Every business owner should spend time understanding the revenues of their business. Why?
Because financial forecasting in this dynamic market can only help your business to grow exponentially and consistently, companies need financial forecasting to predict their future revenue streams, spending patterns, and money flow, which enables them to make decisions based on solid information. Financial stability and business growth demand the right forecasting model since it is needed for daily operation management, investment planning, and financial statement preparation.
Here in this article, we will examine the six fundamental forecasting models, including top-down, bottom-up, and more.
Key Takeaways
- Past financial records enable organizations to predict future outcomes.
- Expert estimates are a key component of qualitative forecasting, often used when historical data is limited or when future events are uncertain.
- Data-driven forecasting techniques that make use of quantitative statistical models constitute quantitative forecasting.
- Financial forecasting applications enable vital cash flow management, budget creation, money investment planning, and operational funding purposes.
- This tool makes financial trends and market risks easier to predict and future changes more predictable.
What is financial forecasting?
Financial forecasting can be defined as the evaluation of historical financial data and patterns to predict the future performance of the company. Financial forecasters employ both qualitative and quantitative forecasting techniques. When historical data is unavailable, qualitative methods can assist in making predictions; however, they rely on the judgement of experts to produce predictions. Quantitative forecasting techniques can be used when historical data from several categories and periods is available for analysis and estimation.
The operations management, business planning, and budgeting departments are responsible for financial forecasting. As a financial forecaster, you can make reasonable projections regarding a company’s sales in the upcoming quarter or how much it can invest over the next year. Forecasts can be updated regularly to compare projected and actual outcomes and make necessary corrections.
What makes financial forecasting important?
Financial forecasting will provide the foundation of your business to plan for the future:
1. Cash flow
As an entrepreneur, it is important for you to keep track of your cash flow towards the positive side because business success depends heavily on effective cash flow management, which creates better financial organization structures and operation control systems. Knowing the cash flow amount accurately at the beginning of every financial year will help maintain a cash reserve.
2. Financial needs
You plan to purchase or commit to anything, depending on the budget. Meanwhile, with business, you have to do something similar. Budgeting can benefit from the information generated by financial forecasts. Have your forecast team ready to make your business budget. This will depend on data from the previous financial year; you can spend time reading, assessing, and predicting the new cycle needs.
Keep a check on your revenue and sales that can provide substantial capital expenditures and investments. Also, spending on expanding your team to achieve greater goals in the next financial year can be done by having a proper business budget.
3. Investing
Companies require financial forecasting to raise capital for expansion. While you are going to have meetings with your potential investors, you have to get your plan ready for the next financial year. Furthermore, in the meetings, you can have the investors evaluate the investment quality and goal alignment through financial statement analysis and projection assessment.
4. Making decisions
Leaders use financial forecasting models to understand company conditions, which helps them make both short-term and long-term organizational decisions. Analyzing previous experiences grants precise forecasting abilities so you can spot market adjustments and changes in market competition.
5. Efficiency
There can never be only one possible outcome for anything; similarly, your business plan has multiple possible outcomes. This helps you make different plans and predictions for the future. Evaluating different possible outcomes enables you to develop plans and backup strategies that maintain business operations stability.
6. Improving plans
Now, as you have made your budget and decisions and have your cash reserve ready, somehow, not every time will your planned actions be successfully executed. Enhancing plans through corrective actions will help you notice variations by checking your projections against actual outcomes. To operate successfully, a business needs to properly examine cash flow statements, balance sheets, and profit and loss statements.
7. Mergers and acquisitions
It delivers results during mergers and acquisitions. Business leaders who need to judge organizational prospects highly demand a company’s future analysis.
Top 6 Financial Forecasting Models
These are the top 6 financial forecasting models that you can use in your business to predict the future performance of the company and make decisions accordingly.
1. Top-down financial forecasting models
Top-down forecasting proves useful to new market ventures and startup businesses. Market evaluation measures market dimensions and product adoption potential within a particular industry. You can have your team discuss business assessments for both market expansion and new market entrants. This is mostly possible when you have new product development or a launch in your company.
2. Bottom-up financial forecasting models
Bottom-up financial forecasting involves an assessment of the current financial statements and sales data. By using this method, you analyze the detailed performance data and can, therefore, predict future results. It can also compute the potential revenue by multiplying the average sales value with the expected sales for all the products.
3. Statistical Forecasting Models
Data correlations with statistical forecasting models represent business statistics findings, also known as quantitative forecasting models. This approach might assist you in assessing how its operations compare to those of companies operating in a comparable industry or market. It can also be used to evaluate growth rates, profitability, and benchmarks.
Statistical forecasting methods like straight-line, moving average, simple linear, and multiple linear regression are used to spot patterns and, in regression, understand relationships within data. In simple and multiple linear regression, independent variables are compared with the dependent variable to understand how they influence it.
4. Delphi forecasting
Delphi forecasting is a model in which professionals examine industry data and information. A facilitator leads the group, which works together continually to generate ideas and evaluate information to reach a consensus. Answering a sequence of questions that build upon one another during cooperation is a common part of Delphi forecasting.
The questions make sure everyone in the group has the same information, helping them explore important issues and make better decisions. By reviewing and revisiting answers several times, you work with other experts to create a clear set of opinions using this method.
5. Correlation forecasting
Finding related variables and monitoring how they move in tandem or follow one another are key components of correlation-based forecasting. Many businesses use this approach since it evaluates the connections between many aspects. By examining the relationship between two factors, you can ascertain how development in one area may impact another.
You can monitor things like price and costs or supply and demand. For instance, supply usually falls as demand rises. Therefore, a company may raise its inventory supply or allocate funds to purchase additional products in response to a predicted rise in demand for a specific product.
6. Asset and liability management forecasting
Asset and liability management forecasting is the primary tool for many financial institutions and pension funds to attain their financial objectives. This tool makes use of risk management strategies to lessen the consequences of things such as interest rates, foreign exchange, and economic movements. Firms that employ this tool usually check it every few years to be sure that they are protecting their investors and are still on course to meet their goals.
Pro forma financial statements, for example, show predicted results that can help forecast the company’s future before the end of the financial quarter, helping with risk analysis and investment planning. They can also give a glimpse of future asset management, which is especially useful during mergers, acquisitions or when the company is just starting out.
In conclusion, financial institutions should pick the right forecasting models to make better decisions and improve risk management, helping them handle changing economic conditions. These models help businesses gain valuable insights that lead to better growth. Online businesses using advanced forecasting gain a competitive edge in the market.
FAQs on Financial Forecasting Models
Check out these frequently asked questions about financial forecasting models.
How often should a business update its financial forecast?
The frequency depends on the needs of the company, though it is generally advisable for businesses to review and update forecasts once a quarter or annually.
What is the difference between short-term and long-term financial forecasting?
Short-term forecasting predicts near-future outcomes (within a year), while long-term forecasting projects 3 to 5 years into the future.
How can businesses improve the accuracy of their financial forecasts?
Accurate forecasting can be achieved by businesses through the use of current data, model updates, and constant assumption checks.
What are some common mistakes in financial forecasting?
Common errors in predictions are mostly a result of coming up with old data, excluding the key factors or assuming the unpredictable.
Can forecasting models be applied to small businesses?
Yes, forecast financial planning can be utilized by small businesses to acquire vital information, plan for expansion and guard against dangers.
Smart Financial Forecasting with Cheqly
Your cash flow can be managed efficiently, and financial decisions can be improved if your business uses Cheqly’s real-time insights, business accounts, and low-cost transfers.
Open a Cheqly business account for better financial control.