What is Financial Forecasting? And Why Should You Care?

Posted By Pedro Gonzalez, CPA on Nov 17, 2020 | 0 comments


Financial forecasting is the process of predicting the future outcome of economic, marketing, and financial trends. It is the process of estimating or predicting a business’s future performance. The financial prognosis obtained through the financial forecasting process will help you predict how your business will look financially in the future. Analysis of future trends in areas like sales performance and customer behavior is key to developing an accurate business plan, determining appropriate levels of funding for your projects and acquisitions, supporting banking and investors requirements, and managing cash flow to name a few.

Financial forecasting is a vital part of business planning that uses past financial performance and current conditions or trends to predict future company performance. In other words, financial forecasts are a tool by which businesses can set and meet goals.

Financial forecasting is an analytical process based on systematic procedures that estimates and predicts future patterns using historical business data, business statistics, information about the economy, industry trends and more. The financial forecast is a managerial tool from which business decisions and strategies are formulated.

Why is financial forecasting essential for your business?

Cash flow is the lifeblood of businesses. As a business owner, you need to make sure that you allocate your finances to different processes and departments in the smartest way possible regardless of the size of your business. This is where financial forecasting becomes important for businesses.

A financial forecast is no less than a map for your business; it provides a clear path towards your business goals. In simple terms, it is a financial plan that estimates the projected income and projected expenses of your business. It has the capability to provide several advantages:

  1. Provides better control over cash flow. It allows you to allocate money to different tasks in a more efficient manner and helps you channel your cash in the right direction.
  2. Shows financial viability of new ventures. A financial forecast is a representation of how financially viable a new business venture is expected to be. By estimating the projected income and projected expenses, you will be able to know whether it is a sound idea or not.
  3. Measures financial performance. One crucial aspect of financial forecasting is that it allows you to measure your future financial performance against set standards. It acts as a benchmark against which you can match your performance, identify holes in your operation, and take necessary corrective actions.
  4. Lowers financial risks. Financial forecasting helps you identify processes that are the most money consuming. You can lower your financial risks by pumping money from such processes and channeling it towards more profitable ones.
  5. Determine future cash requirements. By getting a clear idea of projected expenses, you will be able to determine how much money your business will need. It helps you make sound financial decisions by specifying whether your business needs private equity or borrowings.
  6. Acquiring financing. You need financial forecasting to get necessary investment from lenders and investors. A sound financial forecast presented before the lender makes you look more credible and trustworthy. You can leverage that goodwill to secure required financing for business expansion and operation.
  7. To chart a course of where you want to go. If you aim for nothing, that is probably what you will get. The financial forecast becomes the road-map of what you are aiming to achieve and how you intend to get there. It provides a lot of insight as to the resource requirements and milestones needed to reach your goals.
  8. Sound management decisions. As a business owner and manager, important decisions need to be made on a regular basis. The accuracy and correctness of your decisions are largely dependent on your true understanding of your business position.
  9. Financial Requirements. Financial forecasting plays an important role in calculating the financial needs of your business. Your business will need adequate capital. Whether it be fixed or working capital, financial forecasting will help you make accurate predictions about what your business needs to succeed. If your business is expanding, further capital may be needed for your new venture. You would then need to have a good idea of what capital will be required to be successful. Forecasts will help you decide if additional private equity or borrowing is necessary.

Forecasting is extremely important today for any business regardless of their size, but unfortunately, many small businesses do not conduct this process. Business owners are often too busy solving problems and searching for the next sale and miss to be forward thinking. In addition, the challenges of COVID-19 in our economy, has made financial forecasting more challenging. However, no forecasting is not an option. Businesses must adapt to the current circumstances and forecasting must adapt and become flexible and agile to make the necessary modifications as new data becomes available.

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