Budgeting and Forecasting are two important constituents of managerial decision making process. Even though both of these functions are distinct and are not same but their use and their dependency on each other make them inseparable and thus many confuse the two as same and use them interchangeably. Let’s understand the technical difference between these two.
Budgeting is a process of monetizing the plan and giving the plan an understandable structure. Budgeting provides us an outlook about the expected end results based on what has been planned or established. Most of the time budgets are based on standard costs and revenues which management establish before the task is executed. So, we can say that budgeting is a process of monetizing standard plan.
Forecast on the other hand is the expected end results based on the latest experience and circumstances at hand. Forecast enables management to predict the results by adjusting their existing plans according to the latest information. As circumstances are seldom static and thus can change over time and things might be different from what they were initially planned. Therefore, forecast helps management to adjust its plan accordingly and it is forecasting that pushes management to adjust the standards for a relevant range of time based on latest information.
Students should not confuse revising of budget with forecasting. As the reason of revision is forecasting and not the revision itself.
Let’s understand the difference with an example.
At the start of a financial period, company expected to produce 200,000 units at the end of first quarter. Information gathered at the end of first month in the quarter revealed that labour’s learning rate was faster than expected and thus they have became more efficient and effective. If process keeps its current pace as experienced in first month then it is expected that at the end of quarter output will be 230,000.
In this example 200,000 is the budgeted figure. This is the amount which management established before starting production. During the production process however based on month end information it is predicted that output will be 230,000. This is the forecast amount which has been ‘forecasted’ based on the latest information. And now this forecast will be used to prepare a revised budget to see its effects on different aspects.
Now a days budgets are prepared on run-time basis and thus incorporating the effect almost absolutely when things change from standards. Therefore, dividing the two process now is a hard thing to do as they are closely connected with each other.