Financial Forecasting – A Useful Guide To Understand Forecasts Of Finance
What is Financial Forecasting ?
A financial forecasting is the process of identifying trends with the help historical data and previous reports to projects those trends to provide information to decision-makers about the company's financial position.
Although entrepreneurs find financial forecasting least enjoyable. They prefer concentrating on actually developing and running their business, but importance of forecasting can’t be ignored. You need to have it in place to attract investors and funding. All your long-term strategic planning is based on these financial forecasts. These forecasts can’t be of any help if they are not fairly accurate and mostly lead to upset investors, mismanaged expenses and ultimately running out of cash. Here we are sharing a few tips that will not only help you to make your forecasts more realistic but also let you know more clearly.
Financials Forecasting Tips - Practical Guide
1. Use of Multiple Scenarios
When forecasting growth, impulsively one tends to be optimistic and sometimes to counter this temptation entrepreneurs use tremendously conservative approximations in their business plans and even investor presentations / pitch decks. In practice neither of the two is a correct way to forecast. You should consider at least two scenarios- one a little cautious and another optimistic. This becomes extremely important when there is uncertainty surrounding major factors that could impact your business such as government regulations, entry of new competitors or any change in macroeconomics.
2. Previous Reports and Statements
For better forecasting of financials, gather your important past reports, financial statements and data. You’ll need to focus at your past records in order to good projection like your income, cash flow, and balance sheet. After gathering useful documents and report you have to make sure which data will be used to predict what ? so use it accordingly.
3. Start with Expenses
In any business most easy thing to predict are the expenses as its beyond doubt that these costs will exist in the time period that you are forecasting for. You should start your forecast of financial model by outlining your fixed expenses like any financial advisory or CFO does. Next step is to consider all costs that can vary with revenue directly. If revenue grows by a certain margin, cost of sales also grows by the same margin. Although there could be fluctuations but generally these costs will reflect revenue to a good extent. Multiple forecasts help you in identifying costs that you can cut if business is rough or where to invest in case you surpass expectations.
4. Ascertain & List your Assumptions
Financial analysis of the market is vital to any business growth. Any financial forecast involves making assumptions about things that are beyond your control. The most appropriate approach in managing assumptions is to overtly ascertain and list them down. These should include the growth or shrinkage in market, change in number of competitors, any advancement in technology that could impact your business etc.
5. Focus each step in your Sales process
When making projections for revenue complete funnel of your sales channel should be taken into account instead of simply doing a guesswork for the top-line number. Projections for every step of the sales funnel is to be produced and use these to deduce the top line number.
6. Compare your projections
Try to find out comparable companies and compare your financial projections with their results. This will help you to assess the credibility of your forecast. For some businesses you might not be able to find data on comparable businesses, in such a scenario your projections are to be compared with your operating history. Significant financial ratios like gross margin, total head count per customer/client etc. are to be considered when comparing. In case your projections are surpassing by 10% this indicates an over optimistic approach. Same can be inferred when your projections are superior to all the competitors in your industry.
7. Review regularly
Once you are over with your financial forecasting exercise don’t just put it on one side. You need to review it regularly to assess whether your outcome is same as your projections or not. If not, then you have to make amendments as per the new information. To make better strategic decisions for your business you must update your financial forecast at regular intervals. With time you’ll gain expertise and will be able to rectify mistakes in your approaches. As you become more skilled in Financial Forecasting costs & revenues and foreseeing the market changes, you’ll be assured of self in making future projections.
Keep a close eye on your competition. New competitors may mean that your sales will decline unless you take more important measures within you report. For example, if you own a garment company, your sales may be influenced by other garments company. So it very important factor for you to keep track on market trends and competitors for better financial forecasts.