Budgets, Forecasts, and Projections…oh my!
When I was a young CFO and had just completed my first transaction with a Private Equity firm, I recall having discussions with the Operating Partner about the differences between the budget, the forecast, and the projections.
I realized that I had been using them, somewhat interchangeably, without really giving thought to the specific purpose and methods of each model.
I recall being embarrassed.
Perhaps I can spare someone else the small embarrassment. 🙂
Read on to understand the definitions, purpose, and characteristics of all three and how I have used them.
Budget:
Definition: A budget is a detailed financial plan that quantifies future expectations and actions relative to acquiring and using resources. It’s typically set for a fixed period, usually a one year at a time.
Purpose: Primarily used for planning and control. It represents a business’s financial position, cash flow, and goals over a specific period.
Characteristics: Fixed, based on historical data, often used as a control tool to assess performance against set targets and to hold stakeholders accountable.
Forecast:
Definition: A forecast is an estimate of future financial outcomes for a company or country. Unlike a budget, which is a planned outcome, a forecast is typically a prediction based on current conditions and expected future trends.
Purpose: Used for anticipating outcomes and trends. Forecasts are frequently updated as new data becomes available. This data consists of both internal and external information.
Characteristics: More flexible and dynamic than a budget, often revised regularly, reflects current market conditions and operational performance.
Projections:
Definition: Projections are forward-looking statements that are based on a set of assumptions about future events. They can be a part of both budgeting and forecasting but are more speculative. The top-down method is used more often for projections than for budgeting or forecasting, where the bottoms up approach should be used.
Purpose: Used for exploring “what if” scenarios and understanding the impact of various strategic decisions under different assumptions.
Characteristics: Typically, more about exploring various scenarios than predicting future outcomes, highly dependent on the assumptions made.
In summary, think of it like this:
A Budget is a plan for where a business wants to go.
A Forecast indicates where it is actually going.
Projections explore various hypothetical scenarios based on different assumptions.
In practice, I have become accustomed to utilizing all three. The bigger the company you’re with, the more important appropriately using all three can be.
However, when push comes to shove, a rolling 12-month forward forecast will probably be the most useful tool you and your company can utilize to guide you. This is because it is the best indication of what is actually going to happen and should be relatively dynamic with a monthly update. I find it is usually best to include an update to the rolling forecast for the rolling 12 months with each monthly close process.
During the monthly reporting cycle, it is also important to perform variance analysis between actual results and the original budget and forecast, respectively. This will help you learn what you did correctly, and what you might need to correct in the future.
Lastly, where and when possible, it is best to prepare a complete set of financials (i.e., Income Statement, Balance Sheet, and Cash Flow Statement) for each method.
Now that you perhaps better understand the purpose of each model, let Tyche Advisors help you get started! Click here to do so.