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Budgeting versus Forecasting

What is 'budgeting' and 'forecasting?

One of the problems about using terms such as 'budgeting' and 'forecasting', is that there is no generally accepted definition of what they mean.  Budgeting is often referred to an annual exercise where the organisation's resources gets spread among the departments, while forecasting is about predicting the future. In recent times, forecasting is seen by some as a replacement for budgeting, and the mechanism through which continuous planning can be achieved. Given my understanding of 'budgeting' and 'forecasting' I would have to disagree - but it may be that I have misunderstood what is implied by these terms. This makes it very confusing for organisations wanting to adopt a 'best practice' approach as they too may misunderstand what is meant. For example, making a statement such as 'replace your outdated budgeting process with rolling forecasts' could imply that budgeting is bad while forecasting is all you need. Which could be both right and wrong depending on how your understand what is meant by each. Now I've got you totally confused, let me explain how I sees the difference between planning, budgeting and forecasting.
In my world, planning is an umbrella term that describes a management process for evaluating a variety of scenarios concerning the future. The aim of planning is to decide on how best to allocate resources for a given business environment, that will help an organization achieve its purpose. Those resources may come from the operation of the business, as an investment from a third party, or as a loan to be paid back at some future date. To manage the future requires knowledge on:
  • What does the future look like of we continue as we are today. This is sometimes referred to as 'business as usual'. Typically this future can only be predicted a few months ahead with any degree of accuracy. It is built 'bottom-up' and based on reality. It has nothing to do with the targets that were originally set and has everything to do with what is genuinely expected to happen. To me, this version of the future is a FORECAST.
  • What could the future look like if we were operating as though we were achieving our purpose. This will look at market growth, and the position we feel we ought to have over the next few years. This view recognises that something has to change and cannot happen though organic growth as dictated through 'business as usual'. The output is typically a high level P&L and a set of business process goals to be achieved. To me, this version is the TARGET.
  • What do we have to do to bridge the gap between 'business as usual' and the 'target' versions. This will require changes to the way in which the business operates. It could include new products, services or entering new markets. It could also include radical changes to existing business processes. However, all will consume resources, have specific business improvement goals, and milestones through which implementation can be tracked. I call these STRATEGIC INITIATIVES.
For me BUDGETING is the aggregation of resources for 'business as usual' and those that are needed for the chosen strategic initiatives.  That's it - but it does mean the budget needs to be split.  From a timing point of view, there is no reason why 'Business as usual' couldn't be generated on a rolling 6 - 12 month basis and regularly challenged as to whether the activities are delivering value for money.  However, initiatives are not the preserve of annual or quarterly processes. They should occur as and when required.  For further details see my blog on continuous planning. In some ways it doesn't matter what the names are for the processes I've just described. But it's vital that they are performed and that everyone involved knows exactly what the terms mean.