How Financial Forecasting Can Benefit your Business

Financial Forecasting is a powerful tool that business owners can use to plan for the future. If you're looking to grow your business, having an idea of its future financial performance will enable you to make smart choices that help you achieve your goals. No matter the size of your business, a well-researched forecast will provide you with valuable insight that'll help keep you competitive and successful.

Why write a financial forecast?

Forecasts will outline potential risks and opportunities and you will be able to allocate your resources to meet those challenges. For example, you can identify potential cashflow shortages or periods of increased expenses. Looking forward can also help you to find new market opportunities or potential investments that you might want to plan for.

Planning for the future, whether that be the next financial year, the next three years or the next five, will help your business achieve its goals and remain competitive in its industry. Accurate forecasts will allow you to make plans for your resources (everything from capital to labour), in the long term.

If your goals will require help from an investor or another stakeholder, a forecast can help you communicate the strength of your business and strategies to them. Being able to demonstrate the future performance of your company will build trust in your work and confidence in your business and make it easier to secure funding.

You can also use a forecast to track your business' progress by comparing the company's real performance to the metrics outlined in your projection. This is a great tool for reviewing a period of time but can also be used to pick up problems during the period you've forecast and adjust to correct them.

What is a financial forecast?

We can never know what the future holds but we can make accurate estimates based on previous performance. This process is called Financial Forecasting. The process involves analysing a business's historical financial data as well as external factors like industry trends and how the global and local economies are faring. Typically you would gather financial projections from your business such as cash flow and expenses, and then choose a time frame – anything from the next quarter to several years in the future.

There are a variety of techniques you can use to create accurate financial forecasts such as trend analysis, statistical forecasting and scenario planning. Which technique you choose will depend on the type of data you have available, what your goals for the forecast are, and how accurate you wish to be.

Trend Analysis

Looking back at your businesses' historical financial data and identifying patterns is trend analysis. It's useful for forecasting revenue, expenses, and cash flow. For example, you may be able to see when your business typically has its “peak season”.

There are several types of trend analysis, each helpful in its own way:

• Time-series analysis looks at data over a specific period of time – a quarter, a year or even longer.
• Moving averages is a method that involves plotting the average of a dataset over a specific period of time, like 3 to 6 months. This has the benefit of “smoothing out” short-term peaks and troughs in the data, making it easier to see the trends.
• Seasonal decomposition is a time-series analysis technique that allows you to separate out any seasonality in the data so that you can identify the underlying trends.

Trend analysis doesn't consider any external factors that could impact your financial forecasting, so it's usually done alongside other forecasting techniques.

Statistical Forecasting

As the name suggests, statistical forecasting uses mathematical and statistical methods to analyse historic data. Like trend analysis, statistical forecasting can be used to study a specific period of time, but there are several analysis methods that fall under statistical forecasting that use other parameters:

• Econometrics combine statistical methods with economic and financial theory, to analyse data and make predictions.
• Regression analysis uses statistical analysis to identify relationships between variables. For example, how changes in inflation are related to changes in GDP.

Statistical forecasting can provide more accurate predictions (if your data is accurate!) about future performance than trend analysis and can be used for complex systems like economies and stock markets.

Scenario Planning

When you're planning for the future it's good to consider likely scenarios, and how you can prepare for them. Scenario Planning is a strategic planning technique that helps you do just that. By creating a set of plausible scenarios that are consistent with the way your business behaves, you can identify and plan for any potential risks and opportunities that might arise.

A basic scenario plan takes four steps:

1. You identify key factors and drivers that could influence the future of your business, such as the economy, new technology or upcoming regulations.
2. Outline a set of plausible scenarios based on various combinations of the key factors you identified.
3. Analyse the scenarios you outlined, looking for potential risks and opportunities.
4. Plan the actions that your business can take in the event of each scenario, so you can respond in the most effective manner.

These scenarios can be used to make strategic plans across all areas of your business. Good scenario planning is not a one-time thing – you should return to plans periodically to update them so that they accurately reflect any changes in your business and its environment. On its own, scenario planning isn't a financial forecast but combined with other techniques you can build a set of strategies to weatherproof your business or help it grow to new heights.

Take the stress out of financial forecasts

Often day-to-day work gets in the way of stopping to make plans for the future, especially when it involves making more work for yourself. The team at Giltinan and Kennedy are experienced at generating financial forecasts for any size business, so you can trust they will be meaningful and robust. To find out more about how we can help you plan ahead, get in touch today.