Budgeting vs Forecasting: Which Is Better?

Budgeting and forecasting are essential tools for managing finances and ensuring that you are on track to achieve your financial goals. Whether you are running a business or managing your personal finances, budgeting and forecasting can help you make informed decisions about spending, savings, and investments.

In this quick guide to budgeting and forecasting, we will cover the basics of budgeting and forecasting, as well as provide tips and strategies for creating effective budgets and forecasts. You should get a good idea of which one is right for you: a budget, or a forecast. 

What is Budgeting?

Budgeting is the process of creating a short-term plan based on current income and expenses. Budgets are not for planning because they are intended to apply to a specific period, usually one month. After the current month, a new budget is formulated for the next month without looking to the past or the future. A budget can help you:

• Track your spending: By creating a budget, you can see exactly where your money is going each month.
• Get an understanding of your discretionary spending. A budget can help you determine if expenses are reasonable or necessary and inform if you will have money left over at the end of the month.
• Identify areas for improvement: By analyzing your budget, you can identify areas where you can cut back on spending and save more money.

How to Create a Budget

Creating a budget is a relatively straightforward process. Here are the steps to follow:

Step 1: Determine Your Income

Start by determining your total income for the month. This should include your salary, any bonuses or commissions, and any other sources of income.

Step 2: List Your Expenses

Next, list all of your expenses for the month. This should include fixed expenses like rent or mortgage payments, utilities, and insurance, as well as variable expenses like groceries, entertainment, and clothing.

Step 3: Categorize Your Expenses

Once you have listed all of your expenses, categorize them into essential and non-essential expenses. Essential expenses are those that you must pay each month, while non-essential expenses are things that you could live without if you needed to.

Step 4: Calculate Your Net Income

Subtract your total expenses from your total income to determine your net income for the month.

Step 5: Adjust Your Budget

If your net income is negative, you will need to adjust your budget by cutting back on non-essential expenses or finding ways to increase your income. If your net income is positive, you can allocate the extra money to savings or investments.

To be quite frank, you can create a budget on a plain piece of paper, or even the back of an envelope. Budgets are simple, and while there are lots of budget templates available on the internet, you can do the arithmetic easily without them. Simply add all income and subtract all expenses. The difference should be positive. Keep it simple is the best strategy for most people, and a budget using paper and a pen or pencil is quickest and easiest and will do the job.

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What is forecasting?

Unlike a budget, a budget forecast is far more useful, but also more involved. A forecast will let you know where you’ll be financially in the future, based on current and anticipated spending. Knowing the outlook of your likely financial position in the future, you can use this information to make adjustments to your current spending decisions. Forecasts apply time value of money algorithms along with projections of inflation to forecast your finances in the future.

Unlike month-by-month budgets, forecasts usually cover a 5-year projection. Financial projections beyond 5 years are generally in the realm of financial planning. Financial plans are long-term projections and are considerably more complex than budget forecasts and are not covered in this article.

Making a forecast requires a software program, and unlike the many budget templates online, or available for download, there are far fewer forecast programs because the calculations are costly to develop. For this reason, budget forecast software is relatively expensive, usually several hundred dollars.

Forecasting is the process of predicting future financial conditions based on past data and current conditions. It involves analyzing historical data, market trends, and other factors to estimate future revenue and expenses. Forecasting helps you make informed decisions about the future of your business (or family) by providing insight into potential opportunities and risks.

Steps for creating a forecast:

1. Creating a budget forecast involves several key steps, which include:
2. Define the budget period: Determine the timeframe for the budget forecast. It can be weekly, monthly, quarterly, or annually but 5 years is common.
3. Gather historical data: Collect financial statements, cash flow statements, and other relevant financial data for the past period to understand past trends.
4. Identify revenue streams: List all sources of revenue, including sales, subscriptions, advertising, and others.
5. Estimate revenue: Based on past trends, market conditions, and expected growth, estimate revenue for the budget period.
6. Identify expenses: List all expenses, including fixed and variable costs, such as salaries, rent, utilities, supplies, and others.
7. Estimate expenses: Estimate expenses for the budget period based on past trends and expected growth. This can be done by reviewing previous expenses and considering any changes in the market.
8. Create a budget using the forecasting software (all forecasts begin with a budget): Compile revenue and expense estimates into a comprehensive budget forecast. This should include income statements, balance sheets, and cash flow statements.
9. Review and adjust: Review the budget forecast regularly to ensure it remains accurate and make adjustments as necessary. This may include revising revenue or expense estimates based on changes in the market or unforeseen circumstances.
10. Monitor actual results: Monitor actual results against the budget forecast to identify any variances and adjust the budget as necessary. This helps to ensure the budget remains relevant and effective throughout the budget period.

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I love earning a flexible income and know many other people enjoy this as well. With inflation and so many other economical issues, more and more people are looking to side hustles and flexible streams of income.

If you earn more than $400 per year in freelance income, you’ll need to claim that income on your taxes.

Setting Aside Money For Taxes is Crucial

When I started freelancing, I was lucky enough to know other bloggers and freelancers who were already finding success. One of the main things they emphasized was to save a portion of your freelance income for taxes.

In 2015, I didn’t know how much I’d earn or if I’d even be successful. But I ended up earning around $9,000 that year in freelance income alone. I’m so grateful that I took this advice and set aside around 25% of my income for taxes.

However, there will still be several tax mistakes I made early on as a freelancer. Here are 4 mistakes to avoid at all costs.

1. Not Opening a Business Bank Account

Initially, I was so excited to start making money through freelancing that I didn’t even think about opening a separate bank account. I just sent invoices on PayPal or accepted deposits into my personal bank account. The idea of opening a business bank account never occurred to me. As far as I was concerned, I didn’t have a business. I was just hustling to pay off my debt.

When it came time to file taxes, my finances were a mess. It took a long time sort through my income to separate freelance payments from my W-2 income. I had a hard time remembering what certain payments were along with professional expenses like coaching, running my blog, etc.

Opening a business bank account is crucial because it makes it so much easier to track your freelance income AND expenses. When you file taxes, you need to submit a profit-loss statement and the process is much smoother when you separate your finances.

I understand that getting a business bank account can seem like a big deal. Some business checking accounts have strict requirements that you may not be able to meet. Keep in mind that just opening a separate bank account (designated for business finances) can suffice as well. The key is just to keep everything separate to avoid costly tax mistakes.

2. Missing the Quarterly Tax Deadline

Before freelancing, I had always just filed my taxes once annually before April 15th. However, freelancers should pay quarterly estimates throughout the year. As a freelancer or gig worker, taxes aren’t being withheld and you’re responsible for paying them.

At first, I understood this part and just thought I’d set aside of percentage of my freelance income each month. Then, I’d pay my taxes in a lump sum in the spring.

Here’s the thing. Freelancers who don’t pay quarterly estimates could be subject to a penalty fee from the IRS. When I got together with my accountant to file in 2016 AND 2017, I had to pay the penalty fee.

Yes, I made this mistake twice. The next year, I got more serious about meeting my quarterly estimated dates and asked my accountant to remind me.

For reference, the quarterly estimated tax payments deadlines for freelancers in 2023 are:

• April 15th (For Q1 income)
• June 15th (For Q2 income)
• September 15th  (For Q3 income)
• January 15th the following year (For Q4 income)

Learn more about paying quarterly estimated taxes here.

3. Not Tracking Expenses as Carefully Each Month

Not tracking business expenses carefully is one of the most common tax mistakes freelancers make. Freelancers are independent contractors and can, therefore, write certain expenses off when they file taxes. However, if you don’t track your expenses well enough, you won’t know what to deduct.

I realized I could claim costs for things like:

• My cell phone bills (when used to conduct business calls)
• Food and travel expenses for professional conferences
• Fees to host my blog
• What I spent on courses and training
• Contractors and virtual assistants I paid to help with my freelancing business

Filing taxes after year 1 and year 2 of freelancing was brutal because I didn’t really have a system to track these things. Instead, I’d be overwhelmed with reviewing past bank transactions for the past 12 months each spring. Not fun.

To fix this, I started using a bookkeeping software through GoDaddy. It was only $10 per month and automatically tracked my business transactions so I could categorize them. Unfortunately, GoDaddy booking is no longer in service and I’m thinking of switching to something else like Quickbooks.

Regardless, investing in a tool to help you track and categorize business transactions can be a lifesaver. You can easily download the reports from the software to ensure you can claim all qualifying expenses on your taxes.

4. Failing to Match My Income Records with My 1099s

If I earned a certain amount of income with a freelance client for the year, they would often send me a 1099 form. One time, I remember a freelancer friend of mine telling me how she was horrified that a client put the wrong amount on her 1099. Apparently, she had kept her own meticulous records of how much she earned with that client. What was shown on the 1099 was very off.

I remember thinking about how I had failed to even check my 1099s to compare it with my records. This could create problems in the future if a client reported something to the IRS and I reported something else.

From then on, I made it a habit to cross-check these tax documents and make sure clients know if the numbers were severely off. Clients are humans too and can easily make mistakes.

Summary: Avoid These Freelance Tax Mistakes Early On

I made quite a few tax mistakes early on my in freelancing career. However, there are still some things I got right including hiring a CPA who has experience working with freelancers early on. There is so much to learn when you freelance and it takes time.

But, if you can learn from others what no to do in certain areas, you’ll save yourself a lot of time, effort, and money.

This post was originally published on this site

The post 4 Tax Mistakes I Learned Early on from as a Freelancer first appeared on Budget Financial Plan Calculators.