lack of market share and profits per customer||Consistently not meeting the ROI or business performance expectation|
Every last quarter of a fiscal or calendar year ends. Businesses prepare their budget for the upcoming year. They first takes the previous one to three years historical actual financials along with a pre-defined strategic assumption from top management. Their first forecast of the next year then goes into working session with top management to set their budget for next year. During the year, each department or division takes the actual amount spent compared to the budget on a monthly or regular basis. Each department or division justifies why they missed, met, or exceeded the budget (or the expectations). Then, they reforecast for the remainder of the year with a solid action plan for this coming month to be on track for meeting the expectation. You repeat this process throughout the year so there are no surprises to impact the bottom line at the end of the year.
A forecast is not like a budget that you can just present and set aside. You want to monitor them on a regular basis. Instead of making adjustments, you need to re-forecast based on the current trending or seasonality. The re-forecast presentation allows you to recommend appropriate action steps to the management team.
If there is a regular monitoring process in place, you can spend time proactively managing the business instead of reactively putting out fires. When Whole Foods missed their quarterly expectation on May 6, 2014, not only their stock price dropped 21%, the investors’ confidence in the Whole Foods’ management team also dropped. Again, no one likes surprises!