Financial forecasting best practices are more likely to be adopted and maintained by business executives who want to succeed — and weather unforeseen setbacks. Although it’s difficult to foresee the future, as the COVID-19 pandemic of 2020 showed, effectively hedging against worst-case scenarios gives a company a fighting chance to adjust.
Companies don’t all happen to be well-capitalized, have sound balance sheets and stable cash flows. Financial health is a product of thorough data analysis, in-depth knowledge of the industry, and up-to-date customer and consumer information. In good times, finance teams that get forecasting the fair share in the company’s success. They’re on the verge of becoming heroes in bad times. Is this an exaggeration? No way. According to data, business leaders recognise the importance of their finance teams’ meticulous preparation in navigating a complicated era.
According to Brainyard’s Summer 2020 Finance Priorities Survey, 72 percent of respondents believe financial planning and analysis (FP&A) is becoming more important, often significantly, followed by related corporate strategy and growth. Finance executives were far more likely than nonfinance respondents in the same survey to claim that adding goods or services is a necessary response to COVID-19. They can say that with confidence because they’ve planned.
What is Financial Forecasting?
Forecasting is predicting what will happen in the future based on past events and current events. It’s a strategic tool that assists companies in adjusting to uncertainty by forecasting demand for products or services. A sound financial forecast includes both macroeconomic variables and circumstances that are unique to the enterprise. Financial forecasting is a financial plan that forecasts the expected profits and expenditures of a company. Short- and long-term outlooks on factors that could affect sales, as well as contingencies for expenses not currently seen as appropriate, are all part of a detailed forecast. Organisations that produce accurate financial forecasts depend on model-building experts, whether on staff or on a consulting basis, who combine their work product with insights from people who have a clear understanding of the company, its markets, and the populations it serves. Similarly, data collection and software play an essential role in the financial forecasting process.
Straight line, moving average, simple linear regression, and multiple linear regression are the four traditional quantitative financial forecast models. All depend on data that can be measured, monitored, and made statistically.
Financial forecasting strategies may also be qualitative, depending on data that can’t be evaluated objectively, such as changing consumer tastes, but that’s still essential to the company. Predictive modelling algorithms, which use machine learning and data mining to predict and forecast possible future outcomes, are also necessary to note.
Advantages of Financial Forecasting
Aside from the obvious advantages, the method of creating a financial forecast causes finance departments and line-of-business colleagues to pause and consider the importance of rolling forecasts. CFOs must also make confident choices, such as planning for a specific number of months or using a rolling model.
Forecasts, unlike other financial data, are just that: projections based on changing circumstances. Companies that have as many potential variables as possible and invest in rigorous data collection, on the other hand, are better placed to make rational predictions and have a high level of trust in the forecast’s accuracy.
The following items should be included in a financial forecast:
- Prior findings were weighed against the circumstances at the time: There are formulas to decide how much weight to assign any piece of data, whether you’re assembling a fantasy baseball roster or measuring the success of a product line. Keep in mind that COVID-19 has distorted a lot of assumptions. Examine the data sources’ historical accuracy.
- A forward-looking time horizon: You have the option of doing a regular 12-, 18-, or 24-month period, looking further ahead or doing a rolling forecast.
- A complete analysis of a macroeconomic risk: A sudden, significant global catastrophe, such as a natural disaster or pandemic, falls into this category.
- Best-case sales scenario: What if anything for every product and service falls into place perfectly?
- Worst-case sales scenario: What happens if something goes wrong? Make use of scenario design techniques.
- Expenses expected: These would need to be recalculated, as they are likely to have changed due to a mass exodus from office space.
- Worst-case unanticipated costs: What if the data is stolen in a cyberattack, or a hurricane or fire destroys a plant?
- Internal dangers: Companies may have blind spots when detecting internal risks, such as a high-level executive committing fraud. Risk-adjusted forecasting is a technique in and of itself. Consider that, according to crisis management experts, a company’s mismanagement is almost twice as likely as an external cyberattack.
Financial forecasting precision may determine whether a company survives the most serious — or mundane — unexpected events.
To conclude, this blog is created to help you understand that why financial forecasting helps your business. This blog will allow you to know the advantages and the importance of financial forecasting. I hope that this blog added some value to your information bank and was worth your time.