In essence, a budget is a quantified expectation for what a business wants to achieve. Its characteristics are:
- The budget is a detailed representation of the future results, financial position, and cash flows that management wants the business to achieve during a certain period of time.
- The budget may only be updated once a year, depending on how frequently senior management wants to revise information.
- The budget is compared to actual results to determine variances from expected performance.
- Management takes remedial steps to bring actual results back into line with the budget.
- The budget to actual comparison can trigger changes in performance-based compensation paid to employees.
Conversely, a forecast is an estimate of what will actually be achieved. Its characteristics are:
- The forecast is typically limited to major revenue and expense line items. There is usually no forecast for financial position, though cash flows may be forecasted.
- The forecast is updated at regular intervals, perhaps monthly or quarterly.
- The forecast may be used for short-term operational considerations, such as adjustments to staffing, inventory levels, and the production plan.
- There is no variance analysis that compares the forecast to actual results.
- Changes in the forecast do not impact performance-based compensation paid to employees.
Thus, the key difference between a budget and a forecast is that the budget is a plan for where a business wants to go, while a forecast is the indication of where it is actually going.
Realistically, the more useful of these tools is the forecast, for it gives a short-term representation of the actual circumstances in which a business finds itself. The information in a forecast can be used to take immediate action. A budget, on the other hand, may contain targets that are simply not achievable, or for which market circumstances have changed so much that it is not wise to attempt to achieve. If a budget is to be used, it should at least be updated more frequently than once a year, so that it bears some relationship to current market realities. The last point is of particular importance in a rapidly-changing market, where the assumptions used to create a budget may be rendered obsolete within a few months.
In short, a business always needs a forecast to reveal its current direction, while the use of a budget is not always necessary.