Financial forecasting is indispensable to the success of any business to chart the right course for optimum financial efficiency and profitability. Bidding adieu to guesswork is your best bet if you wish to have a rational blueprint at your disposal.
An old saying goes that the purpose of forward forecasting is not predicting the future but influencing it. For many decades businesses have relied on a few methods for financial projections. One of the drills is- to close the books, reflect on the numbers, and repeat.
Budgetary forecasting is not meant to be done just once, as it is an ongoing process. The forecast must be updated quite regularly as trends or circumstances change. Besides, at the end of each accounting period, you must compare the financials to the forecast and make adjustments accordingly.
Key Elements of Budget Planning and Forecasting
A comprehensive financial forecast comprises three crucial elements, which are as follows:
- Cash flow statement
- Balance sheet
- Income statement
These documents are known as pro forma forms that are based on financial projections. In each accounting period, you prepare the same documents anyways; however, these documents are used to cover the future instead of the past.
Now, we need to know the methods used for collecting the data for pre forma documents. The two categories these methods fall under are:
- Historical or Quantitative data gathering
- Research-based or Qualitative data gathering
For financial projections, you will use a blend of these two methods for forecasts. You are recommended to collect as much data as possible for accurate forecasting.
1. Historical data gathering
Forecast preparation is relatively easier on an accrual basis than cash basis. When prepared by external parties such as investors or lenders, it makes more sense because they are in a position to understand it better. Also, understanding the relationship between revenue and expenses becomes easier on an accrual basis. Knowing what to include in your forecast is of utmost importance. For this purpose, you must extract key insights from past financial statements and data trends.
As the name suggests, collecting historical data can be instrumental in preparing financial projections. You will need to observe your business’s performance in the past for better financial projections. You might need to make a few operational changes, though.
The only downside of historical data gathering is that it doesn’t consider the latest development into account, which could have a considerable impact on your business performance and financial health. The COVID-19 pandemic is a classic example of such developments.
2. Research-based data gathering
Budget planning and forecasting are not always about just analyzing your business’s performance. Whether it is a financial projection for a startup or an established business, observing your competitors’ performance can lead to great insights. Obtaining precise figures may not be possible for you; however, customer ratings can be quite handy in spotting areas in which you can gain a competitive edge.
Research-based data gathering doesn’t demonstrate exceptional measurability; however, unlike historical data gathering, it takes into account several factors that the latter doesn’t. Also, for accurate budgetary forecasting, you should communicate with people outside your company and interview industry experts to access key insights.
Which way to go- Historical or Research Based Data Gathering?
Taking the middle ground is your best bet for reasons more than one. Using qualitative data might lead to over-optimism, which isn’t a good idea, to begin with. In stark contrast, an overly conservative forecast might drive away your investors.
For these reasons, financial experts highly recommend creating 3 financial forecasting scenarios for optimum accuracy.
- Best-case scenario
- Worst-case scenario
- Expected case
Financial forecasting calls for analyzing a lot of data which could be historical or research-based. For accuracy in financial projections, you must also interview outside people and industry experts. Also, it is a good idea to hire a finance business management agency such as FinAccountants.