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Understand the differences between budget and forecast

Understand the differences between budget and forecast

Good results do not happen overnight. It takes hard work and, more importantly, seriousness to do the financial management of a business – of any size. That is why it is necessary to understand what budget and forecast are in order to get the most out of these concepts.

Any finance professional who keeps up-to-date has heard of budget and forecast and their importance in the company’s budget planning. However, in practice, they end up not applying or taking full advantage of them to increase the business’s profitability.

Therefore, in this post we will explain their differences, when they should be used and what their importance is for corporate financial management. Are you ready to learn? Then let’s begin!

What are budget and forecast?

The definitions of the terms “budget” and “forecast” help us understand the role each one plays in the company’s financial management.

While the first is the determination of the budget amount dedicated to a company, sector, expansion or even task, the latter is a kind of adjusted prediction of how this budget will be used in shorter periods, allowing for adjustments and reassessments midway through.

Simply put, if a company’s annual budget for research and development is $180,000.00, the forecast will be the prediction of how this amount will be invested in each month, each quarter, each semester, etc.

Most of the time, dividing the budget by the months of the year and obtaining an average does not correspond to reality and makes managing the budget and preventing it from being exceeded even more difficult.

What are the differences and when to use them?

As you may have noticed, budget and forecast are quite different, but at the same time complementary. Below, we explain their roles in more detail and give examples of how to use them in the day-to-day of the company.

Budget

Budget is an extremely important tool in any company. It is the one that will define what the company can and cannot spend during a certain period (usually one year), and it also includes financial goals, cost control and optimization, and the gain of new revenues.

Its determination goes through a historical analysis of the company and its evolution, in addition to other factors such as seasonality, demands, consumption evolution and even the geopolitical scenario in which the company is inserted.

For example: based on the growth history of the last 4 years of a company, the percentage of increase in new revenues, and indices such as projected inflation and minimum wage, it is possible to set a budget to be spent on the hiring of employees, real estate lease, and the logistics expenses for the following year. It should never be done by intuition.

Forecast

On the other hand, forecast works on the annual budget in more detail, trying to predict and adjust its use in shorter periods, such as months, quarters and semesters. This type of approach is important to prevent going over budget, or draining it at precisely the most needed times.

For example: a company that manufactures Christmas ornaments expects a 25% increase in demand for the following year. With this data (and many others), it has already drawn up a budget for hiring temporary labor.

However, during the first months of the year, it will hardly be necessary to touch that budget, since the biggest cost is concentrated in the months before Christmas. By using forecast, it is possible to make this budget unavailable or limited in order to avoid spending it at the beginning of the year.

Budget and forecast go hand in hand

In the financial management of the company, budget and forecast should always go hand in hand. There is no point in doing one without paying attention to the other. That is why these two tools have such a positive impact on companies.

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