Financial forecasting is one of the cornerstones of managing a business’s finances and analyzing its performance. Growing businesses often struggle with the uncertainty of how their finances will fare in the future. The good news is that financial forecasting can help business owners deal with this uncertainty.
If you’re pondering the question, “What is financial forecasting,” allow us to be of assistance. Taking the time to learn how financial forecasting works and looking at a financial forecast example are excellent ways to prepare for the future and ensure business success.
What Is Financial Forecasting?
Financial forecasting refers to the use of historical data and financial statements such as expenses, sales, cash flow reports, and revenue, to predict future financial performance. The process often involves a fair amount of making assumptions and guesswork because there are unforeseen factors that your company will encounter. How you handle these unexpected challenges makes a difference in your company’s financial performance.
As such, forecasting is a crucial part of making any business decision, whether you use qualitative forecasting or quantitative forecasting.
Benefits and Importance of Financial Forecasting
Financial forecasting is important because of its role in the decision-making and business planning process. Predicting budgets, revenue, and other factors is part of strategic planning for the future. When you have a forward-focused mindset, your business will be more successful.
Financial forecasting:
- Allows businesses to establish realistic goals
- Prepares business owners and managers to make future decisions
- Improves internal taxing and fiscal controls
- Helps you identify problematic areas
- Reduces your financial risk
- Is attractive to investors
We’ll dive into each of these points below.
Establish Realistic Goals
When you utilize accurate forecasting and financial modeling, you can predict if your business is going to grow or struggle and by how much. This allows you to set realistic goals that you can achieve and then manage your expectations throughout. Being able to set goals that you can achieve is an important part of being a successful business. Remember that realistic goals will also reduce your liabilities to stakeholders, as they will have accurate expectations.
Prepare Yourself to Make Future Decisions
Another key benefit of financial modeling is it helps managers and business owners make future decisions. When you create a set of achievable goals that your team can focus on, you can make decisions more readily.
Whether you aim to reduce debt, grow revenue from a new service, or open another location, these goals will be more defined with solid data and metrics to support proper decision-making.
Improve Internal Taxing and Fiscal Controls
Financial forecasts are used to predict what taxes will be levied on your profits or revenues, along with other bills and expenses. Understanding what is coming up in your company calendar for accounts receivable is a key factor in driving your business to success.
Identify Problematic Areas
When you use financial forecasting, you reduce your financial risk because you educate yourself on where your money is and where it is going. You analyze past financial data and identify problematic areas that need fresh or improved strategies. You can incorporate these strategies into financial forecasts to get a more accurate picture of your business’s future performance.
Reduce Your Financial Risk
When you create a budget and haven’t done any financial forecasting, you risk putting your company in debt. Financial forecasts also help you manage finances more efficiently by channeling resources to the right areas to improve your profitability.
Become Attractive to Investors
When you perform proper financial forecasting, you can create accurate, useful financial reports. This will make your company more attractive to potential investors. Additionally, maintaining accurate financial records and performing regular financial forecasting shows potential investors you have a solid business plan and are serious about the success of your business.
How to Do Financial Forecasting: A Step-by-Step Guide
When you don’t conduct annual financial forecasting, the growth of your business may be difficult to measure and success may be more difficult to achieve. The following steps will help you understand the financial forecasting process, so you can apply it to your business. If you are overwhelmed, look into forecasting software that lets you input independent variables as well as the dependent variable.
There’s a lot to learn when you get started with the financial forecasting process. The following is a basic plan set forth by financial experts:
1. Set the Goal of Your Financial Forecast
What do you want to learn from your data? Are you hoping to go through your finances and budget to reduce debt, identify areas where you’re bleeding cash, or to make an expansion? Perhaps you want to use the current budget to shape where your company will head in the future. Having a plan will give you direction with your financial forecasting.
2. Gather Your Financial Records
You need to look at your business’s past financial data to get a better idea of what you can do in the future, so you must gather the documents that contain this information. Gather any bank statements, creditor statements, and all relevant financial records.
Other information you want to have handy includes the following:
- Equity statements
- Liability statements
- Loss statements
- Revenue statements
- Expenditures
- Earnings per share
- Comprehensive income statements
- Fixed cost statements
Keeping all important documents in one place before you begin financial forecasting will help you become more efficient. It will also help you create a more accurate financial forecast.
3. Establish a Time Frame
You need to have a clear understanding of how long you want to work toward this goal. Do you want to grow your income over the next twelve months or over the next two years? Are you looking to decrease your debt by half in the next year? A goal needs a specific time frame so you can measure progress and analyze performance more easily.
It is important to remember that the shorter the time frame, the more accurate your financial forecast will be. You should also note that most forecasts are for a fiscal year. This is because trends change over time.
4. Analyze Financial Records and Data
Once you have all the information easily accessible, you need to read through it, from your cash flow statement to your income statement. Highlight any expenses and make a list of these. Organize them into the right categories, so you can analyze how much you spend in which areas in real time.
At this point, you can choose your financial forecast method: quantitative or qualitative forecasting. Quantitative forecasting uses historical data and information to identify trends, patterns, and more. Meanwhile, qualitative forecasting analyzes expert sentiments and opinions on the market and company.
Each method has its own advantages and limitations. It’s important to note that qualitative forecasting is better for newer companies as they won’t have much data to rely on.
5. Document and Track Results
Once you have the past data available, you need to start tracking how you move forward. This means keeping all financial records easy to access and analyze. This is especially true when considering major external and internal developments. You should update your forecasts regularly to reflect new data and findings. There are many tools available to aid in the process, such as forecasting software that will automate some tasks for you.
6. Repeat the Process for Different Indicators (Cash Flow, Revenue, Expenses, etc.)
Once you have learned how to do financial forecasting in one area of your business’s finances, you want to repeat the process through the other areas. Use business financial forecasting to determine what your revenue will be for a set time period, whether six months or a year. Remember that the shorter the time period, the better your financial planning predictions will be.
Financial Forecasting Examples
There are several different financial forecasting methods to help your business grow. Learning how to utilize them and put them to practice will benefit your company regardless of what your business is, so keep the following financial forecast example methods in mind.
1. Sales Forecasting
In sales forecasting, you use data to predict what you will get in revenue from products or services in the projected period in which you are setting goals. There are two types of forecasting methodologies for this business model: bottom-up forecasting and top-down forecasting.
There are many benefits and uses of sales forecasting, and they include planning production cycles and budgeting. This process will help your business manage resources effectively. This type of financial forecasting is ideal for seasonal sales as well because it will predict how much help you need to have available to meet your goals.
2. Cash Flow Forecasting
Cash flow forecasting is used to provide an estimate of the cash coming in and out of your business for a specific period. This is one of the forecasting methods that include expenditures and income. There are many benefits to this process, including identifying budget needs and allocating surpluses. It is worth noting that this method is most accurate in the short term.
3. Income Forecasting
This type of forecasting gives you an idea of the income your business can earn in the future. It uses data from the company’s past revenue the company and its current growth rate to create estimates of future income. This is an important part of forecasting your balance sheet and cash flow.
You will want to note that third parties such as suppliers and investors use this data in making their decisions as well. They use this forecast to extend credit or purchase a company.
4. Budget Forecasting
With this type of forecasting, you will can your financial data to get a better understanding of what you need to budget for. This forecast uses data from past expense reports to create expense reports for the period you are looking at. It helps you analyze different scenarios to make financial decisions.
Additionally, budget forecasting helps you get an idea of what to expect in terms of your company’s performance and what the right budget is. The budget may help you achieve different business goals, like paying company debt or working toward expansion.
Consolidate Financial Data
Keeping your business data organized and easily accessible is key to having a successful company. There are many aspects to achieving this, but one of the most essential is financial reporting, such as forecasting your business performance.
Financial forecasting is much easier when you have the right tools to keep your data organized. A huge part of financial organization is managing customer payments. Podium has a fleet of payment tools ready to help you streamline customer payment processes. From card readers to text-to-pay and recurring payments, Podium can help you get paid faster in a way that’s convenient for your customers.
Ready to give it a try? Start a free 14-day trial of Podium today.
