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What Is Financial Forecasting?

Financial forecasting allows entrepreneurs to build a framework under which they can prepare and adapt their strategy and decision-making, as it provides a realistic glimpse into the future. Every business can benefit from ongoing financial forecasting.

What is financial forecasting? Why is it important? How can I perform financial forecasting? This article takes a closer look at these questions, and the fundamentals of financial forecasting.

Definition of Financial Forecasting

Financial forecasting is the process through which a business performs financial projections to facilitate decision-making relevant to the business's future performance. In simpler terms, it involves estimating or predicting how your business will look financially in the future or, at the very least, what is the most likely scenario. Usually, one should start by analysing past business performance, current trends, and other relevant factors, both internal and external. However, aspects of financial forecasting will vary depending on the type and purpose of the forecast.

Read also: How to do financial forecasting.

An excellent and common application of financial forecasting is predicting revenues. For example, a company will prepare a projected income statement to get a snapshot of expected sales, cost of sales, expenses, profit, and other critical financial information over a certain period. Other aspects of financial forecasting include predicting costs, capital, and assets.

What Are the Benefits of Financial Forecasting for Business?

Financial forecasting plays a critical role in a business's ability to survive harsh economic times. Companies that adopt and maintain good financial forecasting practices are better positioned to grow and withstand unexpected setbacks. Forecasting gives a business a chance to adapt successfully against future worst-case scenarios. The following are some of the key benefits of financial forecasting:

Reduction of Financial Risks

A financial forecast informs a company's critical financial decisions. Forecasting is essential in the budgeting preparation process; as such, a financial forecast does more than predict the financial status of a company in the future - it has an immediate and long-term impact on its strategic decisions. If you do not have a comprehensive forecast report, chances are your financial decisions are ill-informed, exposing you to numerous financial risks in the unforeseeable future.

Annual Budget Planning

A budget is a company's financial plan for a defined period, usually one year. It represents a company's financial position, cash flow, and future goals and expectations for a set fiscal year. Financial forecasting and budget planning work in tandem. While forecasting offers critical insights into a business's financial future, these insights are invaluable in making budgeting accurate. In other words, companies use forecasting to allocate their budgets or plan for anticipated expenses for an upcoming fiscal period.

Setting Realistic Business Goals

Financial forecasting and goal setting are like two halves of a whole - you can't have one without the other. Wise business leaders link goals to forecasts and plans because they recognize the importance of financial forecasting in laying the foundation of the company's entire strategy. Forecasts set the direction that your team should head. Accurate forecasting can predict whether (and the extent to which) your business will grow or decline, helping you set reasonable and achievable goals and manage your strategies.

Appeal to Investors

Investors extensively analyze a company's financial information before committing their funds to the company. They want to have confidence that their money is safe and that the company will guarantee returns. Besides financial statements, potential investors will evaluate your financial forecasts to predict the business's future financial performance and possible ROIs on their committed capital.

Read also: Immediate expensing of capital property of up to $1.5 million per year.

Identify Problem Areas

Since forecasting partly involves analyzing historical and present data, using the proper forecasting technique can help pinpoint specific issues in your business's past performance. It can provide answers and conclusions to the main strategic problems that contributed to the degree to which the company performed. In addition, the in-depth analytical insights into what the future holds will help identify and prepare for potential problems.

What Is the Difference Between Forecasting and Budgeting?

At a glance, financial forecasting and budgeting may appear similar. In fact, some people use the two interchangeably, thinking they both refer to the same thing. Although budgeting and financial forecasting are often used together, there are distinct differences between the two concepts. The key difference between the two concepts is that while a budget lays out a plan for what a business wants to achieve, a forecast precisely states the actual expectations for the results. Simply put, a budget is a plan for where a business wants to go, while a forecast indicates where it is going.

Realistically, a financial forecast is more useful among these two vital management tools. First, it offers a short-term representation of a business's actual circumstances, and second, it informs the budgeting process. In other words, without forecasting, a budget would not exist.

The Importance of Financial Forecasting

Financial forecasting is an essential step at the start of each accounting period. It uses previous data to determine how your business can maintain adequate cash flow to cover its financial needs. As explained, the data produced is also crucial in creating a budget for your business. As a result, you can assess whether the forecast results indicate sufficient revenues to support your business expenses.

Another situation that highlights the value of financial forecasting is seeking investment. You want investors to chip in to fund your projects and expansion. Your current or prospective investors will review, among others, your financial forecasts to get a picture of what the future of your business looks like and to determine if they're making a worthwhile investment in channelling their money into your business.

Bottom Line

Most business owners often undermine the value of regular financial forecasting. This explains why many businesses struggle and even collapse in the face of adversities. Even though you cannot predict the future, financial forecasting best practices are the closest thing to having a glimpse of what this might look like. It helps you plan and prepare for the worst-case scenarios and blossom where most businesses die.

Take advantage of the steps above by contacting Prasad & Company LLP for accurate financial forecasting that will drive your business to success and increase its chances of surviving the unexpected outcomes.

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