TL;DR — budget = original performance contract; forecast = rolling best guess
Our leadership team gathered in Vermont this week to review our latest quarterly performance and spend a few days hashing out big picture trends and goals.
The agenda eventually steered toward the 2025 budget and where we thought the rest of the year would land.
This had me thinking about a key financial distinction that’s not often discussed: budgeting vs. forecasting. These tools are not the same and therefore the terms should not be used interchangeably.
First, some quick definitions:
- Budget = original set of projections used for management and team accountability
- Forecast = where you expect financial performance to land by the end of the year
These may seem like trivial distinctions, but they’re quite important…
1) The budget
It’s January and you’ve got full year financials and KPIs in hand, ready to chart the course for the upcoming year’s goals. You set a revenue target, calculate your profit goal, and determine how much you can spend to achieve it (expenses).
You determine that $1.75m sales and $200k profit are achievable.
At this point, you have a budget.
That budget is your original prediction for current year financial performance. Your sales & marketing team will plan their activities around the revenue target, each department will manage to budgeted expenses; and if it all comes together as predicted, you’ll hit your budgeted profit goal (woo).
Think of this as a performance agreement between you and the members on your team. You expect them to take the requisite actions for revenue and expenses to hit their respective targets.
Simple (not easy).
2) The forecast
It’s July and you’ve just been handed the financials through June (Q2). With 6 months left in the year, you’re eager to do some math and see what full year earnings will look like based on the current trends.
After crunching some numbers, you determine that $2m sales and $250k profit is achievable based on trends in the first half of the year.
This exercise is called forecasting.
I recommend doing this each month as new financial information rolls in, but you can re-forecast as often as you like (monthly, weekly, ad hoc, never, etc.).
It’s simply a re-calculation of where you expect to finish the year, and it works best with new information (i.e. it’s easier to re-forecast full year financials when you have 3 months of data, 6 months of data, etc.).
Note: a “forecast” is also commonly referred to as a projection, prediction, pulse, plan, or expectation.
3) How to use this
A few tips when it comes to using both budgets and forecasts:
- Set a budget at the beginning of the year and use it as a management tool with your team. As your company grows, you’ll want it to act as a performance agreement with each person or department.
- Your budget is an internal company document. Don’t expect to be 100% accurate. Especially if you’re doing it for the first time. You’ll get better with practice.
- As actual financial results roll in each month, you should compare them against the budget to measure how everyone did (known as “budget vs. actuals“). Did the sales team hit their target? Where and why did you miss the budget? Did your operations team exceed their budgeted spend? This is how you level up the team and the company.
- Re-forecast monthly (or quarterly if new to this). Why do you need to regularly update your financial performance? A host of reasons: the bank is asking to measure debt covenants, you’re trying to plan cash flow for the rest of the year, several new employees are joining the team, you want to know how big a distribution you can take at yearend, etc.
Our team sets the budget at the beginning of the year plus a mid-year refresh. And we re-forecast at least monthly, if not more frequently, because we’re scaling quickly and we have bank debt. If you’re a small business with minimal amounts of debt, then you can probably do this just a few times a year.
Here’s a simple cheat sheet to help you navigate these tools:
