Why Are Financial Forecasts Important to Businesses?
Uncertainty is a certainty in business. No one knows what tomorrow has in store, let alone the coming months and years.
And yet the financial forecast is a staple of business management.
What kind of utility can anyone expect to get out of a set of projections that could change the day after they’re released? More than you might expect.
Financial forecasts are a critical tool that actually help businesses navigate the unpredictability of the future. They allow leaders to make more informed decisions, allocate resources efficiently, and steer the company toward its goals.
The following are some of the basics of financial forecasting, as well as the benefits it delivers.
The Basics of Financial Forecasting
A financial forecast is an estimate of future financial metrics. Your typical company financial forecast will include projections for revenues (sales), expenses, profits (earnings) and cash flow, among other figures. The projections will cover a specified period, usually a quarter or a year.
Here are some of the fundamental steps involved in putting together a financial forecast:
- Gather historical data: Historical data provides a foundation for predicting future performance. So, you’ll need to start by collecting past financial statements, sales records and expense reports, among other data and documents.
- Identify reasonable assumptions: There’s no way of knowing the future — the best you can do is make educated assumptions about future conditions. For instance, you’ll need to make assumptions based on expected changes in your industry/market, economic conditions, and/or company-specific factors such as new product launches or geographical expansion.
- Choose a forecasting method: Most forecasting methods can be broken down into two categories: qualitative and quantitative. Quantitative methods, such as straight-line, moving average and percent-of-sales forecasting, are heavily based on historical data. Qualitative methods, such as market research and the Delphi method (consulting with experts), go beyond the numbers.
- Develop the forecast: Create projections for revenue, expenses and other key financial metrics using the chosen method. This typically involves building detailed financial models in spreadsheets.
- Review and revise: Forecasts have a better chance of remaining relevant throughout the year if you regularly review and update them to reflect any new information or changing conditions. The less you tend to forecasts, the less relevant and accurate they might become.
The Benefits of Financial Forecasting
Financial forecasting offers numerous benefits, from ensuring a business remains afloat to providing the optimal conditions for growth.
Here are some key advantages:
Informed Decision-Making
Financial forecasting provides a basis for informed decision-making. Once they’ve got a grasp on future financial scenarios, business leaders can make wiser strategic decisions about hiring, expanding, investing, and more.
Resource Allocation
No company enjoys limitless resources, making intelligent resource allocation a must. Financial forecasts help businesses determine where to allocate capital, labor and time in a way that makes the most of their resources without overextending themselves.
Performance Monitoring
One can’t really tell how well or poorly their business is doing without appropriate benchmarks to measure against. By comparing actual outcomes with forecasted results, a business can identify areas of under- and overperformance. This enables managers to take corrective actions promptly and adjust their strategies to stay on track.
Risk Management
Forecasting allows businesses to identify potential risks and develop strategies to mitigate them. For instance, if a forecast predicts a downturn in sales, a company can take preemptive measures, such as reducing costs or diversifying its product line to try to cushion the impact. Being proactive about risk management can help a business avoid a financial crisis and maintain stability.
Investor Confidence
Investors and other stakeholders are more likely to have confidence in a business that has a clear understanding of its future financial prospects. Also, a well-prepared financial forecast can be a powerful tool (or a baseline requirement) for securing funding. It shows potential investors that the company has a solid plan for growth and an educated view of its financial future.
Does Your Firm Have a Financial Forecast? If Not, We Can Fix That.
No one can predict the future with absolute certainty. But financial forecasts are a useful way to anticipate and prepare for potential scenarios — good and bad.
If you want to start producing these valuable estimates, but you don’t have the accounting resources, get in touch with McManamon & Co. We provide accounting, tax, fraud, forensic and consulting services for small and midsize businesses — specifically, our outsourced CFO services can help you tackle forecasting and other essential tasks, even if you don’t have the resources to justify a full-time accountant.
Want to learn more? Call us at 440.892.8900 or contact us online.
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