If you’re a business owner or been thinking about opening up a new venture, the thought of improving its performance must have crossed your mind. And that’s where financial forecasting comes into play.
It’s simply the process of looking into the future of your business based on historical data and trends. In this post, you’re going to learn the basics of financial forecasting and how it can help you.
What is Financial Forecasting?
The definition is literally in the name. Financial forecasting is forecasting a business’s financial status.
More specifically, this is the processing, predicting, and estimating the future performance of a business based on current data at hand. Company revenue is used as the benchmark in most basic cases.
The sales figure can say a lot more than how much profit your business made. Those data sheets are effectively a portal to your business’s future. But it takes a different set of capable eyes to capture the essence.
Apart from the current sales figures, historical data is also used in financial forecasting. It helps analyze the performance with regards to the past, present, and hopefully a better future. This method is widely used by successful CEOs and entrepreneurs around the world for its accuracy.
Why is Financial Forecasting Important?
Any business with long-term objectives can definitely benefit from this process. It also helps to set new standards for the business as well as guide the decision-making process.
Another very important reason why entrepreneurs use this process is to convince investors.
Suppose, you own a winery and you wish to expand across different states. You know it will be a successful venture. But how do you attract more investors?
That’s where financial forecasting comes to play. You can accurately determine the future of your winery by considering all the variables in your current model and projecting them into a future scenario.
CEOs love this model because it can bring important insights such as how to spend business resources, what the industry holds for the future, how long the debts will hover over the business, how to pay the shareholders, etc. to light.
And when you have at least an idea of what you’re diving into, making the right decisions at the right time becomes a lot less burdening to your shoulders.
Types of Financial Forecasting
When venturing into the dynamic world of forecasting, you should know about the types as well. There are two major branches of forecasts. One is Qualitative while the other one is Quantitative.
Qualitative financial forecasting does not rely on computers to analyze large data sets. It’s quite an unorthodox way of finding out the connection between events. Rather than following the sales figures, Qualitative Forecasts focus on decisions taken from experience and intuition.
It starts with gathering opinions from major positions in each department. Analyzing their insights might be crucial for forecasting.
The next step might be taking a similar scenario from a different environment and projecting it onto the subject scenario.
The Delphi Method is another important aspect of financial forecasting. It indicates that company professionals fill out a questionnaire. Based on it, another questionnaire is created and filled. Now, these are combined and presented to the participants to re-evaluate their answers.
Scenario forecasting is another great method. The person tasked with the forecasting will project different results based on the consequence of scenarios. Your management team has the freedom to select any result you want.
Unlike qualitative forecasts, quantitative financial forecasts solely depend on large historical data sets. These are used to find patterns and trends in the business space. These forecasts are more accurate in sectors where numbers speak louder than legacy.
Pro-Forma Financial Statements is a great method used in this forecast where the sales data from the previous years are used to make the prediction.
Another method is Time Series Analysis. For short-term goals and objectives, this the perfect method to use. It involves collecting data for a certain period and analyze it to find trends.
Lastly, the Cause-Effect method dictates that every effect on the business is related to the cause. The consumer’s income, their confidence in the business, unemployment rate, etc. directly influences the sales figures. The goal of this method is to find the connection.
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