A company uses various tools to design plans to take the company ahead. Two such tools are budgeting and forecasting. Both tools help organizations to make more informed decisions and combat headwinds. Since both budgeting and forecasting support the financial decision-making of the company, people often use them interchangeably. However, both budgeting vs forecasting have significant differences between them. The primary difference between the two is that budgeting is about quantifying and assessing the viability of a plan. On the other hand, forecasting takes historical data into consideration to understand where the company would stand in the future.
Before we detail more differences between budgeting vs forecasting, it is important to understand what each of the two concepts means.
What is Budgeting?
Top management of a company aims to ensure that they have a foolproof plan to boost the performance of the company. By making a budget, management decides about the future of the company, wherein managers and board members come together to talk and discuss where the company would be in the years to come.
Thus, budgeting involves discussing long-term plans, ways to create more expansion opportunities, track progress, etc. One department that is closely involved with the budgeting process is the finance department. Both higher management and the finance department sit together to charter the future course of the company.
There are two major approaches of Budgeting – the Top-Down Approach and the Bottom-Up Approach. In the top-down approach, as the name suggests, management prepares the budget as per the objectives of the organization, and after that, managers are given the task to implement it. On the other hand, a bottom-Up approach requires managers to prepare a budget department-wise. After that, the budget is sent across to the management for their approval.
What is Forecasting?
Forecasting is about understanding, analyzing, and determining the possible future outcome. Forecasting is based on past performance, wherein analysts study the past performance of a company to arrive at future expectations in terms of revenue, financial statements, and other metrics. Various entities such as the company’s management, economists, investors, and the government may use forecasting data to understand resource allocation and expenses.
One can broadly classify forecasting into Qualitative and Quantitative forecasting. Qualitative forecasting can further be classified into Expert Opinion and Consumer Survey methods. On the other hand, the Quantitative method of forecasting includes methods such as Time Series, Moving averages, Exponential smoothening, Regression analysis, Input-Output analysis, and so on.
Now that you know what both the concepts mean let us see the differences between Budgeting vs Forecasting.
Forecasting vs Budgeting – Differences
Following are the differences between Budgeting vs Forecasting:
Forecasting largely involves analyzing past data, understanding the trends, and using it to estimate future outcomes. Budgeting is about expressing the financial plan in quantitative terms. The management does budgeting in close coordination with the financial department.
What it Depicts?
Budgeting is mainly a financial presentation of a company’s business plan. Forecasting, on the other hand, helps to predict trends in business.
Under forecasting, there is no set target. Mostly, it is an estimate that the company thinks it would be able to achieve. On the other hand, Budgeting has a set target as management needs to decide on the expenses and other targets and allocate resources to the departments.
Budgets are less flexible, and companies adjust or make edits to them less frequently. A company makes changes in budgets only when there is any change in an underlying assumption. On the other hand, companies adjust forecasting more frequently owing to environmental changes or add any new or relevant data.
Forecasting is usually done on a quarterly basis, six-monthly basis, or annual basis in accordance with the decision of the management. Budgeting, on the other hand, is done on an annual basis. For the rest of the year, management and the entire organization follow the same budget. Management may evaluate the budget occasionally and take action if needed.
Budgeting is much wider in scope. One can apply it in a number of other fields as well and not just to finance. In comparison, forecasting has a limited scope and is mostly used in relation to the company and organizations.
Forecasting is more of an estimate as it talks about what the company may achieve on the basis of past performance. On the other hand, Budgeting is more about fixed targets and what the management aims to accomplish.
Budgeting is a tactical tool that allows companies to manage their operations in an accounting year. On the other hand, forecasting is a strategic tool that assists a company in checking its future performance.
Since forecasting is more of an estimate, it is only natural to have variance. Therefore, variance analysis makes sense. Budgeting is all about how the company is allocating its available resources and then strictly follows it. Therefore, there is usually no need for analysis.
Even though there are several differences between budgeting vs forecasting, a company needs to have proper coordination between them. We can say that the budgeting sketches the path in which the managers plan to take the company. On the other hand, forecasting helps to determine whether or not the company is achieving its budget goals or where it is heading.