The Importance of Financial Forecasting

The Importance of Financial Forecasting

665 Views

Business leaders that adopt and undertake best practises for financial forecasting are better equipped to expand their businesses and handle unforeseen setbacks. Despite the fact that it is difficult to forecast the future, as the COVID-19 pandemic of 2020 has shown, the company has a better chance of adapting if it can properly hedge against the worst-case situations.  

The truth is that businesses don’t become well-capitalised, with solid balance sheets and positive cash flows by accident. Rationally analysing data, being closely connected with the firm, and having the most recent customer and market insights are all essential to financial health. In more prosperous times, finance teams that perform accurate forecasts benefit from the company’s success.    

They are very nearly heroes during difficult times! 

Hyperbole? Nope. According to data, business executives are aware of how their finance teams’ diligent planning helped them survive a very trying time for all businesses. The financial planning and analysis (FP&A) function was assessed as increasing in importance, frequently significantly, by 72% of respondents to Brainyard’s Summer 2020 Finance Priorities Survey, closely followed by the related corporate strategy and development. In the same survey, finance executives were substantially more likely than non-finance respondents to agree that expanding products or services is a required response to COVID-19.    

What Is a Financial Forecast?  

By studying the past and the present, forecasting is the process of predicting what will happen in the future. Based on anticipated demand for products or services, it serves as a planning tool that enables organisations to respond to unpredictability.  

A solid financial forecast includes both macroeconomic aspects and circumstances unique to the business. Financial forecasting is a financial plan that calculates the future income and expenses of a business. A comprehensive projection includes, but is not limited to, short – and long-term outlooks on variables that may have an impact on revenues and backup plans for expenses not now considered required.  

Organisations that provide accurate financial predictions rely on model-building professionals, either on staff or as consultants, and combine their work with input from individuals who have a thorough grasp of the organisation, the sectors it serves, and the communities it works in. Similarly, data collection and software are crucial to the financial forecasting process.    

Which Skills Are Required For Financial Planning? 

Statistical and mathematical skills are necessary for creating models. Teams in charge of financial planning must also be:  

  • Being comfortable sifting through large and varied data sets from sources outside of sales, marketing, human resources, and operations. 
  • Able to manage and aggregate raw data using formulae and procedures to produce results that are simple to understand. 
  • Knowledge of financial systems, including ERP, and how this software can automate reporting and support more complicated analyses. 
  • Adept at working with colleagues from different departments to comprehend corporate priorities and objectives. 
  • Possessing in-depth understanding of the business and its procedures. 
  • Those who can solve problems by transforming mountains of financial data and more ambiguous information into clear reports.   

Straight line, moving average, simple linear regression, and multiple linear regression are the four common quantitative financial forecast models. All rely on quantifiable, controllable, and measurable data that can be displayed.  

Financial forecasting techniques may also be qualitative, relying on information that cannot be assessed objectively, like changing client preferences, but is nevertheless crucial to the success of the company. You should also take into account predictive modelling algorithms, which foresee and predict expected future outcomes using machine learning and data mining.    

Why Is Forecasting Important? 

Financial predictions are crucial for corporate planning, budgeting, operations, and funding; they merely assist executives and external stakeholders in making wiser decisions.  

A financial projection is an estimation of how much money a firm will make in the future, and it’s an essential step in creating the annual budget. It guides important financial choices like whether to fund a capital project, add staff, or seek funding. Business balance sheets and other disclosures provide significant information from their financial forecasts.  

A financial projection gives firms access to unified reports, enabling finance departments to set realistic and doable company goals. Additionally, it offers management important information about past and projected performance of the company. Financial predictions are crucial in investor interactions and loan applications, in addition to guiding internal fiscal controls and choices. Forecasts are taken into account in the decision-making processes of banks and other funders.  

Startups are also not exempt either.  

Benefits of forecasting 

In addition to the advantages described, creating a financial forecast compels finance teams and line-of-business associates to pause and consider the merits of rolling forecasts.  

CFOs must decide whether to employ a rolling model or project out a certain number of months. Will the projection be incremental, building on last year’s, or will we start with a (almost) clean slate, borrowing a page from the zero-based budgeting movement? Which potential new product lines need to be included in a formal forecast since facts supporting their viability exist?  

The benefits of that job include the capacity to decide wisely even when pressed for time, the ability to confidently approve a new capital project based on evidence, and increased success in obtaining loans or luring investors.   

Traditional vs Rolling Forecasts  

8 Essential Elements of Financial Forecasting 

Forecasts, in contrast to other types of financial data, are only projections based on dynamic situations. However, businesses that invest in rigorous information collection and include as many potential variables as is practical are better positioned to make rational assumptions with a high level of confidence in the forecast’s accuracy.   

A financial projection should include:  

  1. Prior outcomes weighed in light of the circumstances at the time: There are methods to decide how much weight to give every piece of data, whether you’re creating a fantasy football roster or assessing the effectiveness of a product line. Keep in mind that COVID-19 has distorted several presumptions. Examine the historical precision of the data sources.  
  2. If you have the option of performing a typical 12-, 18-, or 24-month time frame, looking deeper into the future, or creating a rolling projection. 
  3. A complete analysis of a macroeconomic risk: this involves a sudden, significant, worldwide occurrence like a pandemic or natural disaster. 
  4. Best-case revenue scenario: what if every product and service works out exactly as planned? 
  5. If everything that may go wrong did go wrong, what would be the worst-case scenario for revenue? Apply scenario planning techniques. 
  6. Expected costs: these will need to be adjusted because they have probably altered as a result of a mass exodus from office space. 
  7. Worst-case unexpected costs: what if you experience a cyber-attack and lose all of your data? What if a storm or fire completely destroys a factory? 
  8. Internal risks: companies may have blind spots when it comes to spotting internal risks, such as a high-level executive defrauding, since risk-adjusted forecasting is a practice in and of itself. But keep in mind that, according to crisis management specialists, a business is nearly twice as likely to have management failures as foreign cyberattacks.  

If financial projections are accurate, organisations may be able to withstand even the most catastrophic unforeseen occurrences.    

Budgeting and financial forecasting 

The majority of experts concur that a strong financial strategy is based on accurate forecasting as well as wise spending guidance. Although some people conflate the phrases “budgeting” and “financial forecasting,” they are two distinct procedures.  

A crucial first stage in the budgeting process is financial forecasting. Realistic budgets are more likely to be developed by organisations that put a lot of effort into developing accurate financial predictions. Budgeting should always be preceded by financial forecasting to make sure expenditure is in line with variables that may have an impact on overall financial success. Without financial projections, those who design budgets run the danger of going over budget and not having enough cash on hand to cover unforeseen expenses or revenue shortfalls. A lack of a projection could also prevent the company from approving a new capital investment or from releasing a product that could have become a driver of growth.    

7 Reasons Why Your Company Needs a Financial Forecast 

Fast-growing businesses and entrepreneurs could discover that the impact of financial projections on performance is disproportionate. Perhaps you don’t need to accept that additional venture capital funding after all! 

The absence of a finance team should not deter entrepreneurs from using financial forecasting or modelling. There are several CFOs available for hire that can offer a knowledgeable viewpoint.  

An accurate financial projection will:  

  1. Act as a foundation for budgeting decisions. 
  2. Ensure creditors and investors that your business has a plan in place and is ready to deal with any unforeseen circumstances that could affect revenues. 
  3. Give people who are making significant financial decisions a gauge to go by. 
  4. Make sure the company is ready for both the best and worst-case scenarios. 
  5. Create safeguards and increase awareness of a wide range of internal and external factors that may have both short- and long-term effects. 
  6. Ensure that corporate executives are not caught off guard by circumstances that can have an effect on performance. 
  7. Get businesses ready for expansion, often known as increased demand for their products and/or services.
  8. Once your business is ready for expansion, check out the infographic below for tips on business growth!entrepreneur investment partner

    Infographic created by Excellere Partners, an entrepreneur investment partner

     

Software for Financial Forecasting 

Financial forecasting is now both simpler and more complicated than it was a few years ago.  

We now have access to a wide variety of data, most of it in real time. Consider client segmentation, real-time stock market data, fraud detection, and purchasing trends. That creates a tonne of opportunities but also increases complexity. Forecasters need to locate the appropriate data, record it, and then incorporate it into their analysis, frequently using machine learning.  

Spreadsheets alone are insufficient for fast-growing businesses to collect, model, and consume information efficiently. Now let’s talk about specialised financial management software. When all stakeholders have access to the same data set, financial forecasting and reforecasting become faster, more accurate procedures. Look for the capability to automatically collect all the financial and operational data and KPIs in one regulated environment.   

If you would like to see how Itas Solutions can help you and your organisation reap the benefits of IT and the latest cloud solutions for your business accounting including needs forecasting, with powerful cloud accounting software such as Sage’s Intacct, we will only be too happy to show you the benefits and how we can help.  

Who we are 

Itas Solutions began in 1995 with just one client and today serves over 200 businesses around the UK and we are always on call to help our clients. 

Itas is a company trusted by our clients for more than 20 years, and we have grown through customer and IT professional recommendations who appreciate the knowledgeable yet individualised service we provide. 

You can reach out to us at [email protected], give us a call at +44 (0) 1824 780 000, or send an email to learn more about how Itas can assist your company with finance automation, Sage implementation, and improved purchasing control. 

Finance