Budget vs. Forecast: Key Differences You Need to Know

For businesses, it’s critical to have an accurate budget and an accurate forecast. This is especially true of small businesses where a single accounting oversight can leave a business owner strapped for cash or, worse, having to let an employee go.

Are you scratching your head right now? If you have always thought of your business budget and your business forecast as one and the same, you’re not alone. Forecasts and budgets are two different, yet equally important, financial animals. Here's what you need to know.

What's the difference between a budget vs. a forecast?

The difference between a budget and a forecast is that a business's budget is a plan that its management sets to determine how they want to grow the company. A budget doesn't predict what will happen but sets a plan for what the business owner wants to happen. A forecast, on the other hand, estimates the future financial progress and outcomes of the business. Management teams use historical data and growth rates to forecast what the business's financials will look like in the future.

Business budgets 101

A budget sums up a business's goals for the upcoming year. Think of it as a plan of action over a certain amount of time. In a budget, costs and revenue are input into a spreadsheet.

When it comes to creating a budget, remember that a budget should:

• Consider the expected demand for products and services.

• Take a company’s highest priorities and arrange the appropriate resources to cover those priorities.

• Show potential problems early enough that a company can take action.

• Have a baseline to show against the actual results.

Different types of budgets include:

• Sales budget.

• Production budget.

• Marketing budget.

• Project budget.

Why should you create a budget?

A budget is a key management tool for small business owners. When you think of budgets vs. forecasts, think of a budget as a plan: It helps you map out where you want to be in the next one, two, or five years.

You set your business budget with the help of your forecast (after all, you don't want to budget for financial growth that won't really happen based on historical performance), execute on your plan and compare your actual progress against what you planned for in your business budget.

Setting and sticking to a budget is a great way to make sure that your team is always investing in the things you've decided will make you successful and make real progress to that goal.

Forecasts 101

Forecasts are more abstract in the sense that they are working from historical data to project or predict what might happen in the future. They also look at current and future possibilities as a way of safeguarding a business.

Like we mentioned above, a budget uses these predictions in order to fiscally prepare should they happen. Following a budget is an obligation for a small business, while they are not obligated to follow a forecast. People divide forecasting into two different types:

• Judgment forecasting—Judgment forecasting utilizes only your intuition and experience to surmise what might happen in the near future. It is best used when there is no historical data to work from like for new product launches.

• Quantitative forecasting—This type of forecasting uses large amounts of data to derive the most likely situations that a small business might face. It relies on repeated patterns in order to come to its conclusions.

Using both judgment forecasting and quantitative forecasting allows a small business to get the most accurate take on what the fiscal year might bring.

We also recommended that you use at least two, ideally three forecasts. These different forecasts should account for the best possible growth, the worst possible growth and "okay" growth. Looking at this can help you understand just how fast you're growing.

Why should you use a forecast?

As we mentioned above, you don't want to waste time budgeting for financial and business growth that will never really happen. A forecast helps you ground your predictions in reality by taking past financial growth and projecting that growth in the future.

A forecast also helps you react to change in a way that a budget does not. For instance, if your business typically has a slow month, a forecast will show you that in the numbers. Or, if you have forecasted your growth based on retaining a large client and that client for some reason is no longer using your services, you can quickly adjust your forecast to compensate for the loss.

This article originally appeared on Fundera, a subsidiary of NerdWallet.