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For investors, it's important to understand the businesses in which you own stock. Are they winging along with an inflated stock price based on a fad, or are they built for the long term, with a firm sense of how they make money, how they spend money, and how their industry and their market are changing? Savvy executives use a combination of planning, budgeting, and forecasting as they plan where their company is headed in the future and how to get there.
When businesses engage in planning, they look at what they want to accomplish and what it will take to get there. Figuring out how to stay successful involves knowing what has worked in the past and how the market is changing. After he became CEO of Microsoft in 2014, Satya Nadella laid out the company's move to become a success in the "mobile-first, cloud-first" world. The shift in focus from devices and services to mobile and cloud trends is part of planning.
Procter & Gamble is another well-known company whose planning for the future has taken a bold turn. In 2014, the company announced it would shed up to 100 brands over the next couple of years to focus on the 70-80 brands best positioned for success.
Once a company has firm goals in mind, it needs to look to its budget. Budgeting is both a short-term and long-term endeavor in which a business (or non-profit organization, or school district, or person...) determines how much money will be coming in and how to balance this with how much will be spent. If you want to get a feel for a company's budget, check out its cash flow statement, where it keeps track of the cash coming in and going out, as well as the income statement, which is also known as the "profit and loss statement" or "statement of revenue and expense." These can be found in the 10-K reports public companies must file with the SEC, which you can look up via the EDGAR SEC datatbase. The SEC provides a beginner's guide to financial statements here.
Forecasting is a crucial part of planning and budgeting as companies try to predict, for instance, what will happen to the cost of materials they need to create their product and the prices people will pay for their product. Is bad weather in Brazil denting the coffee bean crop? That's bad news for coffee companies, who will need to take that into account when setting prices and budgeting for beans. If the weather's impact on the crop is slow to materialize, then the coffee company will have time to work the impending shortage into its forecasts and perhaps lock in lower prices by planning ahead. Similarly, if a new iPhone is coming out in the fourth quarter, then competing smartphone companies may budget for less income in that quarter as people flock to the new iModel.
Businesses are always involved in the processes of budgeting, planning, and forecasting, and investors can keep an eye on how well a company is doing by checking out financial statements and staying on top of strategy changes.
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The article What Is the Difference Between Budgeting, Planning, and Forecasting? originally appeared on Fool.com.
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