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Having an oracle would be ideal, but in the meantime, learning how to conduct financial forecasting for your business can help you catch a glimpse of the future.
We all want to see the future, don't we?
Being a couple of steps ahead is crucial for success in business and finance, and luckily, financial forecasting is the closest to a crystal ball when predicting a company's performance. In this article, we'll go through the basics you need to know to implement it in your business strategy.
Let’s dive in!
Financial forecasting is a process that involves comparing a business' current and past performance to predict its future, using data such as cash flow and expenses as relevant markers. It is a handy tool for financial departments, and when done correctly, it can help strategic planning and decision-making for all companies.
Although it involves a fair amount of guessing and assumptions, implementing a correct forecasting model can offer valuable performance insights that prove accurate in the long run, fostering a more focused approach for financial departments. Think of it as taking a glimpse into the future to make planning strategies more intentional.
Budgeting can sound similar in functionality, but being part of the same strategy doesn't mean they're interchangeable. While budgeting can help you set a goal for your business, crafting a financial forecast will allow you to set realistic expectations for the future using information that's already part of your company's history.
There's more than a single approach to financial forecasting. Models vary from qualitative to quantitative, and according to Harvard Business School, companies tend to choose one of seven main methods to determine future income and growth rates.
As the name implies, these methods rely on a mix of mathematics and historical data to predict future business performance, and their accuracy depends on the nature and quality of the data.
One of the most popular quantitative methods is Straight Line Forecasting, which involves gathering rough growth estimates and projecting them to the foreseeable future. For example, if your company's growth rate is 10% over a year, this method would predict a 10% growth rate for next year. Even though this method does not consider unpredictable scenarios (such as market fluctuations), it can be an excellent no-fuss starting point for forecasting.
For a more detailed approach, other quantitative methods like Moving Average and Multiple Linear Regression involve comparing specific data through more complex mathematical equations.
Quantitative methods tend to be the most popular in financial forecasting, but they often leave out more subjective elements that should also be part of a finance strategy. Here is where qualitative methods come into play.
For example, the Delphi Model relies on the experience and knowledge of financial experts who analyze the market conditions and apply them to a business, completing multiple questionnaires until they reach a consensus.
Also, did you know conducting market research is considered financial forecasting? All it takes is analyzing and referencing patterns in markets and consumers, and it can help set realistic expectations for startups when it's too soon to compile historical data.
Modern technologies have a lot of influence on financial forecasts, and AI is no exception. Machine learning algorithms are known to handle large amounts of data, and they can be a modern-day ally for saving time and reducing the need for manual data analysis.
As a real-life example, Caterpillar's finance team is constantly incorporating new AI tools to improve the accuracy and efficiency of their forecasts.
That's it! You've completed our crash course into financial forecasting. But if you're not confident about how to begin implementing this technique, here are some questions that can help you set the path to reading your company's future.
What's the goal? - Are you trying to learn from your company's previous patterns? Do you want to take a more holistic approach to your finance strategy? Do you need to create a data-based scenario for investors? Are you trying to achieve a more stable cash flow? Setting a specific goal for your forecasts is vital to making the most out of the process and getting the most accurate results.
What can we use? - Gathering the most relevant data and recognizing your business' context will help you see the bigger picture and assess your current strategy.
What's the best method? - Is it qualitative? Is it quantitative? Remember, your goal and available data are the keys to choosing the correct forecasting model.
Once you've completed your forecast, remember it doesn't have to end there! Evaluating and analyzing the results can help you monitor the progress as you come closer to your goals, and your forecast can assist with anything from finding flaws in your financial plan to establishing a more accurate budget.
Strategic planning can be tedious, but you don't have to do it alone! Book a call with one of our CFOs and start planning for the future 🚀