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Financial Forecasts vs. Projections: 3 Essential Differences

insightsoftware -
July 21, 2023

insightsoftware is a global provider of reporting, analytics, and performance management solutions, empowering organizations to unlock business data and transform the way finance and data teams operate.

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Financial Forecast vs. Projection In a Nutshell: Projections outline financial outcomes based on what might possibly happen, whereas forecasts describe financial outcomes based on what you expect actually will happen, given current conditions, plans, and intentions.

Even among seasoned financial professionals who generally should know better, the terms “financial forecast” and “financial projection” are often used interchangeably. There are, however, some subtle but very important differences between the two expressions. For some insight into those nuances, it’s helpful to begin with the definitions established by the American Institute of Certified Public Accountants (AICPA):

The AICPA defines both terms as “prospective financial statements that present, to the best of the responsible party’s knowledge and belief, an entity’s expected financial position, results of operations, and cash flows.” So far so good, but from there, the definitions of these two terms begin to diverge.

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Financial Forecasts vs. Projections

A forecast, according to the AICPA, “is based on the responsible party’s assumptions reflecting the conditions it expects to exist and the course of action it expects to take.” A projection in contrast, “is sometimes prepared to present one or more hypothetical courses of action for evaluation.”

Projections outline financial outcomes based on what might possibly happen (in theory), whereas forecasts describe financial outcomes based on what you expect actually will happen, given current conditions, plans, and intentions. That has powerful implications in terms of the process for creating these analyses, the audience that uses them, and the types of decisions that are affected by them.

Let’s consider a few examples. Imagine that the CEO of your distribution company asks for an analysis of what might happen if the firm were to expand its market coverage to a new country or region. That would presumably precipitate some discussions about the number of new locations, the expected volume of increased revenue, staffing requirements, capital investments needed, and any other related revenue and operating expenses. Because this is a theoretical scenario, an exploration of something that might possibly happen, the resulting financial analysis would be deemed a “projection.”

Now consider a slightly different situation, in which the company has already made a firm decision to expand. Based on all of the same information (including the latest market data and economic reports), you develop a detailed analysis of what the company should expect in terms of revenue and expenses, capital investments, and cash flow. This time, the analysis is based on actual plans and conditions as they are known today. In this case, your analysis would be deemed a “forecast.”

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Both forecasts and projections are forward-looking statements; they both amount to predictions that management is making about future financial results. The difference is whether those predictions are based on theoretical conditions and actions, or on the best available information that aligns with a clearly intended course of action.

Note that both of these terms are different from “budgets.” While projections are predictions of what management expects might happen and forecasts are predictions of what management expects will happen, budgets are an expression of what management hopes to make happen. Because budgets often serve as targets for performance management, they do not necessarily align fully with forecasts either.

Key Differences between Financial Forecasts and Projections

So what are some key differences between forecasts and projections? Let’s explore those in further detail:

1. Assumptions (and Rigor)

The first difference between projections and forecasts, of course, has to do with the assumptions that go into making them. Forecasts require a higher level of rigor because, by definition, they may be relied upon as predictions of what is expected to occur. They imply that to the best knowledge of management, each forecast represents something approximating expected actual financial results.

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Projections, in contrast, allow for virtually unlimited flexibility as to assumptions, provided that those assumptions are made clear to the people who are relying on the information presented, of course.

2. Timeframes

Although projections and forecasts are not necessarily strictly limited as to the timeframes they represent, forecasts tend to focus on shorter-term expectations. After all, the further out you extend a forecast in time, the less likely it is to be accurate. Forecasts are frequently presented that aim to predict quarterly or annual results, but rarely do they extend much beyond a one-year timeframe.

Projections, in contrast, may address either short-term or long-term scenarios. Looking into the future beyond a one-year horizon, it can be difficult to predict with much accuracy what demand might look like, which products might be in play, how the competitive dynamics facing the company might evolve, or what the overall economic climate will be.

Although it is entirely possible to build a longer-term forecast based on all known variables and the current intentions of management, the likelihood of such long-term forecasts being accurate decreases as the time horizon increases.

3. How You Use the Information

You often develop forecasts as market-facing analyses, intended to communicate likely outcomes to investors, lenders, stock market analysts, and other interested observers. Forecasts tell the world what a company’s management expects will come to pass. You develop  forecasts with a certain level of rigor, such that management can show how it is mathematically possible to achieve the results published in the forecast.

Projections, on the other hand, are generally intended for internal use. You often develop them to help answer a host of different “what if” questions from company management. Projections tell a story of what might happen as a result of one or another strategic decision, or they predict (as best as might be possible) how changing economic conditions, supply chain disruptions, or technological changes might impact the organization.

In many circles, it might seem reasonable to use the terms forecast and projection interchangeably; but when you’re dealing with the people who rely on this information to make critical business decisions, it’s important to be precise.

Whether you’re producing a forecast or a projection, insightsoftware can help you do it faster and more accurately, with less effort. We offer a range of financial planning and analysis tools that help finance teams access information in near real time, produce ad hoc analyses, and update their 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 today.

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