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Budgeting and forecasting: A comprehensive guide

       
  • Planning
  • Thought Leadership

Budgeting and forecasting: A comprehensive guide

Budgeting and forecasting: A comprehensive guide

Remember those days when you go on a family trip abroad? All those long hours put into the preparations, the long debates, discussions, planning, etc.

What if you arrive late and miss the connecting train/flight? You have a plan B
What if it pours heavily just before you want to go trekking? You have a plan B

What exactly is happening here? You plan all the places you want to visit and activities you want to do on the trip. Then, you forecast all that could go wrong or deviate from the original plan and create a contingency plan. 

For all of this, you have a budget, and at different points of the trip, you keep a tab of the available budget and make adjustments to your spending to complete the trip and return home safely and happily.

Corporate forecasting and budgeting, too, are somewhat similar. The finance team create an objective/goal that it wants to achieve. The team then plans on all the different activities to reach the goal and prepares a budget for each. It then also forecasts any deviations that could arise in the future by doing a scenario planning exercise and prepares contingency plans. 

The finance team then allocates a budget for each activity to achieve the goal. As the team executes the activities to reach their common goal, the finance team keeps track of the spending and makes corrections/adjustments to the budget to ensure the team achieves the goal within the set budget.

While this is a very crude way to understand corporate budgeting and forecasting, let us dive deeper and understand all there is to corporate budgeting and forecasting.
 

What is budgeting?

According to the Corporate Finance Institute, ‘Budgeting is the tactical implementation of a business plan.’ To achieve the goals of a business’s strategic plan, the finance team creates a detailed descriptive roadmap that sets measures and indicators of performance. The team can then make changes to ensure the business meets the desired goals.

Since a business is far more complex than a family tour plan, different budgets must be created for different business activities. What are the different kinds of budgets? Let us find out now.
 

Different kinds of budgets

Budgets can be of different types based on different categories. Budgets can be classified based on function, i.e. finance budget, marketing budget, sales budget, etc. Budgets can also be classified based on frequency or time period. These are annual budgets, quarterly budgets, monthly budgets, etc. Now, there is another category of budgets, based on the business activities.

You have just now read that each business activity has a budget.  Therefore, to understand the different types of budgets, let us first understand the different types of activities conducted in a business. 
 

All the business activities broadly fall into three categories highlighted in the Cash Flow Statement. These are:

1. Operating activities (Operating budget)

2. Investing activities (Capital budget)

3. Financing activities (Cash budget)
 

All activities, such as sales, marketing, purchases of raw materials and goods, partnerships, product development, and other day-to-day operations, fall under operating activities. The operating budget includes the budget allocated for the business's operating activities, such as salaries, sales expenditures, marketing expenses, etc.

All the activities related to buying and selling assets are included in the investing activities. The budget for such activities, which includes purchases of large assets such as property, equipment, or IT systems that create a major impact on the organisation’s cash flow, is the capital budget. While the assets purchased could vary from industry to industry, the outlay is from the capital budget.

Financing activities are those related to raising funds, finding new sources of additional cash, etc. The budget helps to track and manage the company’s cash flow effectively by assessing whether additional capital is required, whether the company needs to raise money, or if there is excess capital, is the cash budget.
 

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So far, we have seen what budgeting is and the different kinds of budgets. Let us now examine the detailed steps of the budgeting process
 

Budgeting process


Whatever the different kinds of budgets, the budgeting process is more or less similar. Here are the various steps in the budgeting process:

1. Establish goals and objectives

2. Gather data and information

3. Revenue forecasting

4. Expense estimation

5. Budget preparation

6. Budget monitoring and control

Let us briefly look at what each one means.
 

1. Establish goals and objectives

The initial step of budgeting requires establishing precise, strategic goals and objectives for the organisation. Depending on the time period for which the budget is being prepared, these could be annual, quarterly, or monthly goals.

This process involves thoroughly analysing past performance and finalising realistic, achievable, yet ambitious goals. It goes beyond setting mere financial targets. The goals need to align with the company's overarching mission and vision.
 

2. Gather data and information

After establishing clear goals and objectives, the finance team initiates an extensive data-gathering process. This includes collecting internal data like historical financial records and departmental budgets, as well as external data such as market trends and economic forecasts.

This stage is vital for building a robust foundation for precise forecasting.

Additionally, input from different departments guarantees that the budget addresses the requirements of the entire organisation, not just the financial objectives set by the top management.
 

3. Revenue forecasting

Utilising the abundant data, the finance team employs intricate financial models to forecast forthcoming revenues. These models assess diverse scenarios, spanning from the optimistic to the pessimistic, factoring in global economic trends, competitive shifts, and alterations in consumer behaviour.

This pivotal stage ensures the establishment of pragmatic revenue objectives, striking a balance between ambition and achievability. Thus, it offers a metric to gauge the company's performance.

By incorporating a spectrum of potential outcomes, these forecasts provide valuable insights for informed decision-making, guiding strategic initiatives and resource allocation effectively.
 

4. Expense estimation

Concurrently with revenue forecasting, the finance team undertakes the estimation of organisational expenses necessary to realise the projected revenues. This entails meticulous analysis of fixed and variable costs, direct and indirect expenditures, and capital outlays.

Assessing each department's specific requirements, the team identifies potential cost-saving measures and evaluates investments essential for long-term growth, such as technology enhancements or market expansion initiatives.

This meticulous process ensures the budget's comprehensiveness, encompassing all facets of business operations, and remains congruent with the strategic objectives outlined in the initial step.
 

5. Budget preparation

Following revenue forecasting and expense estimation, the finance team consolidates these insights into a comprehensive budget. This process entails distributing resources among different departments and projects, prioritizing expenditures based on strategic significance and projected returns, and establishing expenditure thresholds to uphold financial prudence.

Serving as a guiding framework, the budget directs spending choices and resource allocation throughout the budgeting cycle, striking a balance between adaptability and structure to uphold overarching strategic goals. Additionally, it facilitates performance evaluation and accountability by providing a basis for measuring actual results against planned targets
 

6. Budget monitoring and control

The ultimate phase of the budgeting process involves ongoing monitoring and control. As the fiscal year unfolds, the finance team diligently assesses actual expenditures against the budget, scrutinising variances and probing their underlying causes.

This continuous vigilance empowers the organisation to swiftly address unforeseen hurdles, such as economic downturns or abrupt market shifts, by recalibrating spending and reallocating resources as needed. 

Regular budget evaluations further instill accountability among departmental leaders, ensuring expenditure alignment with the company’s strategic objectives and financial benchmarks. This agile budget management approach safeguards the organisation's trajectory toward its goals amidst internal and external fluctuations. 

These are the various steps in the corporate budgeting process. Such a complicated process with highly sophisticated exercises such as scenario planning, rolling forecasts, and the like can be daunting for the finance teams to do manually. Therefore, there is a need for tools, platforms, and technologies to aid in the corporate budgeting process. So the logical question then is, what are the various technologies that are available for the FP&A manager and his team to use?

Before we get into that, there is one other area to look at. So far, we have seen the definition of budgeting, the different kinds of budgets, and the steps involved in budgeting. From the above, one must have noticed that forecasting, be it revenue or expense forecasting, is a key subset of budgeting, which in turn is a subset of corporate planning. Let us learn a little about forecasting before looking at the different technologies available to modern finance teams for budgeting and forecasting accurately and efficiently.
 

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What is the role of forecasting in the budgeting process?

Forecasting is an important part of the budgeting process and helps businesses identify opportunities for growth and anticipate financial challenges.

To understand this better, let us take the example of driving a car. What is the most important part of driving a car? Keeping the steering wheel in control.

But you cannot drive a car only by looking at the steering wheel. One has to look ahead at the windshield and move the steering wheel in accordance with the road ahead. Likewise, a business looks into the future to forecast revenue and prepare the budget accordingly.

That is not all. One also must look into the rear and side view mirrors to avoid collisions with oncoming traffic while driving forward. Likewise, businesses use historical data to forecast expense trends and include such expenses in the budget.

Businesses can proactively allocate resources and mitigate risks by accurately predicting revenue streams and expense trends. Additionally, robust forecasting enables organisations to adapt swiftly to evolving market dynamics, seize emerging opportunities, and stay ahead of competitors.

Ultimately, effective forecasting empowers businesses to optimise their financial strategies and drive sustainable growth in a rapidly changing economic landscape.

Now that we have learnt that forecasting is very important for the budgeting process, let us now look at the different methods of forecasting.
 

Different methods of forecasting

Broadly, there are two types of forecasting:

  1. Quantitative methods of forecasting
  2. Qualitative methods of forecasting
     

Quantitative methods of forecasting

Most often businesses use quantitative methods of forecasting to ensure higher accuracy of forecasts. There are different quantitative methods based on the complexity of the forecasts.
 

Straight line forecast

This method can be used for micro and small businesses that are just getting started. It does not require complex modelling. At the same time, it does not account for factors such as market fluctuations, supply chain issues, etc.

The straight-line method in forecasting assumes that a company's historical growth rate will persist. It predicts future revenue by multiplying the previous year's revenue by the growth rate. For instance, if last year's growth rate was 12 percent, it's presumed to remain at 12 percent in the next year.
 

Moving averages forecast

Trends play a crucial role in forecasting. This method considers trends in its calculations by taking the average of several previous periods to forecast the future. 

Since this involves examining a business’s high or low demands more closely, it’s often beneficial for short-term forecasting for monthly or quarterly budgets. For example, you can use it to forecast next month’s sales by averaging the previous quarter.

To increase the accuracy of the forecast, one can always add weights to the periods with more emphasis given to the recent periods.
 

Simple/multiple linear regression forecast

This method considers the impact of various factors/variables on forecasted revenue, improving forecast accuracy and complexity. For example, the method will consider the impact of changes in market demand, availability of raw materials, global economic outlook, global supply chain conditions, past performance, etc., while calculating the forecasted revenue.

If only one factor is being considered, it is called simple linear regression. If the number of factors is multiple, it is considered multiple linear regression.

Business leaders often turn to multiple linear regression forecast methods to get their future projected revenues.
 

Qualitative methods of forecasting

Numbers alone do not tell the whole story. Hence, businesses also rely on qualitative methods to complement their quantitative forecasting methods.
 

Market research

This method is often used by new businesses that do not have historical data. It helps business leaders obtain a holistic market view based on competition, fluctuating conditions, and consumer patterns.

This research is conducted by distributing consumer surveys, or telephonic conversation with consumers/prospect consumers.

This can be done in-house or outsourced to experts to do the same for you.
 

Delphi method

In the Delphi method, experts assess market conditions to forecast a company's performance. A facilitator distributes questionnaires to experts seeking their forecasts based on experience. These inputs are compiled and sent to other experts for feedback. This process is repeated again and again until a consensus is achieved. This iterative process helps refine predictions and mitigate individual biases for more accurate forecasts.
 

We now understand the role of forecasting in the budgeting process and the different types of forecasting. From this knowledge, we can notice that doing all of the budgeting and forecasting manually can lead to multiple errors and inaccuracies. It is for this reason that finance teams use technology to aid in the budgeting and forecasting processes.

 

What are the various budgeting and forecasting software available in the market?


Multiple tools, platforms, and technologies can address different levels of complexity and automation of forecasting. Finance teams need to consider the capabilities of the tech, the business need, and the complexity of the forecasts they are dealing with, before purchasing. Here is a brief look at a few options:
 

Spreadsheets


Spreadsheets are the most loved and most commonly used tool for financial forecasting and budgeting. Finance teams typically leverage spreadsheet functionalities such as data analysis tools, mathematical functions, scenario modelling capabilities, sensitivity analysis, scenario planning, and what-if analysis to project revenues under different scenarios and assess the impact of different variables on revenue forecasts.

What finance teams often overlook are the drawbacks of using spreadsheets. While spreadsheets allow for driver-based planning and scenario modelling, conducting comprehensive scenario analysis with multiple variables and assumptions can be cumbersome and time-consuming, limiting the accuracy of revenue forecasts. 

Also, spreadsheets do not provide the depth of analysis required for such complex forecasting. For example, if finance teams want to understand the effect of multiple key drivers like pricing, marketing expenditures, hiring, and promotions on revenues in quarterly/monthly time periods, it might not be easy to get that level of in-depth analysis from spreadsheets.

Even with respect to forecasting expenses, spreadsheets cannot handle the complexity of the estimation models with increased variables and data volume. Also, spreadsheets will not be able to access real-time data for factors such as inflation rates, industry benchmarks, etc., resulting in scope for inefficiency.

In addition, manual allocation to various departments and manual categorising expenses based on department, project or cost centres cannot allow for detailed and granular analysis, leading to inaccuracies in expense estimates.

Hence, while spreadsheets are the go-to option for many businesses, as the complexity of business increases, they need to move beyond spreadsheets to more intelligent and capable solutions.
 

Legacy software solutions


Many solutions were designed in the early 2000s during the dot-com rise period. These solutions were absolutely ground-breaking and disruptive at the time, but with the passage of time, they have become old and obsolete. Even though the solutions make changes to their software and try to be at pace with modern solutions, the rigidity, high dependence on technical teams, and code-heavy aspects of legacy solutions make it difficult to work with them in today’s fast-paced business.

Today, businesses need software/technological solutions that bring agility and improve business responsiveness. Also, due to the high costs of ownership, most small and medium-sized businesses avoid such solutions.
 

New-age cloud solutions


The next category is the new age, modern, cloud-based budgeting and forecasting solutions. There are many such solutions in the market today. The finance teams need to carefully weigh the pros and cons of these solutions, rank them, and then decide on the best option for the business. What works for one business may not work for another. This is due to the different natures and needs of businesses. Each business must look for a solution that meets all its specific needs to the best.

What makes these solutions better than legacy solutions or spreadsheets? The answer lies in ‘time’ and ‘accuracy’. The time of highly qualified experts in the finance teams is very valuable for the company. The finance leader wants his/her experts to work on value-added activities and not on manual, laborious work like data gathering, coding, data segregation, collaborating over emails, etc. Also, doing all such tasks manually can lead to errors due to the size of the data being handled.

This is where modern solutions come to help with their in-built AI capabilities. Most modern solutions automate mundane manual tasks, increasing the speed and accuracy of the results.

One such modern solution that is leading the way in innovation and customer-centricity is JustPerform. Relying on JustPerform brings speed, accuracy, and agility to your forecasts by leveraging its built-in artificial intelligence (AI) and machine learning (ML) algorithms.

How does this help? The built-in AI and ML capabilities remove bias from the assumptions that drive the forecasts. Predictive modeling also eliminates manual intervention. JustPerform also brings nimbleness and agility to the process by rapidly changing the assumptions to see the impact on forecasts and different scenarios.

Also, finance users can navigate the budgeting process seamlessly with finance-focused process flows, workflows and a guided interface for frictionless budgeting experience.
 

This is exactly what was experienced by Pan Pacific Hospitality Group, a Singapore-based global hospitality company. JustPerform transformed its budgeting & forecasting process. 

Its capabilities helped to shorten the budgeting cycles and improved the business responsiveness. 

In short, it improves accuracy and confidence in budgets and forecasts and helps management make faster, timelier, and better-informed business decisions.

Accuracy and efficiency are not just about the technology or tool being used but the process and best practices followed. Stay tuned to this space to learn about the best practices in FP&A and budgeting & forecasting in our future blogs.

 

Conclusion


We have seen what exactly budgeting and forecasting are, how forecasting plays a key role in the budgeting process, different methods of forecasting, the available technologies for finance teams to use for budgeting and forecasting, and how modern solutions make life easier for finance teams with in-built AI and ML capabilities, guided workflows, and a process-driven approach to budgeting and forecasting.

The current VUCA business environment is even more volatile, uncertain, complex, and ambiguous, with new forces, such as geopolitics, climate change, shifts in global economic powers, etc., impacting business like never before. In such times, agility and flexibility are key for FP&A managers. Always staying on top of industry trends and best practices and renovating the practice of budgeting and forecasting is essential for survival of the business.
 

Corporate budgeting and forecasting are critical for achieving business goals, involving detailed planning, allocating resources, and continuous monitoring.

Budgeting is the tactical implementation of a business plan, laying out a detailed roadmap with performance measures to achieve strategic goals.

Accurate forecasting allows businesses to allocate resources proactively, mitigate risks, adapt to market changes, seize emerging opportunities, and stay ahead of competitors. Effective forecasting empowers businesses to optimize financial strategies and drive sustainable growth in a rapidly changing economic landscape.

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