Financial Forecasting: Explained
A blueprint of your business vision is essential to communicate your assumptions about future revenue, expenses and strap your boots against any unexpected changes. Investors, employees, lenders often rely on financial forecasts to understand your strategic plan for the company.
What is financial forecasting?
Financial forecasts rely on the analysis of historical financial data together with future expectations alerting business owners to any potential sales shortfall or pending debt. They take various macroeconomic factors into account like inflation, consumer spending, employment rates, industry-specific trends, competition etc. It is a potent tool to analyze the current financial health of the company and estimate the future expenses and incomes based on the predicted demand of the products and services offered. Financial forecasts also help to prepare businesses against worst-case scenarios and can help to make more informed business decisions.
Elements of financial forecasting
Financial forecasting utilizes Pro-forma financial statements like
- Income statement
- Balance sheet and
- Cash flow statement.
Pro forma financial data is built upon the anticipated future revenues and expenses by applying the trends visible in your historical financial data.
In general, financial forecasting involves 3 steps:
- Fetching historical data from the financial statements: This is the most critical step as the data must be accurate. Data for a certain period is pulled up and organized in chronological order.
- Analysis of data to identify trends: After choosing the variables to analyze like sales revenue, a YoY(year on year) or MoM (month on month) change rate is calculated. Based on this you can estimate the change rate for the upcoming months and apply it to your forecasts.
- Create proforma statements: Using the projected growth rates, you can create the proforma statements for the upcoming period to get the estimated values of revenues and expenses.
This is a simplistic explanation of forecasting. A more detailed and in-depth approach is applied in real life incorporating projections and financial modeling. It helps to engage the services of a professional to arrive at a more robust financial forecast.
Advantages of regular financial forecasting:
- A more judicious allocation of resources and cash flow management
- Minimizes liquidity issues
- Help to scale your business to achieve growth objectives
- Efficient business planning by using resources more efficiently
- Securing funding from investors
Financial forecasting is an important business tool to streamline your goals and resources and hence making sound business decisions. A robust financial forecast depends on the accuracy of your historical data. Hence it is of utmost importance to keep your financial data up to date and accurate.