The advantages of financial forecasting are hard to ignore for any business. Whether you’re looking for transparency, attempting to control cash flow, or needing to determine the viability of various investments, financial forecasting is the tool you can use to get there.
But what is financial forecasting, what are the key business objectives of financial forecasting, and how can you get started?
Let’s break it down.
What is financial forecasting?
Financial forecasting is the development of prospective financial statements. These statements include what the company’s perceived business financial position, operational results, and cash flows will be for a defined future time period.
Financial forecasting is different from financial projections.
Financial projections develop the same financial statements, but they are based on what might happen and are often prepared for multiple future scenarios.
However, there is only one financial forecast version since it is based on what the company fully expects the future conditions will be and the course of action it will take.
Financial forecasts are based on current and past company results, as well as competitive intelligence, marketplace trends, and economic forecasts.
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What is the purpose of financial forecasting?
Businesses need sound financial forecasts to help them manage their company. Financial forecasts provide the basis of business planning and goal-setting that allow the company to make good decisions, minimize risk, and keep the business on the right trajectory.
Forecasts can be created and tracked weekly, monthly, quarterly, and yearly (depending on which metrics are being forecasted). However, most companies forecast monthly, quarterly, and yearly for metrics such as revenue, cost of goods sold, gross margin, expenses, and EBITDA.
Businesses use financial forecasts not only to manage their company’s performance – but also to give investors, lenders, and other interested parties the assurance that the company has the right plans in place to achieve the forecast.
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What are the advantages of financial forecasting?
The advantages of having a sound financial forecast cannot be understated – as forecasts are the underpinning of strong business plans that set a company up for success and growth. A few of the core advantages of a financial forecast can include:
- Business Planning: Financial forecasts are the foundation of a good annual operating plan and long-term (3-5 year) strategic plans. They provide the road map for where and when the company expects to increase or decrease key areas of their financial income and investments.
- Viability of Investments: Any new investment (whether it be an acquisition of another company, launch of a new product or service, or technology, plant or real estate purchase) will be assessed in a financial forecast to determine if the investment is viable and profitable.
- Manage/Reduce Financial Risk: Identifying financial risks ahead of time allows an organization to strategize ways to eliminate or reduce the risk. No one wants to be blindsided by any financial hit, especially one that could have been seen coming.
- Budgeting: Budgets should be set based on the financial forecast. If the forecast, for example, assumes no additional headcount or no large equipment purchases then the budgets would reflect this.
- Benchmarks to Monitor Against: Every line item in the forecast can be monitored against to ensure revenue goals are being hit, cost of goods sold, and other expenses are on track in order to achieve the forecasted profitability.
- Control Cash Flow: It’s been said that no one forgives a company that runs out of cash, so cash flow control is essential to a business’ survival. Forecasting cash outlays ahead of time provides company leaders the foresight and time to secure lines of credit or other cash infusion sources to cover times of need.
- Visibility of Future Expenses: If there are large, one-time expenses forecasted in any particular month, having visibility to these helps the company plan for the financial resources to cover them (whether it be bank loans or delaying other expenses in order to cover the one-time expenses).
- Transparency: A financial forecast provides transparency to company employees, banks, investors and other interested parties as to what the company expects its financial performance to be for a particular period. As such, it can provide a sense of stability to those vested in the company’s performance.
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Need help with the financial planning and forecasting process?
At New Life CFO, we provide fractional CFO services for companies of all sizes and industries, and we’d love to help yours, too. We can assist your company in developing and maintaining healthy financial forecasts for your company.
If you’d like to learn more about these services, reach out to us online. We’d love to talk.