What is Financial Forecasting?
Financial forecasting is the process of predicting future flows of cash into, out of, or within a business organisation. It can also come in the form of a forecast for whole economy. Fintalent’s financial forecasting consultants identify several types; The long-term forecast includes predicting assets, cash flows and income well into the future and the short-term forecast covers only one year or less and is based on expectations about conditions such as GDP growth rates in different sectors, inflation rates and interest rates.
As a business owner, you have to make decisions that could have a huge impact on the bank account. Planning out your financial forecasting is an essential part of the startup process because it will help you plan for future losses, avoid sudden revenue spikes and identify trouble areas that could be foreseen in advance.
The Importance of Financial Forecasting
As an entrepreneur, you might be entering a business world you’re unfamiliar with. It’s not enough to know how to sell goods or services. You need to understand the economic environment in which your company operates and how it will change over time. You don’t want to find out that your financial forecast is based on faulty assumptions and have to alter your plans at the last minute after taking unnecessary risks.
A financial forecast helps you understand what might happen in the future based on current conditions and it can help you avoid costly mistakes by allowing you to prepare for them.
How to Create a Financial Forecast
Financial forecasting provides you with a way to make financial predictions about your business for the short and long term. The process of doing this starts by identifying what areas you need to cover so that you can create your own forecast. The forecast will include many sub-forecasts, one for each area of concern, such as sales, profits, expenses and debts. As a business owner, it’s up to you to decide what information is important and how much detail you want to include in each sub-forecast. You might want to estimate your numbers based on estimates alone or take into account actual results from previous months or years.
The basic model for creating a financial forecast includes four steps:
- Identify the important factors that affect your business
- Estimate how these factors will influence your business in the future
- Input these estimates into a spreadsheet that formats the information into an easy-to-read format
- Review your information to ensure it’s comprehensive and correct, then revise as necessary and create reports so you can share it with other people, such as investors and employees.
The Steps for Creating a Financial Forecast
- Identify Important Factors. Most businesses would benefit from creating a financial forecast because it helps them to understand the factors that influence their business in different ways. The factors will vary from situation to situation, but you’ll want to identify the factors that are most likely to influence your business. You might want to include revenue, expenses and profit margins as examples. For example, you could decide that revenue is most important since it influences how much money you can make and determine how much profit your company should be making each year. Then you could create a sub-forecast for each of these areas, such as sales.
- Estimate Future Trends. Once you identify the important factors in your business, you can estimate future trends for each of them. You might already have some long-term forecasts you’ve used in the past and need to update them, or if you don’t have any information, create new forecasts based on your assumptions and projections. For example, if you decided that profit margins are important, your sub-forecasts could include a forecast for sales expenses and debt. These forecasts will indicate what’s likely to happen in the future based on current trends and how much impact each factor has on your business overall.
- Create a Financial Forecast. This step involves inputting your forecasts into a spreadsheet that will allow you to organize them into easy-to-read information. You can create this spreadsheet from scratch or you can use a free blank template from a website such as Smartdraw, which provides templates for most types of businesses. The information in your spreadsheet should be organized so that it’s easy to see how everything fits together and allows you to compare different factors. For example, if you have sales and profit margins in the same spreadsheet, it’s easier to see how changes in one might affect overall business performance than if they’re separated.
- Review Your Information. After creating the financial forecast and inputting your information into your spreadsheet, you’ll want to review it so it’s comprehensive and correct. You can use a review tool such as Excel’s built-in Review tool or download a specialized data analysis tool that will provide you with detailed information on how each factor will affect your business in the future. Before using this tool, you’ll want to make sure it includes all the factors that are important for your business. For example, if you have profits as one of your factors but don’t input any forecasts for expenses or sales, these factors will be left out of the results and you won’t get accurate information about how they influence the overall profitability of your company.
- Share Your Information with Others. You’ll want to share your financial forecasts with investors and employees. If your business is a public company, the Securities and Exchange Commission will require you to report the results of your forecast to investors in the filing process for a quarterly report. If it’s not, you’ll need to include this information in a separate document or include it in emails sent to investors. The specific information you need depends on the type of business you operate but could include overall sales, profit margins and expenses.
If you’re creating forecasts for investors, you don’t have to use the same format as your internal forecasts. In fact, it’s a good idea to create a separate forecast for investors and include additional information, such as graphs and charts so they can view the data in more detail. This helps them understand exactly how your business is performing and how it’s likely to grow in the future.
Financial forecasts are an essential part of planning and decision-making for any size business. They help you understand what factors might influence your business performance in the future and how different actions may affect your earnings. You can use this information to ensure that your company and its employees are on track with their goals, as well as make decisions about how to improve financial performance and profit in the future. When you create a forecast for yourself or another business, you’ll need to consider different factors that could have an impact on future results and estimate what these impacts might be.