How to do financial forecasting in 7 steps
Many integral aspects of your company's current and future operations hinge on the results of your financial forecasts. For example, forecasting results will influence investors' decisions, determine how much your company can get in credit, and more.
As such, accuracy cannot be overemphasized. Here is a step-by-step guide to ensure that you do it right:
1. Define the purpose of a financial forecast
What do you hope to learn from the financial forecast? Do you hope to estimate how many units of your products or services you will sell? Or perhaps you wish to see how the company's current budget will shape its future? Defining your financial forecast's purpose is essential to determining which metrics and factors to consider when doing it.
2. Gather past financial statements and historical data
One of the components of financial forecasting involves analyzing past financial data, as explained. As such, it is important to gather all relevant historical data and records, including:
- Comprehensive income
- Earnings per share
- Fixed costs
It's important to ensure that you gather all required information as your financial forecast's results will be inaccurate if you exclude relevant data.
3. Choose a time frame for your forecast
Financial forecasts are designed to give business owners an insight into the company's future. You get to decide how far into the future to look, and it can range from several weeks to several years. However, most companies do forecasts for one fiscal year.
Financial forecasts change over time as factors such as business and market trends change. Consequently, it is worth noting that financial forecasting is more accurate in the short term than in the long term.
4. Choose a financial forecast method
There are two financial forecasting methods:
- Quantitative forecasting uses historical information and data to identify trends, reliable patterns, and trends.
- Qualitative forecasting analyzes experts' opinions and sentiments about the company and market as a whole.
Each method is suitable for different uses and has its strengths and shortcomings. However, qualitative forecasting is more suitable for startups without past data to which they can refer.
5. Document and monitor results
Financial forecasts are never 100% accurate and tend to change over time. As such, it is important to document and monitor your forecast's results over time, especially after major internal and external developments. It is also important to update your forecasts to reflect the latest developments. Using forecasting software to automate related tasks may help too.
6. Analyze financial data
Regularly analyzing financial data is the best way to tell whether your financial forecasts are accurate. Additionally, continuous financial management and analysis helps you prepare better for the next financial forecast and gives you crucial insights into the company's current financial performance.
7. Repeat based on the previously defined time frame
Smart companies conduct regular financial forecasting to stay in the know and in control. As such, it is advisable to repeat the process once the time period set for the current financial forecast elapses. It's also prudent to keep collecting, recording, and analyzing data to improve your financial forecasts' accuracy.