While there is no all-knowing presence that can tell you without a doubt what your income, losses, expenditures, and other business accounting and financial factors will be with absolute certainty, business owners can implement financial forecasting methods based on past performance metrics to get close to finding those answers.
What exactly is financial forecasting and how can it help your business?
Interactive Accountants has the ultimate guide to financial forecasting. Planning and preparing for your business' future will give you, your shareholders and other investors the best preview of the financial happenings of your business so you can set it up for success.
It is impossible to know for certain all of the factors that might affect your business at any given time– from market values, new technologies, industry operation changes, and more beyond your control, as an entrepreneur, you know anything can happen in the business world. However, many things are within your control as a business owner, such as the ability to make predictions for the future based on past and present data.
Financial forecasting is the method of analyzing the performance metrics related to the past and present of your business in order to predict future performance outcomes. By closely examining revenue, cash flow, expenses, and sales from the past, you can make educated guesses as to how your business will perform in the future.
For business owners, shareholders, investors, and management to make important decisions related to the business, they need to have a general idea of how each decision might affect the company.
Financial forecasting can help make decisions for:
Financial forecasting is additionally important in order to maintain a forward-thinking mindset for your company. If there are future projects or funding endeavors you are considering, financial forecasting allows you to adequately plan for and allocate the appropriate amount of time and funding to those ventures.
It’s important not to confuse financial forecasts with tangible financial data. A forecast is a prediction based on data that already exists but has the ability to change. While there is no magic crystal ball that can determine your business’ financial accounting outcomes of the future, financial forecasting is the closest thing business owners have to provide the most likely financial outcomes that lay ahead.
Financial forecasts should include the following components based on past performance metrics:
While it would be ideal to be able to look at your business as fail-proof, it is not realistic. Any business can undergo unforeseen circumstances like a cyberattack, market crash, employee turnover, natural disasters– or as we all know all too well a global pandemic.
It would be impossible to predict every single potential setback that might affect the business operation, but there are ways to prepare for best and worst-case scenarios with the use of data currently at your disposal.
The methods for financial forecasting to predict business performance can be either quantitative where data can be measured or qualitative where data cannot be measured. When done well, financial forecasting can provide a reliable outlook ahead for the financial outcomes related to your business.
The simplest, most approachable forecasting method includes minimal math and is based on historical data from the business’ cash flow. Straight-line forecasting uses past growth rates to predict future sales with a simple formula.
The formula for straight line method financial forecasting is to calculate the growth rate of the relevant sales data, and multiply that data by the growth rate for the future, predicted amount.
For example, if last year’s revenue was $100,000 and you have a historical growth rate of 20% each year, the financial forecast would be $120,000 for the next year’s period.
Another method based on quantitative data, the moving average looks at performance results of smaller time frames than straight-line forecasts. Moving average forecasts usually look at data in terms of months, weeks, or days, with some of the more common time frames being in 3 and 5-month increments.
This method is used to predict a lot of moving parts within the business, such as trends in revenue, profits, sales growth, and stock options.
This formula consists of the sum of the previous period's sales (for example, 3 months) and dividing that sum by the number of periods.
For example if:
Add those sums to:
Then divide that number by 3:
= $5,947 predicted outcome.
The simple linear regression forecasting method is based on the relationship between a dependent variable and an independent variable, whereas with multiple regression forecasting you are looking at two or more variables to predict future outcomes.
For example, when looking at sales performance, a regressive analysis would encompass looking at how factors in the sales process affect sales performance, ultimately giving insight into how sales would look over time if you implemented those same strategies or adopted new strategies.
Plotted on an x-axis and y-axis chart using the formula: Y = bX + a
This allows you to see the linear trends based on the average of the plotted points, then use that data to predict future sales outcomes.
Linear regression models involve a more complex understanding of mathematics to identify trends and predict outcomes, so it is recommended to use a business financial accounting professional to determine the most reliable financial forecasting results.
It takes a knowledgeable, skilled professional to accurately provide financial predictions based on data. There are many software types for financial forecasting that use a variety of methods discussed here.
While we hope to provide an overview of these methods for predicting business financial outcomes, if you and your business need help with compiling reliable predictions based on the analysis of your past and present financial metrics, we suggest contacting a local business accountant to analyze the financial records related to your business.
An experienced CPA can provide a reliable, results-driven outlook for the future of your company’s success.
Are you a business owner who wants to provide the best possible outlook for the future financial predictions of your company? If you want to show stakeholders and other investors reports for the potential growth outcomes for your business and want data-driven predictions to make decisions for the future success of your company, we can help.
At Interactive Accountants, Matthew Shiebler, CPA has worked with a number of business owners over the past 25 years, helping them with their financial records, tax reporting, and financial forecasting implementation.
Give us a call at (305) 517-3977 or schedule a free consultation online with us today!