What You Need to Know About Financial Forecasting
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When you say it out loud, "financial forecasting" sounds complicated and intimidating.
But it doesn't have to be.
A simple definition quickly demystifies the jargon: financial forecasting means predicting a business' future financial performance. Now that you know what it is, you're probably wondering—what makes it so important?
The answer to that is pretty simple, too: A LOT. Financial forecasting allows you to glimpse the future productivity of your small business so that you can make more informed decisions when it comes to any of the following:
- Planning a more accurate annual budget
- Reducing the likelihood of financial risk
- Identifying problem areas in your business
- Establishing and reaching realistic goals
- Appealing to and securing investors
Different Reasons for Financial Forecasting
Financial forecasting helps answer several questions about the future of your business. How can we achieve our financial objectives in the next eighteen months? How much money can we pay to shareholders this year? How long until we can repay our debts?
Depending on what kinds of questions you're asking, the type of financial forecasting most beneficial to your small business will likely fall into one of the following categories:
- Budget forecasting
- Income forecasting
- Sales forecasting
- Cashflow forecasting
- Assets and liabilities
How to Start Financial Forecasting
Begin by determining what you want to learn from financial forecasting, whether it's budgeting, estimating sales, or something else. This will help you narrow down the kind of financial forecasting that best suits your needs. Then, it's important to gather any relevant historical financial data, such as:
- Losses and liabilities
- Investments and Equity
- Comprehensive income
- Expenditures and fixed costs
There's no hard and fast rule on how much data is necessary, but collecting more will likely result in a more accurate financial forecast. Be careful not to go too far back in the records, as trends over long periods can vary widely.
Determine A Time Frame And Choose A Method
Considering financial forecasting is all about looking ahead, it's crucial to decide how far into the future you want to see. This can range anywhere from several weeks or months to several years, but businesses typically opt for one fiscal year. Then, you can choose between quantitative or qualitative financial forecasting, or both.
Quantitative financial forecasting relies strictly on historical data to identify potential future patterns and trends. Because of this, they are generally more accurate than their counterpart. Some examples of quantitative financial forecasts include:
On the other hand, qualitative financial forecasting relies on intuition and experience. Qualitative financial forecasting is typically chosen when only a relatively small amount of data is available and comes in the following forms:
Conducting a financial forecast of any kind often requires the help of special software or skilled consultants - both of which will examine the available data and make a prediction that you can use to guide your decision-making process.
Monitor Your Results and Analyze Financial Data
It's important to remember that financial forecasting is a prediction, not a guarantee. Everchanging markets and unforeseen obstacles can and will change the outcome of your forecast, but that doesn't mean forecasting isn't worth it.
While any forecast won't be completely accurate, consider how your financial forecast positively impacted your business decisions. Even small positive outcomes are still positive.
Lastly, it would help if you continued to record and analyze your small business's financial data and implement financial forecasting as a regular part of your strategy for success.