Recently, I was talking to a finance professional who oversees accounting processes and helps his organization make decisions about the future in regard to budgeting and forecasting. He posited that forecasting might be more important to running a business today than traditional budgeting – and it made me think. I’m always writing about the constantly evolving world of technology and the fast pace of today’s business culture, so shifting away from a traditional way of accomplishing data management and analysis tasks sparked my interest. Thus, this article will explore the differences between budgeting and forecasting to hopefully arrive at a better understanding of what is more impactful and productive to business today.
When I first heard the term forecasting, I thought it was a synonym for budgeting. Budgeting and forecasting are distinct processes, and it will be good for us to start by differentiating the two. Budgeting is a detailed and comprehensive compilation of how management envisions that the business will perform, in terms of results, financial positioning, and cash flows, for a specific period of time, usually a year. A budget is typically a fixed plan that is updated once a year, depending on how often management wants to tweak the data. Budget users compare actual results to projected numbers in order to identify any variances in performance to come up with next year’s budget. Depending on the way the fiscal year goes, managers might take remedial steps along the way to bring actual results back on track with the budget. Finally, the projected to actual comparison can mean changes to performance-based compensation for employees.
Forecasting, on the other hand, is an estimate of what will actually be accomplished. Forecasting is usually focused on just major revenue and expense line items – and doesn’t typically include financial position, but cash flows might be included in the forecast. The forecast is regularly updated, whether that is monthly or quarterly. Forecasting can be utilized for short-term operational adjustments or considerations, as in sales performance, staffing, inventory, and/or production plans. Forecasting often does not involve variance analysis for comparison of what was forecasted to actual results, but can be used to figure out how you should allocate your budgets for a future period. And another way a forecast differentiates itself from a budget is that any changes in forecasting doesn’t affect performance-based pay for employees.
To summarize, budgeting is a plan for the intention and destination that a business would like to go whereas forecasting is the illustration of where a company is actually going. Their timelines are also different in a way that impacts the way we interact with the processes. Forecasting happens regularly and frequently in comparison to budgeting, which typically happens once a year. Because of how often forecasting looks at the state of the business, you can use the information to take action right away, as needed. Alternatively, budgeting may involve goals that are simply impossible to achieve, especially as changes in the marketplace might come up that take the business in a different direction. Depending on what sector you’re working in and how rapidly it changes, your budget can become obsolete rather quickly.
Let’s get back to the conversation about forecasting versus budgeting in terms of which is more effective and/or more important for modern businesses today. The finance professional that sparked my curiosity about this debate mentioned that, when done well, forecasting often includes data outside of your accounting system, like CRM, Payroll, and industry-specific systems, instead of estimates done by humans 16 months or less in the future. But he wasn’t the first person to make the argument that forecasting is a more productive process than budgeting.
In my research, I stumbled upon an article by Jeremy Hope and Robin Fraser for the 2003 issue of the Harvard Business Review. Hope and Fraser write in “Who Needs Budgets?” about the culture surrounding budgeting, specifically the top-down approach and the micromanagement regarding the monetary goals laid out in the budget, but they also discuss how the status quo of budgeting – then and now – doesn’t accommodate the rapidly changing marketplace. For these two, both corporate culture and the failure of budgeting to achieve successful adaptive strategy are interrelated, and they might have a point. They write, “The same companies that vow to stay close to the customer, so that they can respond quickly to precious intelligence about market shifts, cling tenaciously to budgeting—a process that disempowers the front line, discourages information sharing, and slows the response to market developments until it’s too late.” In other words, they were observing the managerial ownership over planning as problematic not only to the inability to adapt to market shifts and consumer intel, but also to teamwork and cross-organizational involvement in the success of the company. They weren’t the only ones who found budgeting to be dated.
In 2014, Ken Wolf wrote “Why It’s Time to Say Goodbye to Traditional Budgeting” for the American Management Association. In the article, he discuss the three main issues with traditional budgeting: too much time, money and other corporate resources are consumed for the process; not a flexible or adaptable plan, which can quickly become obsolete; and compensation tied to performance versus budgeted expectations leads to ill-conceived motivations and internal negotiations based on market changes. Wolf’s suggestion is rolling forecasts, which “can be defined as a projection into the future, partly based on past performance, that is routinely updated to incorporate input and information reflecting changing market, industry and/or business conditions. It is not meant to be a fixed target, but rather a best current prediction as to the organization’s financial and operational performance over a certain time horizon.” His suggestion is an accommodation of the traditional budgeting process as well as the more modern and adaptive planning approach of forecasting, which seems like a great transition for most companies that are exploring ways to be more effective in their strategy.
I wouldn’t say that I came away from my research with a black and white position on which is better, but that’s also because each company culture is different. Forecasting does seem more adaptive, which is important to the pace of the business world, but you’ll have to evaluate your specific objectives and how the two planning processes help you achieve those goals. Solver offers a planning module stand-alone and as part of the comprehensive suite of BI modules and would be happy to answer questions and generally review BI360’s easy-to-use budgeting and forecasting solution for collaborative, streamlined decision-making capabilities.