A company needs to budget and forecast its finances to understand how its financial situation will likely evolve over time. Budgeting and forecasting are both necessary, but they are very different.

Budgeting sets the financial parameters for the future, while forecasting predicts the future financial performance of a business. A financial model can help in both processes, considering a company’s past performance, current conditions, and future outlook.

Here’s a detailed overview of both processes. We also explain how a financial model can help you budget and forecast for the future.

What Is Financial Forecasting?

Financial forecasting refers to predicting future performance based on known or expected events. It does not set specific goals for a company to accomplish. Instead, it identifies the likely financial outcome of specific scenarios.

For example, a company may use financial forecasting to determine the likely impact of changes to its product line on its future profitability. It may also use forecasting to predict the likely demand for its products in different markets.

How Does Financial Forecasting Work?

Companies use current transactional data and historical trends to forecast future performance. Then, they build models to project sales, expenses, and other financials over a certain period.

They also use market and industry information to gauge the likely impact of external factors. Additionally, they can factor in the potential effects of new products, services, and other initiatives.

What Is Budgeting?

Budgeting means creating a financial plan to estimate future income and expenses in a company. A budget helps an organization allocate resources, evaluate performance, and decide future investments.

Here are five types of budgets companies commonly make:

• Static Budget: A static budget is a long-term budget that doesn’t change over time. It is best suited for businesses with predictable income and expenses.
• Master Budget: It covers all departments and includes income statements, balance sheets, and cash flow statements. It is a comprehensive view of all financial plans for the business.
• Cash Flow Budget: The cash flow budget assumes expenditures and cash inflows for a preset period.
• Financial Budget: The financial budget includes revenue and expense projections, allowing management to plan for the future.
• Operating Budget: It includes the costs associated with running the business, such as payroll, materials, and other operating expenses.

How Does Budgeting Work?

A budget can be created for any period the company wants, such as a year or quarter. The company will use past data to create a budget plan. The budget can be modified depending on company income or expenses changes.

Once a budget is created, the organization must track and monitor actual performance against the budgeted amounts. It helps the company identify any potential problems and address them accordingly.

Budgeting vs. Forecasting: How Do They Differ?

There are some key differences between forecasting and budgeting. Here are some of them.

Timeline

Budgets are generally short-term. Meanwhile, forecasts are typically used for long-term planning and estimating.

Flexibility

Budgets usually need to be adhered to and are less fluid. Forecasting is more flexible and anticipates changes or accommodates new information as it arises.

Variables

Budgets are usually based on previously known variables and data. For example, a company’s operational budget will be based on previous costs and expected expenses. Forecasting relies more on estimated data and assumptions. You may also use market data and other external factors to make forecasts.

Purpose

Budgets are used for planning and allocating resources efficiently. Meanwhile, forecasts seek to predict the future and anticipate risks.

How do Financial Models Help In Budgeting and Forecasting?

Financial models can serve as useful tools for budgeting and forecasting. They can provide a structured approach to gathering relevant data, which can be used to create comprehensive budgets and forecasts.

For example, the cash flow valuation section can forecast expected cash flows over time. Suppose a company needs to generate a budget for the upcoming fiscal year. The cash flow valuation section of the financial model can be used to forecast expected revenues, expenses, capital investments, and other cash flow over the course of the year.

They can use this information to generate a budget that considers all sources of income and expenses. Financial models can also help identify potential risks and opportunities for the budget. The sensitivity analysis section tests how changes in key variables, such as sales and costs, may affect budget results.

Startups also use financial models during the pitching and fundraising process. Investors also want to see the forecasts included in the business plan. Therefore, a comprehensive financial model can help startups deliver an attractive presentation to potential investors that include the forecasts they will likely be interested in.

Where Generic Financial Models Fail in Budgeting and Forecasting

As a startup, you might be tempted to use existing financial models to budget and forecast your future income and expenses. However, these generic models may not always be the best option.

• Lack of Flexibility: Generic financial models are not particularly flexible and may not cover your specific needs or business model. Additionally, they may not be able to adjust to the unique circumstances of your business, making it difficult to predict your future financial needs and performance accurately.
• Outdated Assumptions: Generic financial models are often based on dated assumptions of the economy and markets, which can lead to overly optimistic or pessimistic forecasts. As economic conditions change, these assumptions may no longer be applicable, or they may not be applicable to your business in the first place.
• Unnecessary Information: Since generic financial models are generic in nature, they may include details not relevant to your business. It can result in a lot of unnecessary information that takes up valuable time and resources, distracting from the more important aspects of budgeting and forecasting.

The Alternative? Get Numberly On Board

The alternative to generic financial models is customizing your own model with the help of top financial experts like Numberly. We can help you develop a customized model tailored to your business’s unique needs and circumstances, utilizing relevant assumptions.

Additionally, our model will only include the data and information you need to accurately budget and forecast, leaving out unnecessary details. At Numberly, we understand that budgeting and forecasting can be challenging for startups. We provide the expertise and tools you need to make sure your budget and forecast are as accurate as possible. Contact us today for more information.