Budgeting and financial forecasting are probably the two most important financial processes of any business. While they are often linked together, many companies choose to follow one more than the other.
This guide will help you to determine the differences between the two and explain why a growing number of decision-makers and financial experts are questioning the usefulness of the traditional financial budgets.
A budget is a financial outline of what a business thinks will happen over a certain period of time. A standard budget is static and will incorporate insights about the organization’s income, outcomes, cash flow and overall financial position, and is normally set for the company’s fiscal year.
Based on the size of the business, there might be a budgeting procedure—regularly done later in the year—with contribution from the organization’s profit generating, which should be overseen by your head of finances.
Traditionally business’ forecast is a higher-level projection of the key revenue items and overall expenses of the business. Forecasts can be done over long-term and short-term time horizons. These can be done from top-down or bottom-up. However, recently some forward-looking businesses started to create more accurate lower level forecasts, that are generated once a month or so.
A standard budget is not flexible, in fact, they are barriers to fast business response to change. Rolling forecasts allow for financial flexibility by enabling resource shift where needed on a constant basis.
Companies that recognise the need for financial agility are able to respond faster to changing market conditions and focus on continuous cost adjustment. This eliminates the time wasted on analysing the budget and focuses on more productive continues planning and adaptions required.
Normally a budget is used as a management tool to run the business, where actual financial results are compared to the financial budgets and then analysed. In many companies, the budget is used as a factor in awarding performance-based compensation.
Problem is that business behaviour altering financial budgets might not be driving employees in the right direction, as meeting targets at any costs might raise the expenses and drive up other costs, which is indeed – counterproductive.
With the budget process, you have to put a lot of historically based predictions to estimate the future budget. However, once a couple of months of the fiscal year go by, the budget might be completely irrelevant. While rolling forecasts can be done as often as every month and can be maintained going out 12 months, 15 months or 18 months into the future.
Additionally, rolling forecasts provide an opportunity to estimate the potential outcomes based on the current business market or one could create multiple forecasts that account for a variety of business scenarios.
A report from PwC’s Financial Services Institute also argues for eliminating the annual budget and replacing it with a rolling-forecast process. The report says budgeting processes cost an average of $12 million a year for a company with over $10 billion in revenue and that for 60 percent of companies the annual budget takes longer than three months.
Forecasts, on the other hand, can be generated in-house and bigger organisations have a variety of tools and software to choose from to make creating forecasts very easy.
Since managers from sales and operations are often the closest to what is really happening, keeping them in the process adds more realistic approach. While this is possible with financial budgets, forecasts allow you to involve these people in the process even more. Some software, like ProForecast, offers the benefit of easy collaboration with your team members, where they can have input to their own forecasts or input to the existing one. Team input and collaboration often lead to better business spending and overall more focused team environment.
Those are some strong reasons to rethink budgeting. What do you think? Is budgeting still worth the time and money it takes?