1. Planning Is Aspirational, Whereas Forecasting Is Driven by Expectations
In some respects, this comes down to the difference between wishes and expectations. Financial planning should be based in reality, not fantasy. It’s not necessarily wishful thinking per se; financial planning is aspirational insofar as it embodies an organization’s goals and objectives. It should be realistic, and to that end, it should encompass a set of facts that support the achievement of the organization’s goals. Financial planning is about what management wants to make happen.
Forecasting, in contrast, is about what management expects will happen. It, too, is driven by data, but it also involves a degree of guesswork. Forecasts tend to rely on assumptions about what will happen, or even what will not happen. A food and beverage company, for example, might develop a forecast that predicts likely revenues and margins from the sales of coffee and tea during the coming year. As part of that forecast, the company might assume that commodity prices for coffee and tea will remain relatively stable, say within 10% of current costs.
2. Planning Is Internally Focused, Whereas Forecasting Is Often Outward-Facing
The target audience for financial planning is typically an internal one. The plan serves as a guide for future action by management, a set of guardrails within which the organization should operate. In this respect, financial planning is fundamentally a managerial tool.
Forecasting, in contrast, often serves as outward-facing communication about the state of the organization and its expected financial results given current conditions and assumptions about the future. Forecasts are essential for public companies, as they serve as critically important communications to investors or other stakeholders.
This doesn’t necessarily mean that forecasts can’t be developed strictly for internal audiences. Indeed, they also serve an important managerial function — helping to inform business leaders as to the likelihood that the company will meet its objectives. Interim sales forecasts, for example, are a staple of most organizations. By summarizing the current sales pipeline, predicting future market conditions, and factoring in promotions or other activities aimed at boosting sales, an organization can gain better visibility of its overall financial results, driven largely by top-line revenue.
3. Planning Is Comprehensive; Forecasting May Be Focused in One Area
Generally speaking, financial planning encompasses all of the functions across the entire company. It considers the interplay between inventory levels and sales revenue, or between the investment in a new technology initiative and the associated benefits, both short and long-term. A financial plan should not merely delineate expected revenue and expenses–it must be made with a view to the balance sheet as well. How much investment in fixed assets will be required? What are the expected net cash flows? Will existing sources of financing hold steady as the year unfolds?
Forecasting, in contrast, often addresses a single, focused aspect of the business. Sales forecasts are one such example. It’s common for supply chain managers to forecast demand for various products, including inventory requirements across multiple geographies. Likewise, human resources managers must often predict fluctuations in the need for labor and the availability of workers to meet that need.
Again, this is not to say that forecasts aren’t sometimes all-encompassing. In the case of a public company predicting quarterly profitability, for example, a forecast is a comprehensive document akin to a financial statement. It must address the entirety of the organization’s financial activity.
4. Planning Implies a Course of Action; Forecasting Simply Predicts What Will Happen
By its very nature, planning is intended to lead to a specific course of action. It is the result of a collaborative process that begins with strategic goal setting and proceeds toward the alignment of the organization’s objectives with the reality before it. If the strategic goal is to reach $100 million in sales within three years, then the plan needs to lay out a realistic path for achieving that number.
A thorough and collaborative financial planning process should generate considerable discussion as to how realistic the overall goal is and whether the assumptions upon which the plan is built will pass muster. In other words, financial planning should prompt participants to ask questions, challenge assumptions, and make sure management is not setting unachievable goals based on wishful thinking.
Forecasting, on the other hand, is simply about predicting what is believed will happen. Just as with financial planning, there are assumptions that must be made along the way; but with forecasting, the aim is to describe the world as it is, not as management hopes it will be. In this respect, forecasting is less susceptible to wishful thinking.
In many companies, the concepts of financial planning and forecasting are used somewhat interchangeably. Planning and forecasting have very different goals and are typically based around a different set of facts and assumptions. When you’re communicating with team members and other stakeholders, it’s helpful to be clear about the difference.
Whether you’re producing a financial plan, a comprehensive forecast, or a focused operational forecast, insightsoftware can help you do it faster and more accurately, with less effort. We offer a range of financial planning and analysis tools that can help your team access information in near real time, produce ad hoc analyses, and update data directly from their live enterprise resource planning (ERP) systems. If your organization wants to improve its capabilities in financial analysis, learn how insightsoftware can help you exercise control over your financial planning and forecasting today.
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