No matter what industry your business is in, analyzing data to predict the future is a difficult task. In 2019, businesses were setting record highs in sales and revenue with no warning a deadly pandemic was around the corner. Two years later, CEOs and CFOs are taking the lessons learned from those dark days and using better financial forecasting models to prepare for whatever may come next.
Could your business benefit from financial forecasting? More importantly, what financial forecasting methods will help your business prepare for the next major challenge?
Understanding how to prepare future outlooks today could save your business both time and money in the long run. Let's explore this topic further below.
What is Financial Forecasting?
When it comes to doing business, past performance may have a hand in predicting future returns. This is the role of financial forecasting: the practice of estimating and predicting how your company will perform in the near future by analyzing previous quarters.
One of the most common examples of financial forecasting is analyzing previous company revenue in order to determine potential growth. Let’s say over the past two years, your team experiences strong year-over-year growth in the first quarter and slows down in the summer months before ending the year with another uptick in sales. If you were using this data as the core of your financial forecasting methods, you would be able to plan for growth at the beginning and end of the year, while using the spring and summer to prepare for new product launches or plan marketing campaigns.
Although it sounds easy, financial forecasting can be difficult for startups that are growing at a fast rate. You’ve come to the right place if you need help with financial forecasting. We’ve outlined our top tips and tricks below.
Types of Financial Forecasting
When trying to define “What is financial forecasting?” there is no one-size-fits-all solution. There are several approaches a business can take using models in two financial forecasting model categories: Quantitative forecasts and qualitative forecasts.
Quantitative Forecasts
As the name suggests, quantitative forecasts use hard numbers and data to forecast possible business scenarios in the future. There are multiple ways to create quantitative forecasts, including predictions based on previous sales, budgets, or business over a period of time.
Sales forecasting
Sales forecasting uses current market data to predict how a company will perform in its market. In “top-down” sales forecasting, an executive team will look at the total addressable market and the current percentage of market share to predict future returns, while “bottom-up” sales forecasting starts with the group’s products or services combined with total volume and price points to forecast future revenue.
Cash flow forecast
While sales forecasting depends on analyzing the marketplace compared to your company’s products and services, cash flow forecasting predicts how much money will be going through your accounts over a given period of time. A cash flow forecast should consider how much money your company will receive from all sources (sales, consulting, loans, etc.) compared to how much is going out on expenses (like payroll, facilities, and materials). This financial forecasting model is useful to determine how much cash you will need to maintain short-term operations, or finance long-term growth goals.
Budget forecast
Just as a budget serves as a financial roadmap for your company, a budget forecast is a prediction of how your company will actually perform based on historical data. This financial forecast is important because it helps your executive team understand company health if the budget were exactly correct, with room for variance in both profits and losses. However, budgeting should not be confused with forecasting, as the two plans serve different needs of your business.
Income forecast
An income forecast – also known as a profit and loss forecast – analyzes how much money a company is projected to either gain or lose over a period of time based on historical data. The information included in an income forecast includes sales revenue, cost of goods sold, general and administrative expenses, taxes, and other sources of income and expense centers. An income forecast is used to predict net income, allowing an executive team to see if they need to increase sales or cut costs.
Time series analysis
A time series analysis allows your financial team to consider how a single variable in your operations is affected over a determined period of time. Variables often considered in a time series financial analysis include sales over a period of time, company valuation, or expenses – each offering insight as to the group’s overall financial direction.
Qualitative Forecasts
Although quantitative forecasts look at hard data to determine future growth, qualitative financial forecasts consider soft variables like expertise and industry trends to predict what it takes to achieve long-term success. Even though it is not an exact science based solely on data, it offers a look into how changes in business practices or regulations could affect a company both positively and negatively.
Expert opinions and visions
When a new variable affects business practices and there isn’t an immediate wealth of statistical data available, a company may turn to subject matter experts to interpret the change and explain how it could affect your business.. Turning to experts requires careful vetting of the individuals or groups involved in order to ensure they are qualified to offer actionable insight.
Delphi method
The Delphi financial forecast expands the opinions and visions given by subject matter experts by collaborating data across multiple individuals. This method collects answers from an anonymized panel using a standard set of questions, with an average of all the opinions taken to create a final outlook.
Reference forecasts
Although expert opinions provide historical context and future insight, their ideas can be clouded by personal biases and over-optimistic views. A reference forecast allows leaders to instead look at similar historical situations to analyze how they affected other businesses. Understanding the historical context may help your team forecast how a situation will affect current processes and prepare for change.
Consumer research
Just like the Delphi method gives executive teams insight into an industry’s future direction, consumer research informs financial forecasting from the opposite side: your potential customers. Doing analysis on competition, how customers see your unique value proposition, and what motivates purchase decisions can provide valuable insight on what would happen under certain market conditions.
Scenario forecasts
There’s no shortage of situations that could take place in the future. Scenario forecasts allow your executive team to understand what may happen in a risk scenario, such as a global pandemic, natural disaster, economic downturn, or taking a new direction for your company. By combining historical data with current business practices, your team can get a feel for how any given situation could help or hurt your company, and how to set plans in motion to react to the challenge.
6 Tips for Financial Forecasting
Once you understand the financial forecasting options in front of your company, the next step is to understand how the right process can help your early stage growth. As your team goes through forecasting, these six tips give you the frame of reference needed to make educated decisions based on the data.
Understand the purpose of the forecast
First, it’s critical to work with your financial team to determine why the financial forecast is needed. Is your company planning to launch a new product? Will there be a new push to capture more market share? Is your executive team preparing to onboard new investors? By determining your “Why,” your partners can help you get the right data through the right forecasting method.
Choose a method
Remember: There is no “One Size Fits All” method when it comes to financial forecasting. Aiming to understand the purpose of the forecast can help determine which method would yield the best data for your goals.
Gather past financial data
Even if you are using a qualitative forecasting model, understanding past financial data is key to ensuring your financial forecast is accurate. Past financial data not only provides context for future projected returns, but allows your financial team to provide multiple models based on multiple variables.
Choose the right time frame
Because the future is unpredictable, making long-term financial forecasts can prove to be inaccurate – leaving your team with the wrong data set to make decisions. We recommend companies set a time frame that meets their current needs in order to ensure their outlooks are true to their current data set. The greater the time frame, the more susceptible the forecast is to inaccuracies due to the unknowns.
Document and monitor results
Once a financial forecast is complete, plans and business environments can change. It’s critical to not only document results, but regularly update the forecast based on new data in order to ensure it remains accurate to your current and future plans.
Analyze the data
Once the time frame has passed, it’s important to look back and analyze where the data was correct, and where it fell short. By going through the previous results, your financial team can better understand business cycles and cash flow, leading to better financial forecasts with stronger results for your stakeholders in the future.
What to do With Your Financial Forecasting Data
Financial forecasting data is critical to ensuring your early-stage growth is on the right track for future success. Some of the ways you can use financial forecasting methods include:
- Make better budgeting decisions based on previous sales, profits, and liabilities.
- Present your growth trajectory to potential investors and sell them on your value proposition in the marketplace.
- Show financial institutions and other creditors that your company is fiscally responsible with upward movement to access loans or lines of credit.
- Ensure your co-founders and executive team understand the strengths, weaknesses, opportunities, and threats facing your company, preparing them for both the best- and worst-case outcomes.
- Prepare for growth scenarios to ensure you can service current partners while onboarding new customers with ease.
We’re Obsessed With Creating Financial Forecasts
With decades of combined experience, the Hiline team loves to work with small businesses in early stage growth to help them understand their current course and drive better results from their financial data.
Check out our services page to see how we could fit into your business, or contact us today to set up a consultation with our experts.
Sign up for our newsletter.
