![Share on Facebook Facebook](https://sp-ao.shortpixel.ai/client/to_auto,q_glossy,ret_img,w_24,h_24/https://preferredcfo.com/wp-content/plugins/social-media-feather/synved-social/image/social/regular/48x48/facebook.png)
![Share on Twitter twitter](https://sp-ao.shortpixel.ai/client/to_auto,q_glossy,ret_img,w_24,h_24/https://preferredcfo.com/wp-content/plugins/social-media-feather/synved-social/image/social/regular/48x48/twitter.png)
![Pin it with Pinterest pinterest](https://sp-ao.shortpixel.ai/client/to_auto,q_glossy,ret_img,w_24,h_24/https://preferredcfo.com/wp-content/plugins/social-media-feather/synved-social/image/social/regular/48x48/pinterest.png)
![Share on Linkedin linkedin](https://sp-ao.shortpixel.ai/client/to_auto,q_glossy,ret_img,w_24,h_24/https://preferredcfo.com/wp-content/plugins/social-media-feather/synved-social/image/social/regular/48x48/linkedin.png)
![Share by email mail](https://sp-ao.shortpixel.ai/client/to_auto,q_glossy,ret_img,w_24,h_24/https://preferredcfo.com/wp-content/plugins/social-media-feather/synved-social/image/social/regular/48x48/mail.png)
An essential factor in business management is the ability to discern where the company is headed and what course to chart for maximum profitability. Intuition and guesswork are not sufficient to create a rational roadmap for the future. For that, the process of financial forecasting is invaluable.
What Is Financial Forecasting?
Financial forecasting is creating an educated prediction of future business performance over a set period. It helps business leaders create budgets, plan resources, anticipate risks, improve profitability, and manage growth. While it is impossible to make such a prediction with 100% accuracy, there are several ways to ensure that a financial forecast is reasonable and on track.
Financial forecasting should not be a one-time effort. As circumstances and trends change, the forecast should be updated regularly. It is wise to compare actual financials to the forecast at the end of each accounting period and adjust the forecast accordingly. This ensures your forecast stays accurate and relevant so it can be used as a regular tool to inform business decisions.
What Are the Elements of Financial Forecasting?
A complete financial forecast includes three elements: a balance sheet, cash flow statement, and income statement. These are considered “pro forma” documents, or documents that are based on projections or presumptions. These documents are the same as the ones you prepare each accounting period, except that they cover the future rather than the past.
A financial forecast might also include a position statement, an analysis of industry trends and competitor positioning, or other documents appropriate to the purpose of the forecast.
The methods of collecting data for your pro forma documents fall into two general categories: historical and research-based. You will probably use some mixture of both in building your forecast. The more data you collect and analyze, the more accurate your forecast is likely to be.
Historical (Quantitative) Data Gathering
Note: Forecasts are more easily prepared and understood by outside parties such as investors or lenders when financial statements have been prepared on an accrual basis rather than a cash basis. The association of revenues with expenses is more clearly understood and more universally accepted or required on an accrual basis.
Reviewing past financial statements and looking for trends can help you determine what to put in your forecast. For instance, if you had a consistent 3% increase in month-to-month sales over the last year and nothing major has changed or is expected to change, then you could reasonably predict the same growth pattern for next year. It is likely that there will be a corresponding increase in variable expenses as well. If you look at past records and see a pattern of decreased sales over the summer (seasonality), you can anticipate the same for the coming year.
Historical data gathering is basically observing past business performance and projecting similar performance into the future. This data is particularly useful if you anticipate steady growth and few operational changes. The disadvantage is that it does not take into account new developments such as market trends or increasing competition. It may also be skewed by anomalous circumstances such as the effects of the COVID-19 pandemic.
Historical data is relatively easy to collect and analyze. It is the quickest and least expensive way of creating financial forecasts for internal use within a company or department. It may not, however, be sufficient for presenting to a potential lender or investor.
Research-Based (Qualitative) Data Gathering
Looking outside your company to discover what others are doing may give you insights into what your business has the potential to achieve. This can best be done by observing competitors whose companies are similar to yours in size and scope. You may not be able to get exact figures, but you can see what is and is not working for them and estimate their profits and expenses. Customer ratings and comments on their social media pages may help you find areas where you might gain a competitive edge. For instance, if customers are complaining about your competitor’s slow delivery times, you might investigate what delivery services they are using and consider the possible financial benefit of using a faster service for your own deliveries.
You may gain insights into the future by interviewing knowledgeable people inside and outside your company. Industry publications will often provide information on upcoming developments, market trends, and changes in consumer sentiment. All these things may be considered as you make your financial projections.
Research-based data is not necessarily measurable, but it considers important factors that cannot be found in historical reports. This type of information gathering is necessary for new companies or new projects where little historical information is available. It is also necessary when you are preparing a presentation for a lender or financial partner.
Take the Middle Ground
When creating a financial forecast, particularly if you are using qualitative data, it is best to avoid being too optimistic. On the other hand, an overly conservative forecast may discourage investors or disincentivize innovation. Many financial experts (including outsourced CFOs) usually create three financial forecasting scenarios: a worst case, best case, and expected case.
Constant reassessment of your forecasts will help you make them more realistic. At Preferred CFO, our outsourced CFO team uses financial forecasts as a rolling budget to continually update the forecast as an accurate roadmap for the future.
Why Do You Need a Financial Forecast?
There are four primary reasons for doing a financial forecast.
- Quantify goals. The primary reason is to clearly identify and quantify the company’s financial goal and as part of that identify the steps and the costs required to achieve those goals. This will include capital as well as operational expense projections. The projected balance sheet and associated cash flow forecast will determine if the company can achieve those goals with the current capital level.
- Stakeholder Assurance. The second is to provide investors, lenders, and stakeholders with assurance that the company is on track to meet its targets
- The third is to be able to be more quickly able to determine when things don’t go as planned so necessary adjustments can be made to overcome the challenge or remedy the situation.
- Maximize outcomes. The fourth is to easily test financial decisions and their impact on the bottom line so the business may maximize outcomes.
While some companies forecast only a few months or a year or two into the future, others find it highly beneficial to maintain a 5-year forecast. Ideally, you will maintain short-term, mid-term, and long-term projections.
In Summary
Financial forecasting combines historical data with market research to make informed predictions of future business performance. This allows a company to confidently plan the future, prepare for eventualities, and set a course for growth. The more robust the forecast, the greater the benefit to the company. If you would like further information or assistance with your financial forecasting, we invite you to contact Preferred CFO.
About the Author
![David Guyaux](https://sp-ao.shortpixel.ai/client/to_auto,q_glossy,ret_img,w_300,h_303/https://preferredcfo.com/wp-content/uploads/2017/01/David-Guyaux-e1521517726780.png)
David Guyaux
David Guyaux brings over 25 years of experience as CFO, VP of Finance, and Controller roles within both public and private enterprises. He has organized finances for companies to turn around operations and meet compliance and governmental requirements, as well as to prepare for mergers and acquisitions.
You may also be interested in...
Leveraging Financial Ratios to Assess Company Performance
Overview Financial ratios are crucial tools for any business or investor looking to assess the financial health of a company. These ratios provide insights into various aspects of a company's operations, such as liquidity, solvency, profitability, and efficiency....
Exploring Different Financing Options for Business Expansion
Exploring different options for business expansion is essential for companies looking to thrive in today’s dynamic business environment. By expanding their businesses and benchmarking financial performance, entrepreneurs can unlock new opportunities, drive sustainable growth, and achieve their business objectives.
Why Preferred CFO’s HR Solutions Trump Corporate Giants
In the complex terrain of human resources solutions and payroll management, corporate giants like ADP and Paychex are often the go-to for their seemingly comprehensive solutions that cater to businesses of all sizes. Yet, the reality for many clients is a growing...
Business Budgeting Essentials
Crafting and implementing an effective business budget is a dynamic and ongoing process. With a strategic and adaptable budget, businesses can enhance financial stability and pave the way for sustainable growth.
Tax Planning Strategy For Small Businesses
Business Tax Planning Strategies:A Small Business Owner's Guide to Savings & Compliance Effective tax planning isn't just about minimizing liabilities; it's about strategically positioning businesses for long-term success. From small enterprises to larger...
Financial Advice for the New Entrepreneur
Profitability is not just a financial metric; it’s a mindset that should permeate your business operations. By prioritizing profitability, you can grow your startup into a financially stable and sustainable business that can weather economic challenges and thrive in the long term.
Guide to HR Outsourcing: Strategies for Modern Business
HR Outsourcing for your business In this dynamic and ever changing business landscape, the questions of "What is HR outsourcing?" and “Do I need a fractional HR team?” have become increasingly relevant. HR outsourcing is a strategic practice that involves delegating...
Managing Business Expenses in Inflationary Times
Inflationary times pose challenges, but with strategic expense management, businesses can navigate these periods successfully. By understanding the impact of inflation, implementing cost-cutting measures, engaging in strategic financial planning, and embracing sustainable practices, businesses can not only weather economic storms but also position themselves for long-term success.
Why You Need Fractional CFO Services in 2024
Why You Need Fractional CFO Services in 2024 In the fast-paced, ever-evolving business environment of 2024, companies across the globe are increasingly recognizing the need for innovative financial management strategies. The US and global economy is in a state of...
20 Things Every Entrepreneur Needs to Know about Accounting
While entrepreneurs don’t need to become professional accountants, having a solid foundation in accounting principles and practices will enable them to make informed financial decisions, communicate effectively with financial professionals, and ensure the financial health and success of their business.
Top Human Resources Strategies for 2024
Welcome to our insightful webinar featuring Tom Applegarth, a renowned expert in the field of Human Resources and our expert Outsourced Human Resources Manager at Preferred CFO. In this webinar, Tom shared with us his valuable strategies and insights for HR success in...
Is it Time to Sell Your Business?
Deciding whether and when to sell your business is a significant and complex decision that should not be undertaken lightly. If the timing is right, the offer is right, and the necessary work is done correctly, selling your business can be highly beneficial. However,...
![Share on Facebook Facebook](https://sp-ao.shortpixel.ai/client/to_auto,q_glossy,ret_img,w_24,h_24/https://preferredcfo.com/wp-content/plugins/social-media-feather/synved-social/image/social/regular/48x48/facebook.png)
![Share on Twitter twitter](https://sp-ao.shortpixel.ai/client/to_auto,q_glossy,ret_img,w_24,h_24/https://preferredcfo.com/wp-content/plugins/social-media-feather/synved-social/image/social/regular/48x48/twitter.png)
![Pin it with Pinterest pinterest](https://sp-ao.shortpixel.ai/client/to_auto,q_glossy,ret_img,w_24,h_24/https://preferredcfo.com/wp-content/plugins/social-media-feather/synved-social/image/social/regular/48x48/pinterest.png)
![Share on Linkedin linkedin](https://sp-ao.shortpixel.ai/client/to_auto,q_glossy,ret_img,w_24,h_24/https://preferredcfo.com/wp-content/plugins/social-media-feather/synved-social/image/social/regular/48x48/linkedin.png)
![Share by email mail](https://sp-ao.shortpixel.ai/client/to_auto,q_glossy,ret_img,w_24,h_24/https://preferredcfo.com/wp-content/plugins/social-media-feather/synved-social/image/social/regular/48x48/mail.png)