What is budget projection? (Definition, importance and tips)

Budget projection is a valuable business tool that helps companies and organisations make informed financial decisions. If you're preparing a budget projection for a business, knowing and understanding what it is and why it's important is crucial. This way, you can prepare an effective budget projection that helps the business grow and succeed. In this article, we answer the question 'What is budget projection?', explain why it's important and provide detailed steps on how to prepare one.

What is budget projection?

Answering 'What is budget projection?' means taking a closer look at the process and why businesses use it. Budget projection refers to the process of predicting the future revenues and expenses for a business, organisation or company. Businesses perform budget projections to estimate a company's short and long-term future financial results. They use qualitative and quantitative data to perform rigorous analyses of all available financial data.

Using this data, individuals project the company's overall financial capabilities. People often use budget projection interchangeably with financial projection, forecasting and budgeting. While these terms have subtle differences, they all determine and map an organisation's short- and long-term financial goals.

Related: How to make financial projections: steps and an example

Why is budget projection important?

Budget projection is vital for businesses, companies and organisations because they're able to do the following:

• update plans and forecasts in response to opportunities and threats

• plan and predict cash flows

• create and implement a sound planning, budgeting and forecasting process

• establish more accurate analytics and financial reports

• reduce errors, save time and promote collaboration

• strengthen the links between financial and operational plans

• track performance against targets and more accurately manage sales pipelines

• deliver reliable, timely plans, forecasts and contingency plans

• provide evidence of a company's trajectory to lending institutions and potential investors

• anticipate potential problems such as when rapid growth causes cash flow shortages or changes in projection

• improve collaboration and communication among plan contributors

• inform stakeholders and executives about where to invest

Related: Budget vs forecast: differences and steps to forecast budget

How to prepare a budget projection

Here's how to prepare a budget projection in four steps:

1. Get prepared

The first step to creating a budget projection is preparation. This means preparing your expectations, expenses and assumptions to create a common understanding of the company's financial goals and process. During the preparation phase, do the following:

Set your expectations

Setting expectations for your budget is crucial to tying your budget projection to your revenue. Whether you plan to spend £100k or £150k, have some expectations of what you plan to get in return. For example, if the business plans to spend £50k this year, it can expect to generate £250k in the New Year. Depending on the company's goals, this approach puts the business in a better financial position with a healthier balance sheet and a more data-driven path to financial growth.

Organise your expenses

After setting your expectations, lay out your current expenses. This includes fixed, variable, one-time and recurring expenses for the business. For companies with multiple departments, it's essential to organise the expenses of each department. You can use accounting tools such as Wave or QuickBooks to organise your expenses.

Related: How to track business expenses efficiently: useful tip

Define your assumptions

Once you've organised your expenses, set your assumptions. Ensure any assumptions you make are factual and based on data and logic. For instance, if you're trying to project your Facebook Ad budget for the year, base your projections on past performance or expert advice instead of what the company hopes to achieve. When defining your assumptions, answer the following questions:

• What's the timeline for the projection?

• What does your revenue forecast look like?

• What goal is the projection meeting?

• Do you expect your expenses to change throughout the year?

• What are the revenue and expenditure categories?

2. Perform analysis

After preparing your expectations, expenses and assumptions, perform an analysis of all available financial data to determine the company's overall budget projection. When performing an analysis, do the following:

Gather information

Budget projections use both qualitative and quantitative data, so gather this information before conducting the analysis. Data can be anything from historical and statistical data to insight from expert individuals. Collecting all available financial data is vital as it allows for more nuanced and accurate budget projections, so don't overlook this step.

Perform analysis

Once you've gathered all the relevant data, you can perform the analysis to determine the projection. During the analysis, look at previous historical data and current economic data. Factors that help with the analysis process include:

• patterns and trends

• cycles

• outliers

• relationships

Method selection

Companies use numerous budget projection methods to predict their future revenue and expenses. What you choose varies depending on the purpose of the projection. Some methods provide more accurate projections while others provide basic, simpler data. The three most common budget projection methods companies use are extrapolation, hybrid and regression.

Related: 4 common types of forecasting methods (with examples)

3. Implement the projection

After performing the analysis and selecting a method, make the projection. A common practice when making budget projections is to create multiple scenarios. Modelling different scenarios for your budget projection keeps you prepared for any challenges you may face. It's usually advisable to have at least three scenarios for your projections:

• Base scenario: This outlines your projection if everything goes according to plan, meaning you meet your expectations and don't go under or over your budget.

• Upside scenario: This outlines your budget projection if the company over-performs. For example, some departments may be under the budget, which gives you more money in your budget to allocate elsewhere.

• Downside scenario: This outlines your budget projection if the company doesn't generate as much revenue as you expected or planned. It's crucial as it gives you a contingency plan for your budget.

4. Complete evaluation

Once you've developed your budget projection, don't stop there. Keep evaluating your projection regularly to update it. Every month that passes, you have new financial data to base your assumptions on. Use this new information to update your projection, make adjustments accordingly and stay on top of your financial plan. Setting and forgetting your budget projection can have adverse effects on the business. This is why checking the projection quarterly or monthly against your actuals is vital to see how things stack up.

Tips for preparing budget projections

Here are some useful tips to help you prepare budget projections:

Use budgeting software, tools and applications

Financial and budgeting software, tools and applications make the budget projection process simpler and easier for businesses. They allow for more flexible and responsive financial management. They also allow businesses to track expenses, build complete financial models, input complex financial data and forecast revenue and expense. Find the right budget projection tool for the business and use it to predict the company's future expenses and revenues. Ensure the tool allows you to make adjustments and tweaks to your projections to update it accordingly.

Make sure the budget is realistic

It's easy to get over ambitious and set high expectations for your budget, but this isn't advisable. You're more likely to overspend or underspend and make uninformed financial decisions that adversely affect the company's growth. Setting realistic budgets ensures you make confident financial decisions and save money for future investments and expansion. It also makes your budget projections more accurate, providing concrete goals against which you can measure your success.

Related: How to create a project budget template (with definition)

Start with clean data

Budget projections rely heavily on clean and accurate financial data to provide accurate findings. Use clean data for your projection. As a general rule, start with a well-reconciled and locked period to prevent inaccuracies and mishaps. The goal is to ensure the input is reliable so that the output is good.

Create short and long-term forecasts

Budget projections yield the greatest benefits when businesses use them for both short-term and long-term planning. The short-term projections are part of the long-term projections, allowing companies to highlight challenges as they arise and follow through quickly with solutions. This way, problems don't escalate further or get out of control. Create budget projections for a year (short-term) and two to five years (long-term). Some companies even create monthly and weekly projections.

Plan for various scenarios

When creating your budget projection, plan for various scenarios. This gives you an idea of some of the obstacles the business may face that can adversely affect its initial budget projection. Review external economic and market trends that may negatively impact the business and factor them into your projection.

Please note that none of the companies, institutions or organisations mentioned in this article are affiliated with Indeed.