What Is Financial Forecasting?
Financial forecasting is required for businesses trying to plan budgets and prepare for the future. This is done with multiple methods of data review and historical analysis.
Companies and other organizations need to create financial plans to set budgets, estimate future revenue, and prepare for different scenarios.
Using historical data can help companies with financial planning in multiple ways, both short term and long term.
What Is Financial Forecasting?
Financial forecasting is a type of planning that uses past financial data sets and metrics to make informed financial decisions about the company's future.
Many companies use pro forma statements to predict what their financial future looks like. Pro forma statements are financial statements like income statements, cash flow statements, and balance sheets from previous years to help establish benchmarks and trends.
Reviewing past business performance and market trends helps business leaders with sales forecasting and financial modeling. Analyzing past metrics and data sets not only helps a company learn about its performance but also information about its industry at large.
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Why Is Financial Forecasting Important?
Decision-making for budgets and cash flow is essential to running a business. Businesses looking to expand in terms of goods and services offered or hiring new employees need to make sure they have a growth rate that can support this, especially if an unpredicted worst-case scenario occurs.
Preparing for an upcoming fiscal year before it happens also helps with finding new stakeholders, as investors won't want to put their money into startups or new businesses that haven't attempted an accurate forecast of their finances.
Types of Financial Forecasting Models
Making financial projections is usually done using one of two types of methods: qualitative forecasting or quantitative forecasting.
Qualitative forecasting looks at market conditions and experts' projections to estimate how a business can perform in the future. This isn't always the best financial forecasting method due to the speculative nature of it. Just looking at current or past market trends can be unreliable due to information unrelated to the company being used to predict future performance. Quantitative forecasting uses historical data to project future finances.
Straight Line
Straight-line forecasting uses historical financial data to establish a growth rate and then projects future financial outcomes at a constant growth rate. Although this method uses actual results and data from a company, it's often inaccurate as financial growth rates change regularly due to changes in the economy at large, both in positive and negative ways.
Moving Average
A moving average takes averages of recent data to make short-term projections. This is a fairly accurate forecasting process because it uses a recent time frame and smaller data sets with a limited range of forecasting. Unlike straight-line forecasting, a moving average will reflect actual changes in a company's financial performance.
Percent of Sales
One other quantitative forecasting method is called percent of sales. This method uses data sets related to the cost of goods sold, inventory, and cash flow to project what financial performance will be. This method relies on assuming that these past percentages will remain constant, and might not provide the most accurate forecast.
Financial Forecasting vs. Budgeting
Financial forecasting and budgeting are closely related, but they are also different processes. Financial forecasting is used to try to accurately budget for the new fiscal year.
A company will review its pro forma statements and evaluate its financial position, regardless of the chosen method. Once they have a better idea of how the business could realistically perform, it will be time to write a budget that is informed by the predictions made in the forecasting process.
Who Performs Financial Forecasting?
Many business owners hire financial forecasting analysts or outsource the process to a firm full of these analysts. These analysts have training in economics, accounting, or finance to learn skills that will prepare them to review individual company finances as well as larger market trends.
Sometimes this will be performed by a company's in-house accounting team instead of a dedicated team of financial forecasting analysts.
Career Paths for Financial Forecasting
Several career paths lead to financial forecasting, with some preparing workers for front-line work and others leading to management.
Financial Analyst
If you're looking for a career in financial forecasting, the most direct career path is to become a financial analyst. Earning a degree in finance, accounting, statistics, math, or economics is a good first step. A bachelor's degree in one of these disciplines will allow you to work as an entry-level analyst, while senior roles will likely require a master's degree and additional certifications.
Accountant
Becoming a certified accountant is another way to enter the field of financial forecasting. Although most accounting degrees won't cover all of the skills that a more specialized finance degree will, having an accounting background will help you with understanding balance sheets, cash flow statements, and more.
Economist
Another path to working in financial forecasting is becoming an economist. Economists study historical financial trends and analyze statistics to help companies make wise financial choices.
