In business, the only certainty is that there will be uncertainty. While we can’t predict all future outcomes, financial forecasting offers a framework to prepare more realistic budgets and strategies for growth. What is financial forecasting, and why is it so important for your business? We’ll take a closer look below.
What is financial forecasting?
Financial forecasting models analyse the past to help predict the future. A financial forecast is a plan or model that uses historical business data such as profits, losses, and expenses. These historic figures are used to project future income and expenses, factoring in macroeconomic conditions and business trends. You can look ahead at the year to come or prepare a monthly financial forecast to track trends and create a budget.
While business owners might use financial forecasting to allocate resources and predict expenses, investors will use these models to determine the likely outcome of specific events on company shares.
Why is financial forecasting important?
Financial forecasts allow you to make more informed business decisions rooted in facts and data. Getting in the habit of creating a monthly financial forecast allows you to plan your next steps in relation to funding, operations, and budgeting. Using historical data, you can look to the future of your business to decide whether it’s a good time to hire new staff or fund a new project. Financial forecasting encourages businesses to set more realistic goals in the future.
Yet, these forecasts also provide insight into the past, allowing managers to analyse which factors had the most significant impact on revenue and sales. Financial forecasting models are also important when the time comes to secure funding, whether it’s through investors or lenders. Banks will carefully pore over models to make their own decisions about a business’s potential.
Types of financial forecasting models
There are several approaches to take when it comes to financial forecasting. Generally, you can break modelling into two types.
Quantitative forecasts: These use historical data to identify patterns or trends. Examples could include a time series analysis, pro-forma financial statements, or cause and effect relationships between different variables.
Qualitative forecasts: Also called speculative forecasting, qualitative methods of analysis use expert opinions or questionnaires. Qualitative forecasting is better suited to start-ups without historical data to refer to. Analysts might compare the company to its competitors and conduct market research.
Factors affecting financial forecasting
Financial forecasting involves analysing data as a basis for future predictions. However, there are also a few factors affecting financial forecasting that come from wider market trends and global events.
Economic conditions: Both economic and industry-specific trends should be factored into any financial model.
Latest technology: Technological advances may have an impact on your business prospects irrespective of past sales trends. Will advances in technology render current products obsolete?
Market competition: Is your industry flooded with competitors? Do you need to factor new marketing techniques into your financial forecasts?
Changes to demographics: Changes to neighbourhood demographics such as age and household income could be an important factor to consider in forecasting.
Seasonal business cycles: Some industries are impacted by seasonal trends. The retail industry trades heavily during the winter holiday season, while the travel sector trades heavily during the summer months.
Although these factors are somewhat predictable, you should also consider a risk assessment for unforeseen macroeconomic risks like pandemics and natural disasters. What are the best and worst-case scenarios for your business?
What to include in a financial forecasting model?
Now that we’ve covered some of the outside factors to include in your financial forecasting models, here are some of the more everyday components you might use.
Use your recent income statement, balance sheet, and cash flow statement as reference points for established businesses. Start-ups will need to focus more on industry benchmarks and market research as a guide. In either case, financial forecasting is well worth the effort as it allows you to make better decisions while preparing adequately for risk.
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