Budgeting and Forecasting
What are budgeting and forecasting?
Budgeting and forecasting (B&F) is a two-step tactical planning process for determining and detailing an organization’s long and short-term financial goals. These are planning tools that help management in its attempt to deal with the uncertainty of the future.
The process is usually administrated by an organization’s finance department under the Chief Financial Officer’s (CFO) guidance.
Budgeting Vs Forecasting
| Budgeting | Forecasting |
| A budget is a financial plan expressed in quantitative terms prepared by the management in advance. | The forecast means the estimation of the future situation based on past and present trends. |
| A budget is not a prerequisite for forecasting. | Forecasting is a prerequisite for budgeting. |
| A budget is prepared for a shorter period, say a week, a month, or a year. | Forecasting is done on a more regular basis than budgeting and is prepared for long-term periods. |
| The budget is meant for execution. | The forecast is not meant for execution. |
Types of budget
Some of the known types of budget are as follows.
1. Activity-based budgeting
This type of budgeting involves working in reverse. Budgeting aims to find all the activities that enable you to achieve a certain goal. For example, if you target growth of a particular percentage you will think of all activities that will bring you results. It may include practices like spending more on marketing or reducing expenses.
2. Incremental budgeting
This budgeting involves tailoring the current budget that you have for your business. It involves simple practice, all you need to do is think of what you want and set your budget accordingly. For example, if you want to grow your business by 10% in the next year, you will also increase your budget by 10% to justify your spending.
3. Zero-based budgeting
This type of budgeting starts fresh every year. Look at your business with a fresh perspective and start from zero. Do not consider your previous budgets. This budgeting is helpful for businesses that regulate their extra spending.
4. Value proposition budgeting
In this type of budgeting, you will think of a certain value and you will allocate your budget accordingly. A higher value means higher you can set the budget.
Types of forecasting
Following types of forecasting can be used by businesses.
1. The Delphi method
Use this method when you need to make a long-term forecast about business. It requires you to spend a lot of time and energy. This method is based on the expertise of many experts rather than one expert. For example, you might ask a question to a group of experts and a conclusion about the future might be based on their answer.
2. In-house expertise
The most experienced person is tasked with making accurate predictions in this type of forecasting. This method requires a conclusion of high precision, so, the person with the most knowledge is chosen to predict the answer.
3. Time series analysis
It is a quantitative method of forecasting and you need years of valuable data to forecast. If you want to forecast a particular product, you will need years of data for product history and then you will understand what can happen in the future.
4. Simple method
In casual methods, you perform time series and market analysis, so this method combines two methods. There are numerous methods of causal forecasting which include segmentation, index method, and regression analysis. The regression method is most commonly adopted.
Why are budgeting and forecasting important?
Budgeting and forecasting processes help organizations demonstrate more accurate financial analysis which leads ultimately to revenue growth. These practices save time, reduce errors, promote collaboration and encourage disciplined management. By following these processes, companies can quickly update plans, analyze variances and deviations, make confident strategic decisions, improve collaboration, deliver timely, reliable forecasts and plans, predict cash flow, and more accurately manage sales.
Common challenges with budgeting and forecasting
The chief financial officer (CFO) struggles with the business budgeting and forecasting process which comes along each year. CFOs need to compare and evaluate budgets and forecasting consistently. The common challenges that CFOs counter while going through the budget forecasting process include;
- Poor data management
- No single source of truth
- Poor modeling capabilities while using the spreadsheet
- Setting unrealistic expectations
- Inconsistent approaches
- No common set of assumptions
Budgeting and forecasting best practices
Since effective B&F processes bring organizations several benefits, best practices should be planned, including the B&F process should be comprehensive taking into account all financial information, reducing manual labor, making management a top priority, and agreeing to clear and coherent decisions regarding company vision.
Tips for budget forecasting
Following are some useful tips that help you to improve your budget forecasting and prepare for organizing long and short-term goals.
I) Be flexible
Always use number ranges rather than specific figures to give your company reasonable space to counter unanticipated factors like lessened expected sales or an unexpected rise in product demand.
II) Make a plan
Make sure you have short and long-term goals before reevaluating and modernizing your budget. Use your financial forecast to help you decide the best possible use of funds to ensure that your company can persist to grow and develop.
III) Use the rolling model
Many companies set annual budgets and forecasts. It is always a successful plan to make long-term goals and provide a financial structure for the year. Therefore a rolling budget and forecast, updated every month or quarter can help to keep your organization up to date.
IV) Prepare for multiple scenarios
Keep an eye on what is going on in your organization and economy overall. Positive potential or negative shifts in the external market have an impact on your budget and forecasting so always be prepared for these scenarios.
V) Set a review
Establish regular review meetings to ensure your forecasting is accurate and based on up-to-date metrics. Create a schedule that supports the ups and downs of organizational challenges.
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