Forecasts and budgets

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Preparing a budget can help a business plan its finances over a medium to long term period such as 1,3 or 5 years. It may be difficult to predict how things may unfold but the process of creating the budget forces you to think through all the uncertainties and establish some major assumptions as well as the factors that impact on those assumptions. So the idea is to create an expectation of how the financial plan will most likely turn out based on the information available.

A good budget will allow for some of the major assumptions to be adjusted and show the impact of making such adjustments, to better understand the sensitivity of the model to the assumptions.

Once you have a budget, you can then compare your actual business performance against the budget and it is very useful to analyse where there are variances form the budget and the reason for those.

Medium to large businesses will have formalised processes around preparing an annual budget, presenting it to the board of directors and having the budget approved. This is especially relevant where the performance measured against the budget is used in setting remuneration and targets.

Forecasts can be used interchangeably with budgets but can refer to any prediction over any period and would generally not refer to an approved annual budget. So a business may have an approved formal budget for the year and then during the financial year create various forecasts based on updated information.