“We have a budget. Why do we need a forecast?”
Budgets and forecasts are important pieces of a strong financial toolkit, but many people think if they have one, they don’t need the other. That couldn’t be further from the truth: You’ll get the most mileage out of a budget if you also have a forecast to guide you.
Here’s a look at their key differences and how they can work together to strengthen your firm’s financial planning.
Budget vs. Forecast
Budgeting is like your firm’s financial gameplan. It sets a detailed business plan for your income and expenses over a set period of time, usually a year. For instance, you might budget for office rent, salaries, marketing expenses, and other operational costs. A well-crafted budget helps ensure you don’t spend more than you bring in, aligning your spending with your firm’s financial goals.
I like to think of a budget as a paper roadmap, a way to decide where your firm is going (sort of like our grandparents did when they planned the family vacation).
Financial forecasting is about anticipating future trends and changes. It involves predicting future financial outcomes based on historical data and current trends. Forecasting helps you prepare for uncertainties and make informed, strategic decisions as new information becomes available.
If budgeting is a paper roadmap that you sketch ahead of time, forecasting is a GPS that adjusts with you while you’re actually on the road. Whatever roadblock might come your way – for example, if your firm anticipates an increase in client referrals or a downturn in the economy – forecasting helps you plan for these scenarios, adjusting your strategies as needed.
Key Differences Between Budgeting and Forecasting
Time Frame
Budgeting: This snapshot of your planned financial position, based on expected income and expenses, a budget typically covers a specific period, such as a fiscal year.
Forecasting: Regularly updated to reflect changes and trends, a forecast offers a dynamic, rolling view of what might happen over several months or years.
Purpose
Budgeting: Sets specific financial targets and constraints. It’s about controlling costs and staying within set financial limits.
Forecasting: Focuses on predicting financial outcomes and understanding potential deviations. It’s about real-time, strategic planning and adapting to changes in market conditions.
How Budgets and Forecasts Are Used Together
In practice, budgeting and forecasting complement each other. Here’s how they work together in the context of a small-to-mid-sized law firm:
1. Set the Budget: Every trip needs to start with a destination. A detailed annual budget that outlines your firm’s planned income and expenditures gives you an idea of where you want to go.
2. Forecast for Adjustments: Once you hit the road, your forecast allows you to compare projected and actual results. If you notice that client referrals are increasing faster than expected, you might forecast higher income and decide to allocate more funds to hire additional staff. If your pipeline is drier than expected, you might forecast lower income and consider trimming expenses to compensate – or you might push harder on your marketing efforts to make sure you hit your target.
3. Review and Adapt: A forecast won’t get you very far if you don’t regularly review it. The power of a dynamic forecast is that it starts conversations about how to get to your destination: Find more clients, trim expenses, work more efficiently by better leveraging your staff or tools.
But there’s also the possibility you need to change your destination mid-journey. If your forecast is showing that you are way off your targets, you can change course so that the rest of your year feels productive. (No one wants to chase after a target that can’t be hit.)
Tips for Productive Forecasting
1. Use modeling to create multiple forecasts: Once you have a forecast in place, one of the major benefits is your ability to model. The power of the forecast is its adaptability. We recommend creating multiple forecasts – best-case, likely, and worst-case – so you can sketch out contingency plans and be ready to act accordingly. You never want to make big decisions on the fly – especially when it concerns your staff. Forecasting gives you the structure to anticipate when you might need to make personnel decisions, for instance, if you need to grow, maintain or reduce your staff, depending on which of the scenarios play out.
2. Make forecasting a team sport: On a road trip, you probably only want one co-pilot, but when it comes to forecasting, you need a variety of perspectives. When we lead our forecasting meetings with our clients, we make sure to incorporate the most up-to-date information on things like pipeline, to ensure the highest level of accuracy in terms of sales forecast.
3. Use ‘misses’ as opportunities to learn: When you know your forecast needs to be revised down, it can be tempting to want to ignore it, in hopes that next month will show stronger financial performance. But that’s exactly when you need to look into the details and see what insights might be hiding in the ‘miss.’ If you can dial into any discrepancies, you can figure out whether you’re facing a market downturn, if you had a one-off bad month, if one of your processes needs adjusting, or if your pricing is off. A missed forecast can be a strong diagnostic tool to help get your trip back on track.
For additional help creating an effective forecast, check out our virtual CFO services for law firms or schedule a consultation below.
