It has been colloquially stated that anything that is agreed by a committee is a Plan, whereas the goals and targets set by the Board directors constitutes the Budget, and an optimistic consensus by the organisation’s senior management becomes a Forecast.
In reality, it is much more complex than that, although many of the processes can be quite similar and, in this article, I’m going to break-down the differences between the activities of planning, budgeting, and forecasting and look at each in a little more detail . For this, it is helpful to consider the differences between financial planning and forecasting, the Budget and a business plan. Operational planning involves greater emphasis upon sequencing and timing of events.
What is a Business Plan?
Planning is the strategic evaluation of capabilities, resources and market conditions to enable growth and/or survival of an organisation for the foreseeable future. Typically, business plans will extend for the next 2-3 years, although certain industries may seek longer term planning over 5–25-year cycles. Indeed, significant projects may have a lifetime plan, e.g., nuclear plant construction 100+ year plans.
The objective of a Plan, is to quantify the opportunities that should arise based upon current trends, taking account of anticipated future changes in technologies, circumstances, or personal preferences.
The Plan, of necessity, has to make multiple assumptions and predictions of events that have yet to happen. Consequently, whilst the Plan may become an essential ‘blueprint’ for business borrowing and investment, it cannot be considered as a precise prediction. Simply, it is the most likely eventual outcome of the business operations, provided that there are no significant alterations to assumptions.
Adopted Plans are frequently the potential position that is derived from a collection of ‘best case’ and ‘worst case’ scenario’s which are weighted according to the given possibilities of each occurring.
Plans are summaries of headline events throughout the planning period rather than detailed revenue and cost predictions. Revenue growth predictions, and ‘costs as a percentage of sales’ alongside likely capital and borrowing requirements are key elements, rather than full evaluation of debits/credits.
Planning software needs to embrace techniques for multiple scenario comparison and/or evaluation, plus commentaries and referencing of external data sources, upon which planning assumptions are based.
Leading software vendors today offer integrated planning solutions which can be updated based upon Actuals that have occurred, alongside latest trends and assessments of future markets and business viability. Accordingly, planning software should be simple to implement, easy to create, and fast to update. In other words, it should be agile.
The Plan, plus any future amendments, underpins all future budgets and forecasts that the business may create and is usually generated centrally, whilst being owned by the Board of the organisation.
How to create a Budget?
There can be many distinct and separate approaches towards the creation of the Budget, and it can be useful to understand the purpose of the document, within your organisation, in order to choose which is most suitable. Does the budget represent ‘performance and achievement targets’ against which bonuses and compensation packages may be determined if, and when, goals are exceeded?
The budget should be a collaborative document that indicates the levels of activity and contribution that are being made by individual entities, regions, departments and cost centres of an organisation. Budgeting periods usually align with the organisations statutory reporting year-ends and cover the future 12 months. Although certain manufacturing units may budget each separate production cycle, with the over-riding annual 12-month budget including relevant portions of these production cycles.
Zero-based Budgeting, evaluates projected costs and incomes with reference to business operations, creating all line items considered necessary to fulfil the next 12 months, as guided by a Business Plan.
Detailed examination of both past and current circumstances is required in order to compile data. Individual Budget holders effectively ‘bid for funding’ in order to meet commitments that are given. Budget reviewers need to ensure that assumptions are realistic and affordable using a ‘sharp pencil’.
Driver-based Budgeting makes use of definable and known drivers of business activity, i.e. number of staff and proposed pay grades; or units sold at various price-points, alongside manufacturing costs. This methodology often leads to the expression that “the Budget has greater detail than the Actuals”. Although, such commentary ignores non-financial (ledger) data that is maintained by an organisation.
Budgeting software needs to embrace techniques for not only recording the individual ‘drivers’, but also for the multiple and often complex calculations that can be required in order to quantify effects of changes upon revenues and costs, i.e., weather conditions and footfall as related to in-store retail.
The objective of Annual Budgets is to represent a 12-month view of the organisation’s Business Plan. Budget-holders are responsible for the performance of their units against the predicted results and therefore not only should accept ownership of the numbers, but also be instrumental in compilation.
Where senior management require more aggressive revenue predictions and greater cost controls, then these should be negotiated and agreed with individual Budget Holders as likely and achievable.
Past-performance Budgeting is a methodology that looks at past achievement (actual results) and uplifts for anticipated revenue generation, whilst at the same time applies given costs constraints. Whilst many seasonal businesses would struggle if such routines were adopted, certain organisations can (and do) reasonably predict outcomes on this basis. This can be a rapid way to collate a Budget.
Budget preparation can be extended over several weeks or months, dependent upon the number of steps that are involved, reviews and authorisations, as well as the precision that is required. It should be remembered that Budget is an attempt to “be approximately right, rather than precisely wrong!”
Clearly, accurate collection of an organisations Actuals data is essential to enable realistic Budgeting and comparison of targets to prior results. Comparison of Budgeting vs Forecasting methodologies reveals distinct differences between the granularity of data collected and the time taken to complete.
The Beyond Budgeting Round Table (BBRT) was established over ten years ago with a vision to find mechanisms that could replace budgeting and help to make organisations more adaptive to change.
How to Prepare a Forecast?
Forecasts are a ‘latest best estimate’ of the outcomes for an organisation based upon the current circumstances (order book) and future expectations (pipe-line) plus any exceptional situations that can be foreseen (tariffs, etc.). Forecasts tend to be used by internal management in order to gauge ongoing performance, as against a Budget which may be used to determine compensation packages.
Unlike a Plan or Budget which might be prepared as a standalone report, any Forecast will invariably consist of a mixture of Actuals (periods-to-date) and estimates (remaining periods of the forecast). Forecasts may be prepared to simply reflect updates for the current Budget period, or any extended duration. Whereas traditionally, organisations would have prepared quarterly-basis forecasts, today, most commonly an organisation will create an integrated Rolling Forecast, on a monthly-basis, that reflects periods-to-date (within a financial year) plus the future 12-18 months of anticipated activity. The purpose being such reports being to enable projections of cashflow and borrowing requirements.
The global Coronavirus Covid-19 pandemic has clearly demonstrated the need for all businesses to be aware of accurate cashflow requirements with an ability to quickly reforecast as circumstances alter.
Forecasts can therefore be viewed as ‘snapshots’ of information that are based upon management opinion of initiatives and likely events, without needing to delve into a depth of detail that could delay rapid or regular assessment.
Forecasting software needs to embrace multi-user functionality to enable scenario versioning and end-user commentaries in addition to trend projections and multiple and often complex calculations, manual inputs and projections alongside automated Actuals data reporting and cashflow integrations.
Essential to any budgeting, financial planning or forecasting activity is the ability to easily compile and report upon the consolidated Actuals results, to ensure consistent measurement and evaluation of variances to expectations, and to enable explanation/guidance for future improvement actions. Budgets take time to complete and determine overall corporate “goals”, whereas forecasts need to be compiled quickly, in order to highlight those areas of success, for further exploitation, as well as matters of concern, to enable corrective actions to be implemented to improve performance.
The table below offers a comparison of major distinctions between Budgets, Plans and Forecasts in relation to business requirements and entities:
LSA Solutions consider that today’s leading software vendors offer competitive Solutions that provide not only the required tools to enable profiling of forecast costs and revenues, but also integration of capital and spending to ensure accurate predictions of resource allocations and resulting cashflows.
Choosing the right software for your individual situation and systems may not always be clear however, which is where experienced advisors can add-value to evaluation and selection of the most appropriate software vendor for your particular financial consolidation and reporting requirements.
If you’d like help with improving your budgeting, planning, and forecasting processes, or would like to have an independent review to assist with choosing the right software solution for your organisation, please make contact with us and tell us more about your specific requirements and challenges.