Forecast Budget: Definition, Benefits and Tips To Create One
Updated February 3, 2023
Effective planning is essential to establishing realistic goals for the future direction of a company. Companies use forecast budgeting as a metric to set realistic and viable business goals. Understanding forecast budgeting might help you make and refine strategic business decisions and advance your career as a chief financial controller, accountant or department manager.
In this article, we explain what a forecast budget is, discuss the benefits of formulating a forecast budget compared to a static budget and offer some tips for creating one.
Budgets and forecasts are similar financial tools companies use to establish plans for their future.
A budget shows the financial direction of where management wants to take a company within the span of a year, whereas a forecast uses past historical data to predict a company's future financial outcomes.
A budget forecast combines budgeting and forecasting. It usually uses data from the budget for the upcoming fiscal period to predict the outcome of a budget.
What is a budget?
A budget is a financial document that outlines estimates of revenue, expenditure, debt reduction and cash flow for a fixed period based on historical data. Budgets are often static or unchanging, and businesses update their budgets once a quarter or year. Budgeting looks at how much a company earns and spends and how it can increase sales and reduce expenses to improve profits. Financial professionals also review the budget at the end of each period and compare budgeted and actual performance to help determine the budget for the next period. Some refer to this comparison as variance analysis.
What is a forecast?
A forecast is a prediction of potential future business performance or outcomes. Forecasts are dynamic, and they update as revenue and expenses change. A company affects short-term forecasts for frequent operational needs and uses long-term forecasts to help with strategic planning and long-term business development. Forecasting makes predictions based on a detailed review of actual revenue and expenses and doesn't perform variance analysis.
A company can prepare forecasts for sales, production, costs and financial requirements. For example, sales forecasting analyzes past and current sales performance. It then predicts the number of products and services a business can sell, the cost of production and the profit it expects to achieve for the forecast period. Financial forecasting scrutinizes a company's current financial position, considers industry averages and competitors' performance and projects its growth for the forecast period.
What is a forecast budget?
A forecast budget, often referred to as a financial forecast, is a tool that evaluates current financial performance and economic conditions to estimate and project future business revenue and expenditure trends. Budget forecasting is a blend of both a forecast and a budget and combines elements of both.
Using forecasting and budgeting together helps businesses align goals across an organization and plan for future business development. It provides a basis for strategic business and financial decisions that are realistic. A forecast budget is the responsibility of managerial staff who work with teams to monitor existing revenue and expenses and forecast the performance of budgeted values.
Benefits of a forecast budget
A forecast budget highlights a company's future opportunities and threats and sets realistic business goals based on current actual data and current industry averages. The benefits of a forecast budget compared to a static budget include:
A static budget reviews historical data to set business goals. In contrast, a forecast budget is forward-looking and based on current performance analysis. A forecast budget helps a business effectively predict and manage cash flow and future expenses.
Adjustable time frame
A company sets a static budget for each period. It conducts a variance analysis at the end of the period to generate a budget deviance report. Companies can adjust a forecast budget more often to modify business activities to meet the forecast budget requirements. As a business uses an adjustable time frame for forecast budgets, it doesn't conduct variance analysis.
Combining actual performance results with forecasts is a more reliable metric for business decision-making, as it brings attention to changes in the current business circumstances. Forecasting provides current data for calculated planning and highlights future business threats, like a decrease in sales after a holiday season. This tool helps managers develop strategies to counteract business performance threats ahead of time compared to a static budget which outlines what a business hopes to achieve.
Tips for creating a forecast budget
Here are some tips for creating a forecast budget:
Use accurate data
An accurate forecast relies on an accurate budget. Financial controllers must ensure that all the current data is complete and updated. If a business forecast uses inaccurate information, it can't inform effective decision-making. Using a rolling method of updating a business' forecast budget each month or quarter can keep the metric updated and more accurate.
Forecast multiple time frames
Forecast budgets are beneficial for both short-term and long-term planning. Setting short-term and long-term forecast budgets highlights problems as they arise and allows a company to effect a change in a realistic time frame. Multiple time frames ensure a company is progressing toward its long-term goals, whether that's expansion or acquisition.
Set realistic expectations
Try to establish realistic, attainable and quantifiable forecast budget goals and create a strategic action plan that helps the organization attain its goals. Successful business growth and development can depend on realistic goals and expectations. In this way, the forecast budget is a meaningful metric of performance.
Create a contingency fund
Consider setting aside a contingency fund of at least three months to improve the company's financial stability. This can help a business protect itself against any unplanned threats. A contingency fund can meet unexpected liquidity requirements and prevent the business from losing a primary source of income, like a major client.
Related: What Is a Reserve in Accounting?
Review it regularly
Successful managers often review forecast budgets regularly to ensure that unexpected events don't disrupt business development. You can set regular review meetings with key staff to ensure that the forecast budget reflects updated metrics. This can allow a company to align management goals with staff performance.
This article is for informational purposes only and does not constitute financial advice. Consult with a licensed financial professional for any issues you may be experiencing.
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