Although they may seem similar, the three phases of financial management — planning, budgeting, and forecasting — are significantly different and yet highly interdependent.
Successful financial executives are somehow able to achieve, year in and year out, the best allocation of resources for their company based on a whole host of considerations. Some of these considerations include:
- How much growth the company expects, needs, or wants
- Market trends and events impacting revenues, costs, and available market share
- State of the company’s balance sheet
- Strengths and weaknesses in tech, people, geography, or other success factors
- Potential game changers like a key innovation or acquisition
In each case the relevant information needs to be identified, captured, continually updated, understood, and then acted on over an appropriate timeframe — which can be anywhere from hours to years. Ideally, these actions demonstrate tactical proficiency, embody sound strategies, and achieve well-chosen objectives. This is not a case of “fire and forget.” These three phases of financial management — objectives, strategies, and actions — although different, must somehow be connected. The glue is planning, budgeting, and forecasting — performed in sync to ensure the best outcomes possible given the company’s current circumstances and future prospects. The fact is, you can’t budget well without a plan or plan well without a forecast. Likewise, your forecast will probably be poor if not based on a plausible budget (or several) rather than on “off the cuff” numbers.
Getting the whole cycle right means getting each of these three phases right, separately and together. Which also means knowing how they are different.
Planning Is Different than Budgeting
Although these two terms are closely linked, they are not the same. Plans come in generally two forms — strategic plans and operational plans — both of which typically cover timeframes longer than budgets and, also unlike budgets, are explicitly linked to desired outcomes. Like its name implies, a strategic plan says what you are trying to achieve in the next three to five years and in general the kinds of initiatives you are going to pursue in order to make those things happen. These include the activities you will undertake, the changes to the organization you will have to make, people you will have to hire, and the associated expenditures you will have to make and from where you expect to receive the money for those expenditures.
An operational plan extends out one to three years and includes the same kinds of things as a strategic plan but includes more of them and in much more specific detail. So, instead of a general plan for the whole company, the operational plan might include an operational plan from each department, so a marketing plan, a sales plan, a manufacturing plan, and so on — covering the planned objectives, activities, and related expenses for each department.
A budget usually covers just one year and includes each expense category, which in turn are broken down by quarter and month. The budget is derived from the “bottom-up” requests of the individual departments, based on their operational plans, and also based on the “top-down” financial targets set by senior management. The budget obviously reflects the objectives of the various plans, but in a budget these objectives are implied, not stated. Generally, when you look at a budget you are looking at a spreadsheet of planned expenses where the top row cells are the labels for months, quarters, and year and the left column cells are labels for expense categories, items, subtotals, and totals. Although you cannot say that budgets are entirely meaningless without their underlying strategic and operational plans, it would be very hard to make a case for such budgets or to say why you should not simply add, subtract, or moved money between cells.
Where Forecasting Fits
A forecast is part aspiration and part inspiration — a picture at what you want to happen and what you think you can happen based on historical outcomes, market trends, acceptable risks, and so forth. It is a fiscal year’s projection of revenue broken down by year, half-year, quarter, month, and (in some cases) even week. Since revenue forecasts are about future sales, the sales budget is obviously a key ingredient of a forecast. But so are the budgets and plans of other departments whose activities also impact revenue, such as customer service or even finance (say. if it plans to offer discounts to customers who pay invoices quickly). A rolling forecast is a new forecast generated every period (like monthly or quarterly) that extends out four to six quarters and is based on results to date.
Here then is the takeaway: A forecast without good budgeting is a recipe for disaster — likewise a budget without a good plan to back it up. And so is a “plan” without a good forecast.