Planning is a crucial function for business leaders and managers, regardless of their company’s size or industry. Budgets, forecasts, and projections are integral components of planning, and we hear constant reference to these terms in relation to past and future performance. Too often however, these terms are being used interchangeably or are being confused, and businesses who do so, run the risk of falling short on their desired outcomes.
Let’s clarify things, starting with budgets. Budgets are prepared on a periodic basis (usually once per year and tied to the company’s fiscal year) and represent a plan for expected revenue and expenses (and cash flows). This sets the baseline at a detailed level of how the company plans to operate for the year ahead. Once set, the budget does not change. On a monthly basis, actual performance is compared to the budget and variances are analyzed.
Next, we have forecasts. If a budget is where the company plans to go, the forecast is an estimate of where the company is actually going. Forecasts are predictions of what will happen in the future. They reflect the most recent expectations of revenue and expenses based on the latest information available (i.e., historic results, trends, etc). While budgets are static, forecasts are dynamic and can be done on a rolling basis (say monthly or quarterly). Forecasts should be compared to budget as they can help the company make important decisions to course correct, such as reducing expenses to meet their budget.
Finally, we have projections. If a forecast is an estimate of where the company is actually going, a projection is an estimate of where they company might go should they take certain courses of action. Projections are based on ‘what if’ scenarios and look at expected results under various hypothetical conditions to inform decision making. For instance, a projection may analyze the anticipated revenue and expenses for a company over the course of a year (or more) if they were to undertake a particular investment, introduce a new product, or a change in pricing strategy.
In summary, budgeting is based on where we plan to go; forecasting is where we think we’re actually going; and projections are where we think we’ll go if we assume certain changes. Understanding these planning tools and leveraging them in your business can make all the difference in achieving desired outcomes and avoiding undesired ones.
