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The planning, budgeting and forecasting (PBF) process is a finance department function that is time consuming, often misunderstood, and generally disliked. So, why is it needed and what is it supposed to accomplish? The answer varies depending on who you are talking to and to what aspect of PBF you are referring to.
The PBF process is actually three unique sets of activities often grouped together:
Planning
Planning provides the overall venue and process for stating the direction and financial objectives of an organization. Most companies put together an annual plan that is part of the larger strategic plan of the company, usually covering three to five years. This is where the senior executives lay out their vision for what is possible.
The overall planning picture commonly is comprised of two or three main components:
1. Strategic Plans: Set overall long-range goals and objectives. Often, both are qualitative and quantitative in nature.2. Long-Range Plans: Typically set financial targets over a three to10-year horizon—the quantified financial plan for the strategic plan above.3. Annual Plans: This is the first year of the long-range plan and provides the high level targets to guide the budget.
Budgeting
Budgeting supplies the execution path for the plans with a detailed, operational and short-term view. Whereas planning provides “what is possible,” budgets outline “what is expected” from the business, based on the approved annual plan.
The budgeting process is broadly focused on the following major components:
1. Sales/Gross Margin Budgets2. Capital Expenditure Budgets3. Headcount Budgets4. Operating Expense Budgets.
Forecasting
Forecasts typically use actual performance data to project the remainder of the current year’s performance (rolling forecasts are the same concept but reset expectations for some predefined future period, usually12 to18 months). Forecasts are focused on what is happening from a revenue and income statement perspective.
There are three general forecasting methodologies:
1. Tops-Down Forecasting: Primarily focused on current demand and operational conditions translated into revenue predictions.2. Bottoms-Up Forecasting: Rely on business managers to enter current and specific line item details per the revenue budget.3. Hybrid: A combination of the above two methodologies, e.g., a tops-down focus coupled with a bottoms-up proportional allocation.
As you can see, the processes are related but they are also distinctly different. Recognizing this is part of understanding the overall purpose behind the general process and what types of improvement opportunities exist. In fact, there are significant points of view and multiple studies that outline all the various issues with the overall PBF process; however, few have tried to answer the most important question: What is the main purpose of the PBF process?
Proper financial planning demonstrates the effects of the operational plan components on cash flow and overall financial position. Key characteristics of a financial plan include:
1. Ability to easily produce a complete set of fully-integrated, relationship-based financial statements that provide the comprehensive picture of financial objectives2. Ability to test the sensitivity of various condition assumptions across the full financials3. Ability to quickly and accurately gauge the working capital impacts of the operating activities.
Three PBF process components defined:
1. Strategic Planning: A component of the planning use case in the original PBF breakdown. The strategic planning process quantifies the vision of the company and helps management determines what is possible. Information is at a very high level, is driver and scenario-focused, incorporates full financial statement impacts and produces the long-range plan. Analysis is most powerful here when external drivers are included at the higher levels (i.e. Long-Range or Strategic Plan levels) and the lower levels (i.e. Budgets or Operational Plans) are integrated to shape the outputs.2. Financial Planning: Has a role in building the budget and the forecast and in general terms, is the top-down version of the budget. The output from the financial plan is the input to the operational plan. Scenario analysis, stress testing, working capital analysis and re-forecasting of the full financial statements are the key use cases.3. Operational Planning: The B in PBF and focuses on what is expected while highlighting the accountability in the detailed cost structure. The operational plan is also the basis for the allocation of the top-down financial plans and is at the lowest level of detail.
Why is there generally so little focus on improved financial planning and/or having a financial planning process integrated with the overall PBF process? The answer is that financial planning is difficult and requires unique insight on how the enterprise generates cash flow. Adding to the complexity, most packaged software applications help to gain efficiencies in the PBF components but are not addressing the financial planning attributes. And maintaining the required financial relationships within a spreadsheet-centric environment is incredibly cumbersome with a high risk of error.
The ideal PBF system incorporates financial planning and will:
1. Ensure that the Strategic and/or Long-range Plans focus on integrated scenario analysis. The ability to stress-test plans and run multiple financial and operational what-if cases will provide unique insight to what is possible as well as better forecast what is expected.2. Effectively balance top-down and bottom-up points of view and forecasting methodologies. Top-down projections apply a more centralized view and can include many influencing factors including market data, economic indicators and general product and customer trends. Bottom-up projections are accumulated from many contributors and are more inward-focused.3. Produce more than a great income statement. The financial impacts of the operational plans are best analyzed with integrated balance sheet and cash flow statements.
So, what is the primary point of the planning, budgeting and forecasting process?
An optimized PBF process should provide an effective system of checks and balances on possible and expected performance from top to bottom and from immediate to long-term. It should also let management know in advance how much capital they will need and when they will need it.
Planning is the phase, in terms of finance, In which the overall financial direction of the organization is being set, It generally is for long term i.e3-5 years or more
Budgeting is the activity performed to quantify the planning for the year normally, can be done for longer terms though, Budgeting takes into the consideration the overall planning in context business model and quantify it
Forecasting is an activity which takes into account the historical data, depending on the trends of which the future (months, year) are predicted, It differs from budget in various aspects such as budgeting normally covers the overall business model while the forecasting is done for single items such as volumes, revenues, expenses costs etc
Planning is the direction of a work or project like how, where, when, who, financing etc.
Budget is numeric description of a work/project plan.
Forecasting is evaluation of plan, budget & actual work for future planning.
Planning Planning provides the the direction and financial objectives of an organization.
it consist the following phases:-1. Strategic Plans:2. Long-Range Plans3. Annual Plans
Budgeting
Budgeting sport the plans with a detailed, complete set of Budget/proforma financial Statements it consist of
1)operating Budget.2) Capital Budget
Forecasting
it is the estimation of future outcomes ( the next coming years results)
Planning is basically setting the goals or target could be short or long term. Forecasting is measuring the strength to achieve these goals by reviewing the SWOT (strength, weakness, opportunities and threats) and TWOS (threats, weakness, opportunities and strength) matrix. Finally utilized the funds to achieve these goals within define Budget.
