AccountingTools - Questions & Answers

What is the difference between a budget and a forecast?

Thursday, March 28, 2013 at 9:48AM

Steven Bragg in Budgeting

In essence, a budget is a quantified expectation for what a business wants to achieve. Its
characteristics are:

The budget is a detailed representation of the future results, financial position, and cash flows
that management wants the business to achieve during a certain period of time.
The budget may only be updated once a year, depending on how frequently senior management
wants to revise information.
The budget is compared to actual results to determine variances from expected performance.
Management takes remedial steps to bring actual results back into line with the budget.
The budget to actual comparison can trigger changes in performance-based compensation paid
to employees.

Conversely, a forecast is an estimate of what will actually be achieved. Its characteristics are:

The forecast is typically limited to major revenue and expense line items. There is usually no
forecast for financial position, though cash flows may be forecasted.
The forecast is updated at regular intervals, perhaps monthly or quarterly.
The forecast may be used for short-term operational considerations, such as adjustments to
staffing, inventory levels, and the production plan.
There is no variance analysis that compares the forecast to actual results.
Changes in the forecast do not impact performance-based compensation paid to employees.

Thus, the key difference between a budget and a forecast is that the budget is a plan for where a
business wants to go, while a forecast is the indication of where it is actually going.

Realistically, the more useful of these tools is the forecast, for it gives a short-term representation of
the actual circumstances in which a business finds itself. The information in a forecast can be used
to take immediate action. A budget, on the other hand, may contain targets that are simply not
achievable, or for which market circumstances have changed so much that it is not wise to attempt
to achieve. If a budget is to be used, it should at least be updated more frequently than once a year,
so that it bears some relationship to current market realities. The last point is of particular
importance in a rapidly-changing market, where the assumptions used to create a budget may be
rendered obsolete within a few months.

In short, a business always needs a forecast to reveal its current direction, while the use of a budget
is not always necessary.

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