Any good business owner knows that keeping track of their financials is crucial to success - whether it's tracking profits and losses, or planning ahead for the next business period.
Unfortunately, it can often be difficult to know or understand which metrics to track, or which methods or technologies are best suited for financial matters.
In these modern times where circumstances can change in the blink of an eye, debates have started around whether budgeting or forecasting is the right way to go for businesses.
Another factor is the evolution of technology and what we can do with it - so what is the correct answer when asking if budgeting or forecasting is the best method for your business to use?
We compared budgeting and forecasting processes, so you can identify which method is more effective and productive for your company.
What's the difference between forecasting and budgeting?
When you first encounter the term forecasting, you might assume it is just a synonym for budgeting. However, budgets and forecasts are two different ways to plan, and differentiating between two is a good place to start.
What is a budget?
A budget is a complete and detailed aggregation of how the organisation foresees the performance level of the business, regarding results, cash flows, and financial positioning for a particular time period, usually for the year ahead.
What is forecasting?
On the other hand, forecasting estimates what will actually be achieved by your organisation. A forecast typically focuses on major revenue and expense line items, rather than financial position (but cash flows might be identified). Forecasting involves regular updates, whether you choose to do so monthly or quarterly.
How should my business utilise budgets and forecasts?
Now that we've defined the two terms, we can start discussing the different uses for budgeting and forecasting:
How budgets are used
Budgeting typically happens once a year and results in a set strategy that's usually updated annually, depending how often management wants to revisit the data. Budget contributors compare actual results to projected figures, so they can pinpoint any variances in performance and put together the next year’s plan.
Depending on how the fiscal year unfolds, managers might tweak the strategy and the execution to get back on track in terms of actual results. The projections to actual comparison can translate to changes to performance-based compensation for team members.
How forecasting is used
You can use forecasting for short-term operational adjustments and considerations, like inventory, production plans, sales performance, and/or staffing. A forecast doesn’t usually involve an evaluation of variances between what was predicted and the actual results, but can be utilised to plan how to allocate your budgets for a future period.
A key difference between forecasting and budgeting is that any alterations in forecasting don’t impact performance-based compensation for staff.
Is budgeting or forecasting better for my business?
It's best practice for businesses to use both methods, as they complement each other. But in some cases, your budget can become outdated very quickly.
Take for example the last two years, where unprecedented changes to the world have led to supply chain delays, massive surges in demand for certain products, and unexpected rises and falls in revenue for almost any organisation. This has especially affected businesses.
So whilst budgeting plans for where a company would like to go, in terms of intention and destination, forecasting will illustrate where a business is actually going.
The benefits of forecasting mean that due to the frequency with which it evaluates the state of the business, you can use the data to act immediately if needed. For example, a business may use forecasting to predict the volume of sales for a new product, and thus make the decision whether to sell it or not.
Additionally, budgeting may consist of objectives that are hard, if not impossible, to achieve, particularly as the marketplace changes all the time and can take a business in a different direction.
It's becoming clearer that businesses may find forecasting more useful, especially during unpredictable times like now.
What can help me with my budgeting and forecasting?
Without having software or an app that can create budgets or forecasts, it's a very manual procedure that’s prone to human error.
Rather than turning to accounting software, businesses should consider enterprise resource planning (ERP) software. An ERP gives businesses the whole picture, rather than just financial records.
Decisions can be made quicker with the up-to-date information that an ERP provides - rather than having to take silos of information and then create a composite view from it, which takes time and makes it easy to miss opportunities.
A few ERP functions related to budgeting and forecasting that businesses should look for include:
- Scenario-based budgeting - many ERPs only allow for one budget or plan, but a good ERP will let you create unlimited scenarios that you can then review throughout fiscal periods to compare results and then use them to build more accurate forecasts from;
- Cost centres or business unit dimensions - this allows you to "slice and dice" various areas of your business. So you can not only allocate a cost across the whole business, but you can also allocate a cost to a particular area. So for example, allocating a particular communications cost to the warehousing team whilst allocating a different cost to the marketing team that may need a larger budget;
- Material requirements planning (MRP) - this is the ERP's ability to look back at your sales and inventory history and use an algorithm to calculate what stock you should hold for a given planning horizon. In other words, given how often you place an order for your stock, what level of stock should you ideally hold until the next order arrives? MRP takes what you realistically believe that your minimum and maximum requirements should be, and suggests where you should be looking to maintain your inventory levels; and
- Compatible ecosystem - whilst many productivity functions come straight out of the box, there are some that don't. You should consider the ecosystem surrounding your ERP software and whether there are many compatible add-ons that you may need later down the road. Some ERP vendors have massive ecosystems that will allow you to add to your ERP easily and at low cost.
Not all ERPs have the above features, and it's important for businesses to carefully consider the available market in order to make a wise choice.
The right ERP will provide you with accurate and trustworthy information that can help you make more informed decisions and take your business to the next level - as well as give you back hours of your time that you previously spent on spreadsheets.
Take your business further by optimising your financial and business processes
If you're a business owner that's ready to grow your business and invest in better planning and financial strategies, it might be time to look into how SAP Business One can help you streamline and optimise your financial processes.
Our team of experts has helped small to medium businesses plan for success for decades, and we'd welcome the chance to discuss how we can assist your business as well. Start a conversation with one of our friendly team members today.
This article is an update to our previous post on budgets and forecasting.
