Financial Forecasting: Definition, Methods, Advantages
When it comes to running a business, it’s hard to know where you’re going if you don’t know where you’ve been. Your past actions inform the future, and by looking backward at your historical data, you can accurately predict what lies ahead.
In that regard, financial forecasting often forms the foundation upon which a successful company is built. It helps gauge your overall health—in terms of resource utilization and cash flow—and then acts as a roadmap that can be used to chart a path forward.
But what does financial forecasting entail? And what are its benefits?
Let’s discuss so you can properly align your budget and strategies with your long-term goals.
What Is Financial Forecasting?
Put simply, financial forecasting looks carefully at what happened in the past as well as what is occurring in the present to make assumptions about the future market and financial performance. It can be helpful to understand more about what sales forecasting is, to tie into financial forecasting.
Financial forecasting leverages historic data market trends to set goals, create a guideline to reach those objectives, and then identify how to best allocate your resources to support those plans. Per CFI, financial forecasting can help you:
- Create a business plan
- Raise capital
- Strategically take on debt
- Expand your business
- Sell or dives assets
- Budget vs forecast
- Allocate capital
- Properly value the business’s worth
What Are Financial Forecasting Models?
Financial forecasting relies upon complex quantitative models to accurately project revenue, margins, expenses, and demand fluctuations. Although there are several methods to choose from, the most fundamental financial model is the three-statement model. It utilizes the following historical documents:
- Income statement – Also known as your profit and loss statement (P&L), this document shows your profitability in terms of net income growth or loss over a specified time period. It identifies a company’s revenue, expenses, total income, and net income.
- Balance sheet – This provides a snapshot of a business's value and liquidity at a given time by listing what it owns and owes. A balance sheet is typically broken up into three sections: assets, liabilities, and equity. To be balanced, the total assets must be equal to the sum of equity and liabilities.
- Cash flow statement – This is used to ascertain how much cash is flowing into and out of the business at a designated time, as well as the total cash on hand. A business’s cash flow statement acts similarly to a consumer’s credit score. Creditors and financiers will carefully examine the numbers to determine whether or not you’re a safe investment. This is also divided into three sections: cash flow from operations, cash flow from investing, and cash flow from financing.
While the three-statement model is often the bedrock of financial forecasting models, it isn’t the only one. There are also:
- Discounted cash flow (DCF) models
- Mergers and acquisitions (M&A) models
- Consolidation models
- Budget models
Advantages of Financial Forecasting
Practically every business will benefit from practicing financial forecasting. If you’re hoping to Sell your Amazon FBAbusiness in the future and are looking for new tools for planning and success, noteworthy advantages include:
- Improved cash flow control – Controlling cash inflows and outflows is one of the most fundamental aspects of managing an eCommerce business. Financial forecasting lets you see how money has been spent and gives you insight into your liquidity.
- A performance benchmark – Accurate forecasting can be used to set performance expectations and sales projections. If you fail to meet those marks, you can then take the necessary corrective actions to get back on track.
- Informed budgeting decisions – Your financial models help you derive greater value from the budgeting and financial planning processes. It aligns your spend allocation and capital utilization with your desired financial outcomes.
- The ability to predict trends – Models rely on complex data sets. With the right tools and technologies, they can identify existing consumer trends while predicting future ones.
- Identify cash-flow gaps – Financial forecasting helps you determine how much cash runway you have and whether you need to take on debt. As Sustainability Consultant, Melissa Montalvo notes, “Having a solid financial projection requires entrepreneurs to ask key questions such as how much money is needed and, importantly, by when.”
- Give investors confidence – Often, external stakeholders are necessary for a business to keep growing. Financial models demonstrate the health and growth of a business, lending confidence to creditors and investors that their investment will generate ROI.
Enhancing Your Financial Forecasting
Financial forecasts empower retailers to plan for the future. They leverage historical data and trends to chart the best path forward. But with so many data points to consider, knowing where to focus your efforts can be a challenge.
Need help? Utilizing an accurate forecasting application like Crystal can elevate your business, providing you with the insights necessary to plan your budgets and create a more accurate inventory forecasting and future strategies.
To learn more about how Crystal could enhance your financial forecasting, sign up today.
CFI. What is Financial Modeling? https://corporatefinanceinstitute.com/resources/knowledge/modeling/what-is-financial-modeling/
Forbes. Without Sound Financial Projections Your Business Plan Is Merely Conceptual. https://www.forbes.com/sites/forbesbusinesscouncil/2022/02/04/without-sound-financial-projections-your-business-plan-is-merely-conceptual/?sh=561e9db957d6