Companies do not end up with good cash flows simply by luck.
Financial forecasting is essentially the crystal ball that allows financial advisors to predict the future of a company. Of course, there are always unpredictable and uncontrollable variables that could make outcomes differ from predictions.
When unexpected changes happen, financial forecasts help executives understand how the changes have altered the company’s trajectory and adjust accordingly. Financial forecasts are an important decision-making tool that eliminates the need for making uneducated guesses about the business.
Financial health results from thorough data analysis, in-depth knowledge of the firm, and up-to-date consumer and market information. In good times, financial advisers who forecast correctly share in the company's prosperity, and in difficult times, they may make the predictions that keep the company trending upward.
Financial forecasting examines previous data to forecast a company's future financial outcomes. It helps predict future possibilities for the company based on historical financial data.
Financial forecasts are updated fairly regularly, as often as monthly and usually at least quarterly. A company often has multiple financial estimates for short and long-term analysis. These projections help with determining the next steps for a company and enable executives to pivot if needed.
Financial forecasting and budget forecasting get mixed up because both are part of a company’s financial planning process.
The most straightforward way to differentiate them is to think of budgeting as a company’s goals and financial forecasting as the tool that tells the company if they are likely to reach those goals as things change throughout the year. Executives may use a forecast to create a budget that is aspirational but still achievable.
Unlike a budget, a financial forecast can be used to help shape decisions about the company by informing executives about how variables could affect outcomes. A budget, on the other hand, is more of a baseline for comparison.
Financial forecasts are generally conducted more frequently than budget, making them more flexible and reflective of recent events or variables. Financial forecasting helps management look objectively at a budget goal to determine what’s achievable based on external market factors. In this way, financial forecasting helps keep employee morale high by preventing the pursuit of unachievable budget goals.
There are many different financial forecasting models, but they all fall into two categories: quantitative and qualitative.
Quantitative forecasts are based on data that can be measured, controlled, and rendered statistically.
Qualitative forecasts are based on data that cannot be measured objectively. Qualitative forecasting models are less reliable since they aren’t based on objective facts. They include forecasts based on expert opinions, consumer reports, and reference forecasts. However, they’re still helpful for companies in many ways.
Let’s examine the most common types of forecasting models:
For example, if an executive wanted to predict how much to produce of a certain product for the holiday season, looking at daily inventory fluctuations may not be helpful. Instead, they may use a moving average to predict how the item will trend throughout the season and ensure the correct amount of inventory.
Whatever your preferred financial forecasting model, having the right tools can make all the difference.
A data platform such as Causal automates data imports, streamlines formulas, so you’re not spending days punching in calculations, and gives you visualization tools that help decision-makers see what the numbers actually mean. Also, Causal has a library of financial templates you can lean on to provide you with a head start on financial modeling.
Overall, financial forecasts are an important tool for businesses and decision-makers. They can predict profitability, cash flow, and even inventory needs. Financial forecasting best practices are more likely to be adopted and maintained by business executives who want to expand — and weather unforeseen setbacks. While it's impossible to forecast the future, adequately ensuring against worst-case scenarios provides a company a fighting chance to adapt.