Join Rudolph Rosenberg for an in-depth discussion in this video The difference between forecasting and planning, part of Financial Analysis: Making Business Projections.
Voiceover: Most people use the word forecasting and planning without making any distinction. However, there is a big difference between the two. In this course, we will be sometimes forecasting and sometimes planning, so it's very important that you understand upfront what each of those words mean. Forecasting, in the context of finance, means to estimate the future performance of your company based purely on its past performance and the factual elements available to you.
It's very much like weather forecasting which tells you what could possibly happen to the weather based on the analysis of past and current weather conditions. For example, based on past and current performance you could estimate that your business will generate $10,000 next month. That would be your forecast. Planning is diff from forecasting in the fact that it includes your aspirations in addition to what past and current factual elements are telling you.
In our previous example we had a forecast of $10,000, but your plan could be to reach $11,000 next month. Your plan for next month would be made of $10,000 that could realistically be achieved based on past and current performance and a goal of delivering $1,000 more than usual. Of course, to generate $1,000 more than what your current performance suggests, you would need to put in place new actions or promotion, for example.
In essence, forecasting is about what could realistically happen based on your past and current performance while planning also includes your aspirations for your business. Financial forecasts are usually used to estimate where the business is realistically going in the short-term, assuming that in the future, day-to-day actions will be the same as in the past. Business leaders are always looking for things they can do better or differently in order to improve their business.
Therefore, they cannot have forecasts as their goal since they rarely plan on doing the same thing in the future as in the past. Business leaders prefer financial plans as their target since it is a blend between what could realistically happen and what they will do to have an even better performance.
- Distinguish between forecasting and planning.
- Recall the pros and cons of bottom-up projection.
- Explain how a finance manager can utilize a sales pipeline in business projections.
- Describe how a company can forecast its gross margin by product.
- Identify the pros and cons of using top-down projection.
- Recognize how business plans utilize forecasts.
- Summarize how to develop a set of worst-case scenarios.