How to Do a Financial Forecast For Your Business

Without a doubt, planning your production, marketing strategies, and customer service are fundamental for growing a successful business. However, financial planning – an often neglected part of running a company – is equally important.

No matter if you’re a small startup or an established corporation, having insights on how to predict financial performance can be a true game changer. 

From monitoring revenue projections to managing your business account, financial forecasting offers a reliable roadmap that offers strategic planning opportunities and more.

In the following sections, we show you how to do a financial forecast for your business.

The Basics of Financial Forecasting

Financial forecasting examines a business’s past performance and financial statements (like sales, costs, cash flow, and others) to predict the company’s future financial outcomes. Financial forecasting can be conducted in different forms, based on its ultimate goals and objectives.

In most cases, companies create a financial forecast over a fiscal year. This allows management and all involved parties to have an accurate understanding of the company’s finances and its projected financial performance for the future. 

Financial forecasting is an essential part of the process of creating a business plan and is vital for making informed decisions. 

Types of financial forecasting

Businesses can conduct financial forecasting in different ways. 

Some of the most popular types of financial forecasting include:

• Sales forecasting – a sales forecast can be produced based on two sales forecasting methodologies – top-down forecasting and bottom-up forecasting. This form of forecasting is beneficial and useful for budgeting and planning production cycles and is fundamental for predicting the business’s future. It includes predicting the company’s sales over a projected fiscal period. To forecast sales, companies can use different methodologies, like time series analysis or qualitative techniques.
• Cash flow forecasting – valuable for the business’s liquidity planning and working capital management, cash flow forecasting helps determine the immediate funding needs of the company. It assesses the business’s cash flow inflows and outflow along with its net balance.
• Budget forecasting – budget forecasting helps make predictions about your company’s performance and assesses the best outcomes of the budget. It works based on the assumption that all activities are carried out as initially planned.
• Income forecasting – income forecasting assesses the business’s past revenue performance and current growth rate. This enables it to make an assessment on the future income of the company. It’s a fundamental part of cash flow and balance sheet forecasting.

These forecasting types can be used in different situations, based on the final purpose. 

Financial forecasting methods 

Along with the different types of financial forecasting, there are also multiple forecasting methods that can be applied during the process. These methods are broadly categorised into two types – quantitative and qualitative.

Below, we offer more insights on each one of the available options.

Quantitative methods

Quantitative forecasts rely on historical numerical data and mathematical tactics to make forecasts about future outcomes. 

Some of the most popular quantitative forecasting methods include:

• Moving average – uses the weighted average of previous time periods to create predictions. It requires a close analysis of the company’s high or low demands and is ideal for short-term predictions.
• Straight line – makes the assumption that a business’s growth rate from previous periods will remain the same in the future. Via the straight line forecasting method, companies multiply their previous year’s revenue by its growth rate. Note that this model doesn’t factor in market fluctuations or potential problems in the supply chain.
• Percent of sales – percent of sales forecasting is usually used for the creation of pro forma statements that can apply to any financial document, including income statements, balance sheets, and cash flow statements. This technique relies on future metrics calculations of financial line items represented as a percentage of sales. For instance, the cost of goods sold is predicted to rise alongside sales, meaning that it’s natural to assume an identical growth rate for the two.
• Linear regression – linear regression forecasting can be performed in two methods – simple or multiple linear regression. Simple linear regression makes predictions based on the relationship between dependent and independent variables, while multiple linear regression is used in the case that two or more variables influence a business’s performance.

Quantitative forecasting methods are usually considered more accurate in making predictions about the future based on past data. 

Qualitative forecasting

Qualitative forecasting takes into account other factors apart from numbers. It prioritises knowledge and experience in making predictions about a company’s performance instead of utilising historical data.

The two qualitative methods that companies often use are:

• Delphi method – consists of experts’ analysis of market conditions. This is usually done via a questionnaire provided by a facilitator.
• Market research – forecasting performed based on findings from market research on points like competition, conditions, consumer behaviour, and others. 

In most cases, qualitative forecasting is preferred when there’s insufficient historical data to assess. 

Key Components of a Financial Forecast

The financial forecasting process usually consists of several standard components.

Below, we look at each one in more detail.

Gathering Historical Financial Data

To be able to evaluate past historical performance data and make accurate predictions about the future, you’ll need access to sales data and other financial data. 

Some of the most essential pieces of information to have include:

• Revenue;
• Losses;
• Equity;
• Liabilities;
• Investments;
• Earnings per share;
• Fixed cost;
• Expenses;
• Investments;
• Income.

Although historical numerical data is predominantly used for quantitative methods of forecasting, it’s an inevitable part of making predictions about a company’s future success on a market.

Choosing the Right Financial Forecasting Model

Above, we explored some of the most popular financial forecasting models. We also noted that each one is unique, offering different insights and capabilities when making future predictions.

To get your financial modelling right, make sure that you’re fully aware about the purpose of your forecasting. Think about whether you need short-term or long-term forecasting and consider the level of detail you want your predictions to offer. 

In addition, ensure that you choose the model that fits with your existing resources. For example, if you don’t have any historical data, it won’t be realistic to focus on quantitative methods of forecasting.

Setting Realistic Financial Goals

Make sure that your company is on track for growth without being too optimistic about its capabilities and future outcomes. 

To achieve this, analyse past performance accurately and look at data from revenue, expenses, profit margins, cash flow, and others. Compare your achievements against others in your niche and always factor in external factors that are out of your control (economic changes, new consumer demand trends, and more).

When setting your goals, make sure they’re specific, measurable, achievable, relevant, and time-bound.

Analysing Market Trends and Economic Indicators

Don’t forget that your future performance won’t always be 100% in your control. 

Regardless of the industry you’re in, market changes are inevitable. To be able to adequately acknowledge these, it’s vital to identify trends on time and factor in any economic indicators that may influence your forecasts.

Creating Revenue Projections

Forecasting revenue is at the heart of financial forecasting. It helps companies understand their future revenue of income that they’ll be able to land during a specified period. 

Revenue projections are based on an analysis of past sales data, market conditions, growth assumptions, and pricing. To make an adequate forecast on revenue, you’ll need to carefully assess each one of these points given the available information you have. 

Estimating Costs and Expenses

To be able to realistically predict future costs, you’ll need to look at existing expenses and any external or internal factors that may influence costs in the future.

Think about your fixed costs (ongoing expenses, like rent, insurance, and salaries), variable costs (fluctuating expenses, like production costs, shipping, and sales commissions), capital expenditures (large one-time purchases for technology or system improvements), and depreciation. 

Forecasting Cash Flow

Cash flow forecasting enables businesses to predict cash flows or the way cash enters and leaves the company. Adequate cash flow financial forecasting provides businesses with the ability to make sure there’s enough liquidity to cover daily expenses. 

To forecast cash flow, you’ll need to analyse your operating cash flow, investing cash flow, financing cash flow, and the timing of receivables and payables. 

Planning for Different Scenarios

As part of financial forecasting, you’ll also need to invest time and energy into preparing for different scenarios. During this process, you’ll need to come up with diverse models based on possible future situations.

By doing this, you’ll be able to react in the most adequate manner in the best-case scenario, worst-case scenario, and base-case scenario.

Utilising Financial Forecasting Software

Today, there are plenty of financial forecasting software solutions that you can rely on to automate part of the process, save time, and receive more accurate results.

Via the use of financial forecasting software, you can do the following:

• Automate calculations; 
• Create comparisons of different scenarios; 
• Visualise data;
• Collaborate across teams and departments; 
• Receive real-time updates, and others.

When selecting the right software for your business, make sure that it can be integrated with other existing systems. Also, check the pricing structures and ensure you have enough budget to comfortably cover expenses.

Most importantly, ensure that there is full-time customer support you can count on.

Common Mistakes to Avoid in Financial Forecasting

To create realistic business goals and financial plans for the future, it’s fundamental that you approach financial forecasting strategically. For every business, the process will look different based on the ultimate goals of the company. However, there are several common mistakes that you can avoid by being aware of them.

For example, one of the popular mistakes is setting revenue projections that are too optimistic. Avoid overestimating sales growth, market size, and customer demand. Instead, use historical data and accurate market research.

Another mistake is to neglect the importance of external market factors. After all, your company doesn’t operate independently of its market. Instead, it’s part of an industry that has a life of its own. Take into account factors like economic changes, industry trends, and competitive pressures. 

The third mistake that companies often make is failing to update forecasts on a regular basis. Creating a financial forecast once won’t be enough to guide your business. Instead, make this a monthly, quarterly, or yearly practice.

Tips for Improving Your Financial Forecasts

To make informed financial decisions and minimise financial risk, we recommend following a set of proven tips.

Here are the most important ones to keep in mind:

• Collect data – make sure that you’ve implemented all necessary practices for regularly collecting revenue, costs, cash flow trends, and other important metrics.
• Always use historical information – rather than relying on intuition, base your financial forecasting on the historical data you’ve collected in the past.
• Factor in market trends – stay up to date with changing market trends and keep an eye on things like inflation, interest rates, and industry growth rates.
• Use several forecasting methods – you can combine different forecasting models in order to gain a more comprehensive view of your future financial performance. 

These are just a few recommendations that can help you make the most of financial forecasts. As you go through the process, you may notice that your business can benefit from other, specific practices in the long term. 

Conclusion

Financial forecasting is a vital component of financial accounting. When performed accurately, it can offer valuable information on the future of your business, helping you make strategic decisions and move towards achieving your goals.

By being aware of the information offered in this article and implementing the recommended best practices, you can enjoy peace of mind knowing that you’re making predictions you can count on.

Frequently Asked Questions

What’s the difference between financial forecasts and financial plans?

A financial forecast represents financial projections, predictions, or estimations of future growth. On the other hand, a financial plan lays out the steps that the company needs to take to generate future income and cover future expenses.

Why is financial forecasting important?

Financial forecasting is key for business success as it delivers vital insights for making informed decisions. It helps companies plan for growth, allocate resources better, and set realistic goals – factors that are equally important for assessing a capital project. Financial forecasting also helps management teams handle changes, spot opportunities, and adjust strategies.

What’s the difference between financial forecasting and budgeting?

The main difference between financial forecasting and budgeting is their purpose within financial planning. While financial forecasting is considered a tool for strategic planning, enabling businesses to reflect real-time conditions and achieve long-term goals like debt reduction, budgeting is a more static process. It helps set spending limits and allocate resources across the business.