What's the difference between a financial plan and a financial forecast?

A financial forecast is an estimation or projection of likely future income or revenue and

expenses, while a financial plan lays out the necessary steps to generate future income and cover
future expenses. Alternatively, a financial plan can be looked at as what an individual or
company plans to do with income or revenue received.

Financial forecasting is critical for business success. To effectively manage working

capital and cash flow, a company must have a reasonable idea of how much revenue it plans to
receive over a given time period and what its necessary expenses will be over that same period of
time. Financial forecasts are commonly reviewed and revised annually as new information
regarding assets and costs becomes available.

The new data enables an individual or business to make more accurate financial
projections. It is easier for established companies that generate steady revenues to make accurate
financial forecasts than it is for new businesses or companies whose revenue is subject to
significant seasonal or cyclical fluctuations.

A financial plan is a process a company lays out, typically broken down into a step-by-
step format, for utilizing its available capital and other assets to meet its goals for growth or
profit based on a reasonable financial forecast. A financial plan can be considered synonymous
with a business plan in that it lays out what a company plans to do in terms of putting resources
to work to generate maximum possible revenues.

For an individual, a financial forecast is an estimate of his income and expenses over a
period of time. Based on that forecast, the individual can then construct a financial plan that
includes saving, investing or planning for obtaining additional income to augment his personal
finances – as well as anticipating expenditures that would deplete them.

Financial planning is a continuous process of directing and allocating financial resources

to meet strategic goals and objectives. This can be also be viewed as a single process that
encompasses both operations and financing. The operating people focuses on sales and
production while financial planners are interested on how to finance the operations. The output
from financial planning takes the form of budgets. The most widely used form of budgets is Pro
Forma or Budgeted Financial Statements. The foundation for Budgeted Financial Statements is
Detail Budgets. Detail Budgets include sales forecasts, production forecasts, and other estimates
in support of the Financial Plan. Collectively, all of these budgets are referred to as the Master
Budget.

There are six steps to the process of doing a financial plan

The beginning step :

It is determining your objectives for the plan. You do this by:

1. Quantifying specific amount goals within definite time frames and clarify any financial
goals within those parameters;

2. You will rank your objectives according to your priorities;

3. Together, we will examine these objectives in respect to a client’s available resources and
other limitations. Our key role at this stage is to assist our clients in the establishment of
their financial objectives.

The second step

It is of the financial planning process is gathering data. With our help, our clients will
complete a data survey form or questionnaire.

• Qualitative provides general information concerning a family’s goals and objectives,

lifestyle, health, and investment-risk tolerance level.

• Quantitative provide basic but specific identifying information concerning details of

family’s financial status. Examples include info about investments, cash flow, insurance
coverage's, and present liabilities or other obligations.

The third step

 It is processing and analyzing the information gathered. We will undertake a review of
the following: Our client’s financial position and current cash flow statement; a review of
existing insurance policies and other legal papers such as wills, trust agreements, and buy-sell
agreements; analyze the information to determine the strengths and weaknesses in the client’s
finances; evaluate our client’s objectives in view of available resources, and economic conditions
as they relate to future resources and cash flow for the client. It is our planning role to examine
the viable options for achieving the determined objectives. We begin here to look at the products
and strategies that may be selected for implementing the final plan.

The fourth step

It is the actual recommendation of a comprehensive financial plan for our client. This is a
time for our clients to speak up and ask questions about each strategy or product as it relates to
solutions for achieving their goals and dreams.

The fifth step

This step in the financial planning process is implementing the plan. Our client may need
help in obtaining products and in pursuing strategies identified in step four. Use of products and
services through our office is separate from the design fees and those costs and commissions will
be disclosed appropriately. Also, if need be, we will work closely with other professionals to
carry out the financial plan designed for the client.

The sixth and final step

It is monitoring the plan. Periodically we should review your plan to evaluate the
significance of any changes in federal tax, economic conditions, and available investment
techniques. If you choose to use our investment advisory services you will be encouraged to have
quarterly meetings related to your assets under management.

The financial analysis and recommendations are not intended to replace the need for
independent tax, accounting, or legal review. Individuals are advised to seek the counsel of such
licensed professionals.
Benefits of financial planning

The benefits of financial planning for the organization are

 Identifies advance actions to be taken in various areas.

 Seeks to develop number of options in various areas that can be exercised under different
conditions.  Facilitates a systematic exploration of interaction between investment and
financing decisions.

 Clarifies the links between present and future decisions.

 Forecasts what is likely to happen in future and hence helps in avoiding surprises.

 Ensures that the strategic plan of the firm is financially viable.

 Provides benchmarks against which future performance may be measured.

Financial forecasting

A financial forecast is an estimate of future financial outcomes for a company or country

(for futures and currency markets). Using historical internal accounting and sales data, in
addition to external market and economic indicators. Financial Forecasting describes the process
by which firms think about and prepare for the future.

The forecasting process provides the means for a firm to express its goals and priorities
and to ensure that they are internally consistent. It also assists the firm in identifying the asset
requirements and needs for external financing. Unlike a financial plan or a budget a financial
forecast doesn't have to be used as a planning document. Outside analysts can use a financial
forecast to estimate a company's success in the coming year

Objectives of forecasting

 To reduce cost of responding to emergencies by anticipating the future occurrences.

 Prepare to take advantage of future opportunities.

 Prepare contingency and emergency plans.

 Prepare to deal with possible outcomes

STEPS OF FORECASTING

 Establish a base year.

 Assess revenue and expenditure growth trends.

 Clearly specify underlying assumptions.

 Select a forecasting method.

 Assess the reliability and validity of the data used to determine assumptions.

 Monitor actual revenue and expenditure levels against the forecast and explain variances.

 Update the forecast based on changes.

FINANCIAL FORECASTING METHODS

Quantitative methods

1. Percentage of sales:

• Step 1 : Estimate year-by-year Sales Revenue and Expenses

• Step 2 : Estimate Levels of Investment Needs (in Assets) required meeting estimated
sales (using Financial Ratios).

• Step 3 : Estimate the Financing Needs (Liabilities)

While employing percentage of sales method, we would estimate the cash flows based on
the sales revenue

The first step is to forecast the changes in the sales revenue in the successive years.
Expenses incurring in successive period would also be estimated. These expenses include cost of
goods sold expense, administrative, expense, marketing expense, depreciation expense, and other
expenses.
 However, these revenues and expenses would be estimated on cash, rather than accrual
basis

Budgeting, Planning And Forecasting (BP&F)

Budgeting, planning and forecasting (BP&F) is a three-step strategic planning process for
determining and detailing an organization's long- and short-term financial goals. The process is
usually managed by an organization's finance department under the chief financial officer's
(CFO) guidance.

The three steps involved in BP&F include:

1. Planning outlines the company's financial direction and creates a model of expectations
for the next three to five years. Planning is often the first step in setting up a company.

2. Budgeting documents how the overall plan will be executed month to month and
typically includes estimates of revenue and expenses and expected cash flow and debt
reduction. Companies often set up their budgets at the beginning of a calendar or fiscal
year and leave room for adjustment as revenues grow or decline. Budgets are compared with
actual financial statements to calculate the variances or errors between the two.

3. Forecasting uses accumulated historical data and market conditions to predict financial
outcomes for future months or years. Aimed at helping management teams anticipate results
based on past information, forecasts can be adjusted as new information is available. In
contrast to budgeting, financial forecasting does not analyze the variance between forecasts
and actual performance.

Proper BP&F strategy is beneficial to organizations by producing competitive advantages

such as more accurate financial reporting and analytics, higher overall revenue growth and
increased predictive value.
BP&F best practices

Since effective BP&F processes bring organizations a variety of benefits, best practices
should be implemented, including:

 The BP&F process should be holistic, taking into account any correlation across all
financial information, such as financial statements and balance sheets, and KPIs.

 Reduce manual labor needed by using tools that automate BP&F processes. Manual
solutions are not optimal for growth or dynamic market conditions.

 Make BP&F a top management priority, as company growth depends on a dependable

financial model.

 Maintain clear accountability and ownership over BP&F components.

 Agree on cohesive, clear decisions surrounding strategy, expectations, objectives and

company vision.

 Create a forecast that is rolling and flexible to mimic real business cycles. This
includes performing routine planning discussions and updates.

Software and tools

Budgeting, planning and forecasting software – which can be purchased on its own or as
part of an integrated corporate performance management (CPM) system – consolidates and
centralizes companies’ financial information and automates budgeting processes. Additionally,
BP&F software documents how the overall plan will be followed month to month, specifies
expenditures and provides consistency across reports.

BP&F software helps make it easier for finance managers to produce more accurate
budgets and perform what-if scenario analysis. What-if predictions are one of the more essential
analyses IT, operations, logistics and business managers can perform as company success relies
on being able to accurately guess what will happen tomorrow.
How Do Budgeting and Financial Forecasting Differ?

Budgeting and financial forecasting are tools that companies use to establish
a plan regarding where management ideally wants to take the company (budgeting) and whether
it is actually heading in the right direction (financial forecasting). Although budgeting and
financial forecasting are often used together, distinct differences exist between the two concepts.
Budgeting quantifies the expectation of revenues that a business wants to achieve for a future
period, whereas financial forecasting estimates the number of revenues that will be achieved in a
future period.

Budgeting

A budget is an outline of expectations for what a company wants to achieve for a

particular period, usually one year. Characteristics of budgeting include:

 Estimates of revenues and expenses

 Expected cash flows

 Expected debt reduction

 A budget is compared to actual results to calculate the variances between the two figures.

Budgeting represents a company's financial position, cash flow and goals. A company's
budget is usually re-evaluated periodically, usually once per fiscal year, depending on how
management wants to update the information. Budgeting creates a baseline to compare actual
results to determine how the results vary from the expected performance.

While most budgets are created for an entire year, that is not a hard-and-fast rule. For
some companies, management may need to be flexible and allow the budget to be adjusted
throughout the year as business conditions change.
Financial Forecasting

Financial forecasting estimates a company's future financial outcomes by examining

historical data. Financial forecasting allows management teams to anticipate results based on
previous financial data. Characteristics of financial forecasting include:

 Used to determine how companies should allocate their budgets for a future period.
Unlike budgeting, financial forecasting does not analyze the variancebetween financial
forecasts and actual performance.

 Regularly updated, perhaps monthly or quarterly, when there is a change in operations,

inventory, and business plan.

 Can be both short-term and long-term. For example, a company might have quarterly
forecasts for revenue. If a customer is lost to the competition, revenue forecasts might
need to be updated.

 A management team can use financial forecasting and take immediate action based on the
forecasted data.

Financial forecasting can help a management team make adjustments to production and
inventory levels. Additionally, a long-term forecast might help a company's management team
develop its business plan.

The Bottom Line

A budget is an outline of the direction management wants to take the company. A

financial forecast is a report illustrating whether the company is reaching its budget goals and
where the company is heading in the future.

Budgeting can sometimes contain goals that may not be attainable due to changing
market conditions. If a company uses budgeting to make decisions, the budget should be flexible
and updated more frequently than one fiscal year so there is a relationship to the prevailing
market.
 Budgeting and financial forecasting should work in tandem with each other. For example,
both short-term and long-term financial forecasts could be used to help create and update a
company's budget.

Tips for a More Effective Financial Planning and Forecasting Process

Financial planning and forecasting is an important process that all organisations must
implement once a year to allocate resources and set financial targets and budgets effectively. But
not all managers look forward to financial planning and budgeting. Often, planning can be a
tedious exercise that can be time-consuming.

In preparing their budget and forecast, your department managers take care to follow the
timelines set by your Finance team. Your Finance team would then collate the information from
the different departments and compile them into Then, they will have to go back and forth just to
get the numbers right. This could take weeks or even months.

Importance of Financial Planning and Budgeting

Nevertheless, the importance of financial planning and forecasting cannot be stressed

enough. Done right, you can use financial forecasting activities to track the progress of your
initiatives and at the same time, monitor your operational numbers to drive financial results.

In a 2017 study by the Association of Accountants and Financial Professionals in

Business, 734 financial executives from high performing organisations were interviewed to
uncover what their companies do differently when it comes to financial planning.

Financial Planning Tips

Here are some financial planning and analysis (FP&A) principles from that survey, as
well as some financial management tips, that you can apply in your own organisation.

1. Standardise your data collection processes.

By implementing standardised procedures, your financial planning and budgeting

activities will be efficient, accurate, repeatable, and reliable. If your organisation requires it, you
may consider implementing automation to reduce the risk of human error in the data collection
process.

2. Know the story behind the numbers.

Your organisation should have a clear understanding of what drives the results that you
are aiming for. In particular, you should know how your operational processes impact financial
results. More than the numbers, your variance analysis should give you an idea of what’s
happening behind the scenes.

3. Take action when your departments are falling behind their goals.

As CFO, continuous improvement should be the name of your game. Your departments
should be agile and proactive; when they are falling behind their financial and operational goals,
it’s important that they take a good look at what they are doing to get back on track.

4. Hold people accountable for delivering financial and operational results.

In building a managerial culture, it would be wise to establish a culture of accountability.

For one, there should be a clear delineation of roles and responsibilities. It should also be made
clear which teams are responsible for achieving which particular financial goal. There should be
enough trust in your organisation so that each manager can report their progress or lack thereof
without fear of being penalised or blamed.

5. Monitor actual results and give incentives.

Managers should be motivated not only to hit financial goals, but also their own
operational targets. To promote accountability for each team, there should also be incentives that
are tied to your company’s performance management system.

What’s Next?

By following these best practices, your organisation can significantly reduce the time
spent on its planning and forecasting processes. When you have a clear snapshot of your
company’s financial standing with respect to your targets and goals, you will be able to make
data-driven business decisions and strategies.

Need of Financial Planning:

According to Cohen and Robbins, financial planning should:

1. Determine the financial resources required to meet the company’s operating programme;

2. Forecast the extent to which these requirements will be met by internal generation of
funds and the extent to which they will be met from external sources;

3. Develop the best plans to obtain the required external funds;

4. Establish and maintain a system of financial control governing the allocation and use of
funds;

5. Formulate programmes to provide the most effective profit-volume-cost relationships;

6. Analyse the financial results of operations;

7. Report facts to the top management and make recommendations on future operations of
the firm.

Steps in Financial Planning:

Financial planning involves the following steps:

1. Establishing Financial Objectives:

The financial objectives of a company should be clearly determined. Both short-term and
long-term objectives should be carefully prepared. The main purpose of financial planning
should be to utilise financial resources in the best possible manner. There should be an optimum
utilisation of funds. The concern should take the advantage of prevailing economic situation.

2. Formulating Financial Policies:

 The financial policies of a concern deal with procurement, administration and distribution
of business funds in a best possible way. There should be clear-cut plans of raising required
funds and their possible uses. The current and future needs for funds should be considered while
formulating financial policies.

3. Formulating Procedures:

The procedures are formed to ensure consistency of actions. The procedures follow the
formulation of policies. If a policy is to raise short-term funds from banks, then a procedure
should be laid to approach the lenders and the persons authorised to initiate such actions.

4. Providing for Flexibility:

The financial planning should ensure proper flexibility in objective, policies and
procedures so as to adjust according to changing economic situations. The changing economic
environment may offer new opportunities. The business should be able to make use of such
situations for the benefit of the concern. A rigid financial planning will not let the business use
new opportunities.

Limitations of Financial Planning:

Some of the limitations of financial planning are discussed as follows:

1. Difficulty in Forecasting:

Financial plans are prepared by taking into account the expected situations in the future.
Since, the future is always uncertain and things may not happen as these are expected, so the
utility of financial planning is limited. The reliability of financial planning is uncertain and very
much doubted.

2. Difficulty in Change:

Once a financial plan is prepared then it becomes difficult to change it. A changed
situation may demand change in financial plan but managerial personnel may not like it. Even
otherwise, assets might have been purchased and raw material and labour costs might have been
incurred. It becomes very difficult to change financial plan under such situations.

3. Problem of Co-ordination:

Financial function is the most important of all the functions. Other functions influence a
decision about financial plan. While estimating financial needs, production policy, personnel
requirements, marketing possibilities are all taken into account.

Unless there is a proper-coordination among all the functions, the preparation of a

financial plan becomes difficult. Often there is a lack of co-ordination among different functions.
Even indecision among personnel disturbs the process of financial planning.

4. Rapid Changes:

The growing mechanisation of industry is bringing rapid changes in industrial process.

The methods of production, marketing devices, consumer preferences create new demands every
time. The incorporation of new changes requires a change in financial plan every time.

Once investments are made in fixed assets then these decisions cannot be reversed. It
becomes very difficult to adjust a financial plan for incorporating fast changing situations.
Unless a financial plan helps the adoption of new techniques, its utility becomes limited.