Your business can use historical and recent business performance with the recurrent business cycle and seasonal trends to predict your organization’s financial performance in various scenarios. With this information, you can make critical strategic decisions, such as how much to spend on a major marketing campaign or whether to expand into a new market. There is some risk to using past performance to inform your long-term plans, and this can be compounded during times of economic uncertainty. Your company needs to make plans for the future. During turbulent times, your business can forecast and do scenario planning for the future with our forecasting and scenario planning tools at Centage.
What Is Financial Forecasting?
Financial forecasting identifies trends in external and internal historical data — such as employee hours, expenses, and sales — then projects these trends to provide valuable information to decision-makers. These trends can tell you more about what your business’s financial status may be in the future. It is important to keep a forecast up to date as forecasting further out increases the chance of inaccuracies.
The following statements are essential components for understanding your financial position:
- Balance sheet: This financial statement reports your liabilities, assets, and shareholder equity during a specific time. It shows what your business owes and owns, along with how much shareholders have invested. A balance sheet gives investors or analysts a sense of a company’s financial well-being.
- Profit and loss statement: Also known as an income statement, a profit and loss statement summarizes your company’s costs, expenses, and revenues incurred in a certain period, such as throughout the fiscal year or during a specific quarter. This statement provides information about whether your business can generate a profit by reducing costs or increasing revenue.
- Cash flow statement: This financial statement shows the cash and cash equivalents (CCE) that go in and out of your business, illustrating how well your business generates cash to fund operating expenses and pay debt obligations. The cash flow statement includes transactions the business makes through its three main sources — operations, investment, and financing. The sum of these three areas is known as net cash flow.
These statements illustrate how your organization has been performing and offer insight into what adjustments you may need to make to improve future performance.
Forecast vs. Budget
Though similar, a budget and a forecast serve different purposes. Companies typically create a budget before a forecast. Your budget is a roadmap of your business’s financial goals and how you plan to reach them. A budget helps quantify expected revenues that a company wants to achieve and offers insight into key milestones and resource requirements for achieving your goals. Businesses usually create a budget annually.
A forecast is updated more often, such as monthly or quarterly, and provides the latest picture of what your company can expect based on current realities.
Forecasting is essential to calculate your company’s financial needs. With forecasting, you can decide what capital you need to be successful. If you want to apply for capital like a bank loan, you will need forecasts.
Elements of Financial Forecasts
A forecast includes both budgeted items and actual results to show where your business is headed. When leveraged correctly, a forecast is useful for implementing innovative decisions and changing strategies. Elements of a financial forecast include:
- Historical data: You can use your business’s historical data to forecast your company’s future performance and growth. This data can identify periods that have historically experienced strong or weak growth and help you decide how to allocate your resources accordingly in the future.
- A time horizon: To make significant financial decisions for your business, you need to look into the future. Your time horizon can range anywhere from a year to several years. The further out you forecast, the less accurate the estimates will be, so it’s critical you update your forecast often, especially when you learn new information.
- Reflection of strategic decisions: Financial foresting also reflects your upcoming decisions, such as whether you will cut costs, improve margins, or invest more aggressively.
- Industry context: Your business’s context also influences your financial forecasting. Consider the industry and environment where your company operates, along with factors that impact your business, suppliers, and buyers. It is important to stay up to date on relevant industry and market news to maintain an accurate forecast.
When you understand the role financial forecasting plays in your business operations, you can successfully leverage financial forecasting methods.
Financial Forecasting Methods
You can use qualitative or quantitative financial forecasting methods to determine your future growth and income rates.
Qualitative Forecasting Methods
Qualitative forecasting methods typically deal with more ambiguous or vague values. You can use one of these forecasting methods when you do not have access to all the information and want to make estimates regarding specific aspects of your company. For example, suppose you own a retail business and want to expand into a new area. In that case, qualitative forecasting methods can help you determine how much time it would take for this new area to turn profitable.
If you only need to make predictions about your business’s minor aspects that do not significantly impact your operations, qualitative forecasting can be helpful but is typically less reliable than a quantitative forecasting method.
- Delphi method: This forecasting method involves analyzing market conditions to predict your business’s performance. A facilitator submits questionnaires to a group of consulting experts to leverage their knowledge and experience for business performance forecasts. The facilitator then compiles the anonymous responses, redistributes them to the group, and conducts more rounds of questionnaires. The result is ultimately the true consensus of what the group of experts thinks.
- Market research method: You can use market demand research for organizational planning and to help your business obtain a comprehensive market view based on consumer patterns, fluctuating conditions, and competition. This method is critical for startups without historical data.
Quantitative Forecasting Methods
Methods for quantitative forecasting are based on real data, including sales, financial statements, and bank balances. Companies use quantitative forecasting to analyze business scenarios and performance, which can be especially helpful when your business has valuable historical information.
For example, you can use quantitative forecasting to predict when you will have a certain amount of your bank loan paid off or the value of a regular customer’s order. Though no forecast can be guaranteed, the hard numbers involved in a quantitative forecasting method can give you a higher degree of confidence.
- Straight-line method: This method assumes your business’s historical growth rate will stay constant. To forecast future revenue, multiply your previous year’s revenue by the growth rate. Straight-line forecasting is a starting point, but it does not account for supply chain issues or market fluctuations, so it is less dynamic than other quantitative methods.
- Moving average method: With this method, you forecast the future by calculating the average of previous periods. The moving average method closely examines your company’s low or high demands, which means it tends to be most advantageous for short-term financial forecasting, such as the next month or the next quarter. Using this method to estimate further into the future can be problematic as it may not account for seasonal trends.
- Percent of sales method: Percent of sales forecasting is used to create internal financial statements and calculate future metrics of certain financial items. For example, the cost of goods sold tends to increase proportionally with sales, so you can apply the same growth rate estimate to both. Forecasting the percent of sales can be done by examining the percentage of the account’s historical profits. Assuming the numbers remain steady, you can calculate this by dividing an account by the sales.
- Simple linear regression method: This method uses the relationship between dependent and independent variables to forecast metrics. The independent variable influences the dependent variable, and the dependent variable represents the forecasted amount.
- Multiple linear regression method: You may choose the multiple linear regression method when multiple variables directly impact your business’s performance. Since this method accounts for more than one variable, it can provide a more accurate forecast. A linear relationship must exist between the independent and dependent variables to use this method.
Financial Scenario Planning During Turbulent Times
Though the nature of financial scenario planning is always somewhat uncertain, successful scenario planning can be even more challenging during especially turbulent times. A sound financial forecast can help you navigate the tough times more confidently. Successfully plan for financial scenarios during uncertain times with the following tips:
- Utilize your team: Utilize your team’s financial management and technology skills to develop optimal solutions for your business. Speak with team members who can provide instant insights in their area of expertise that could otherwise not appear in your metrics for weeks. Doing so can help you perform financial scenario planning during times of uncertainty.
- Collect data and analytics: Data informs decisions, and though you may not want to spend this time compiling new data, you can review metrics you may not have previously considered relevant and data you are already collecting. Insights can come from a combination of smaller metrics. A single factor could be enough to provide a new understanding of your business and cause you to adjust your analysis.
- Manage cash flow: Ensuring your company has the proper cash flow to withstand periods of uncertainty and downturns is essential. Effectively managing your cash flow can determine whether your business makes it through turbulent times. Assess your cash flow regularly and implement dashboards and other analytics to facilitate decision-making.
- Keep forecasting agile: Agile forecasting lets you quickly adapt your business to unexpected shifts in market conditions. You can forecast again based on new business drivers and actuals. The key to a reliable prediction of how today’s market conditions will affect your bottom line is identifying critical performance trends right away so you can rapidly modify plans. Use your most recent actuals and historical data to guide your re-forecasting efforts often.
- Become comfortable with estimations: When preparing your financial forecasts, become comfortable with estimates and ranges rather than precise numbers. Many factors can lead to times of uncertainty, such as trade negotiations, exchange rates, monetary policies, and employee health. In uncertain times, it can be helpful to use a broader range than you typically would.
- Turn to your technology: Data visualization, analysis, and accessibility are essential to turning your data into insights. These components are also necessary for presenting data in a way that decision-makers can easily understand and use to create action plans. For a comprehensive view of your business, combine internal, external, non-financial, and financial data into one source you can easily access.
- Leverage scenario planning: You can use scenario planning to test the implications of your plans against assumptions about future and existing scenarios. With agile models, you can assess the influence of scenarios on metrics like costs, cash flow, and revenue. Scenario planning allows you to focus on certain metrics and how they impact your business’s performance, giving you the insights needed to make tough decisions quickly.
- Communicate with your team: Communicate with your team regularly and examine how your business is performing, how metrics are changing, and what insights the data gives you.
- Implement ways to relieve stress among your team: Stress can impact our ability to work effectively, and the stress of uncertain times can lead to errors and inaccuracies in your forecasts. Look for ways to relieve stress for your team members and thank them for their dedication.
You can also use financial forecasting software to help with financial scenario planning.
How Centage’s Financial Forecasting Software Can Help
To a certain extent, every plan is based on assumptions. After gathering input from every department head, setting goals, and estimating expenses, you can use our financial forecasting software to help with scenario planning. Centage Corporation’s software, Planning Maestro®, allows you to test assumptions and predict their effect on your financial statements. When you choose Planning Maestro, you can enjoy the benefits of business forecasting software, such as:
- Test the sensitivity of your plan to a variable and the effect on your financial statements.
- Generate variance reports of forecasted, budget, and actual numbers.
- Ensure that every input is processed according to your unique business structure with automated workflows and built-in compliance.
- Get a long-term view of your business’s finances with rolling forecasts.
- Accurately forecast how multiple scenarios and variables can impact your business to make recommendations and plan for the future.
Planning Maestro allows you to create unlimited scenarios with different models. You can then test the consequences of every scenario without impacting your current plan or budget. Use this scenario planning tool to stay ahead of any risky situations your organization may face and make informed business decisions, big or small. Planning Maestro is available in three editions:
- Standard: If you have a small finance team and want to improve, simplify, and automate the accuracy of your forecasting and budgeting processes, this edition may be perfect for your business.
- Professional: The professional edition is suitable for both small and medium-sized organizations that want more powerful, frequent, and collaborative planning.
- Enterprise: This edition is perfect for larger teams and organizations that deal with complex planning, forecasting, and budgeting.
During uncertain times or volatile markets, predicting future trends and opportunities can be challenging. Our forecasting software makes it easier.
Request a Quote to Get the Best Forecasting Software
At Centage Corporation, we offer corporate software to financial officers seeking assistance with budgeting, forecasting, and financial scenario analysis. With our software, you can track balances, analyze cash flows, and project profit and loss. Our solutions can also connect with ERP software to consolidate your business data for easier analysis.
Our leading cloud Financial Planning and Analytics (FP&A) platform equips your finance team with tools to confidently propose action plans supported by solid insights and data, accurately report on results and progress, and provide the executive team with strategic recommendations. Schedule a demo of Planning Maestro® or request a quote from Centage Corporation.