Financial Forecasting And Data Analysis – Planning for the future of your business is much easier and more effective when you have an idea of what that future might look like. That’s why any business interested in good financial planning should master financial forecasting, which is the process of making accurate predictions that can shape thoughtful and productive financial decisions in real time. Here we will take an in-depth look at the concept of financial forecasting, review some popular financial forecasting models, review some important financial forecasting methods, and learn about some of the best financial forecasting software solutions on the market. 1. What is the financial forecast? Forecasting vs. Budgeting 2. Financial Forecasting Models Top-Down Financial Forecasting Delphi Financial Forecasting Statistical Forecasting Bottom-Up Financial Forecasting 3. Financial Forecasting Methods Straight Line Simple Linear Regression Multiple Linear Regression Moving Average 4. Financial Forecasting Software What is Financial Forecasting? Financial forecasting is the process by which a business uses its current and past financial information to predict its future financial performance. Forecasting is typically applied to support budgeting, financial modeling, and other key financial planning activities. Financial forecasting is often confused with the other key financial planning process it usually informs, namely budgeting. Although the two activities are often closely related, it is important to distinguish between them. Forecasting vs. Budgeting The difference between a financial forecast and a budget comes down to the distinction between expectations and goals. A forecast describes what the business can reasonably expect to achieve in a given period. When done correctly, it represents a reasonable estimate of a company’s likely performance – based on current and historical financial data, broader economic trends, foreseeable factors that could affect performance, and other variables that can be explained by reliable way. A budget, on the other hand, is a byproduct of financial analysis rooted in what the business would like to achieve. It is usually updated once a year and ultimately compared to the actual results the business is seeing to assess the overall performance of the business. Now that we have an idea of what financial forecasting is, let’s look at some of its most popular models. Financial Forecasting Models 1. Top-Down Financial Forecasting Top-down forecasting is a financial forecasting model in which a company begins by analyzing broader market data and eventually narrows down company-specific revenue forecasts from there. It is one of the simplest and straightforward forecasting models that basically involves a business looking at the total market size and calculating its potential revenue based on the assumed market share. Example of Top-Down Financial Forecasting Suppose a company occupies a position in a market that generates approximately $1,000,000,000 in revenue per year. If the company assumes it will have a 2.5% market share, a top-down forecast suggests it will see $25,000,000 in revenue next year. Advantages of top-down forecasting Provides a more streamlined approach for large, established companies with diverse revenue streams than forecasting concentrated at the product level. This is often the only viable forecasting route for startups without detailed financial statements. Disadvantages of top-down forecasting It is often considered faster and shallower than more detailed forecasting methods. A top-down forecast is generally considered a starting point rather than a specific forecast. 2. Delphi Prediction The term “Delphi” here is a reference to the ancient Greek city where the Greeks consulted the mythical oracle Pythias. Appropriately, the Delphi method of forecasting involves financial forecasters consulting experts on their forecasts. With this method, a company sends several sets of questionnaires to a group of experts covering the company’s financial data. With each new round, experts see a summary of the previous round and adjust their outlook accordingly. Ultimately, the hope is that multiple rounds can lead to a consensus among experts that can be applied to the company’s financial projections. Example of a Delphi Financial Forecast If a company takes advantage of the Delphi model, it will gather a wide range of experts and send them questionnaires without any of them meeting face to face. After one round, each of the experts received a summary describing what the other experts thought about the company’s potential financial performance. The experts will be at least partially moved by the group’s response and send a new questionnaire accordingly. The group will continue to receive questionnaires until they reach a consensus, and predictions will be based on this idea. Advantages of Delphi forecasts They are more objective than conventional internal forecasts. Contributions are anonymous so respondents can answer candidly. Disadvantages of Delphi forecasting. The method does not allow for productive and open dialogue, as a face-to-face meeting would. Response time can be slow or unpredictable, which lengthens forecast delivery. 3. Statistical forecasting Statistical forecasting is a general term that represents various forecasting methods. At its core, the model is exactly what it sounds like: predictions based on statistics. Specifically, the term is essentially catch-all, encompassing predictions rooted in the use of statistics derived from historical quantitative data. An Example of Statistical Financial Forecasting One method that usually falls under the umbrella of statistical financial forecasting is the moving average method, listed below. A business can look at the revenue it generated over the past 100 days and apply that statistic to its potential performance over the next similar period. Advantages of statistical forecasting It has a stronger foundation than other methods. This can be easier than other methods, provided you have the right data. Disadvantages of Statistical Forecasting Some methods that fall under this umbrella can provide relatively early estimates compared to other models. Companies without detailed historical data may not be able to make reliable statistical forecasts. 4. Bottom-Up Financial Forecasting As you can probably guess, bottom-up financial forecasting is essentially the opposite of top-down forecasting—it’s a model where a company starts by referencing its detailed customer or product information and works its way up. to a broader income forecast. Example of a Bottom-Up Financial Forecast A bottom-up financial forecast might start with a company looking at its sales volume—or the total number of units of its product it moved in a given period—compared to the previous year. He will then estimate the price he expects to ask for that product next year. From there, he will calculate his estimated income by multiplying the two numbers. Obviously, this example is unrealistic. In most cases, the business in question here will also consider other lower-level variables, potentially including customer information, such as total number of customers or retention rate. Advantages of bottom-up forecasting The model allows for more detailed analysis than most. Provides more room for input from different departments. Disadvantages of Bottom-Up Forecasting Any mistakes made at the micro level can be amplified at the macro level with this model. Extensive bottom-up forecasting can be time-consuming and particularly labor-intensive. Financial Forecasting Methods 1. Straight Line True to its name, straight line forecasting is probably the simplest financial forecasting method that a business can use. It is rooted in basic mathematics and tends to provide rougher predictions than the other, more sophisticated methods listed here. With linear forecasting, a company collects rough growth estimates—usually taken from past numbers—and applies them to future months, quarters, or years. It is usually used when a business assumes that it will grow steadily over a period of time. For example, if your company has seen reliable revenue growth of 5% annually over the past four years, you can use that number to guide your linear forecast and assume that level of growth will continue over the next few years. 2. Simple Linear Regression Simple linear regression is a common method of financial forecasting in which a business examines the relationship between two variables – one independent and one dependent. For example, a company might use this method to forecast revenue by assessing how it might be affected by changes in GDP. 3. Multiple Linear Regression Simple linear regression analysis is often not sufficient to make accurate financial forecasts because financial performance is rarely a function of a single factor. The nature of multiple linear regression is implied by its name – instead of trying to predict how financial results will develop in response to a single variable, the model considers two or more independent factors. 4. Moving Average Moving average forecasting is the most common method used to identify the direction of a security’s trend, but companies can still take advantage of it to project their financial performance. This involves taking the arithmetic mean of a set of data from a past period and applying that mean to future predictions. The method is typically used to estimate potential performance over shorter periods of time, such as weeks, months, or quarters. Financial Forecasting Software 1. Sage Intacct Pricing: Pricing Contact Sage Intacct is a versatile accounting and financial planning software with an accessible interface and a set of features that can streamline your financial forecasting time by
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