7 Critical Steps in Financial Forecasting
Every business will experience ups and downs over time, due to both internal and external reasons. It is impossible to predict exactly what difficulties may arise, including the massive effect of the COVID-19 pandemic on businesses. Shutdowns dramatically impacted businesses of all kinds, especially the entertainment and recreation industry, in which 48 percent of businesses experienced a shutdown.
While some events like the pandemic can’t be foreseen, financial forecasting attempts to see into the future to help businesses succeed, removing as much uncertainty as possible. Solid financial forecasting can do just that by giving businesses the tools to build on success and plan for hard times. Here are some steps to follow in creating a financial forecast.
1. Define Your Time Frame
How will you frame your financial forecast to best inform business decisions? Perhaps a quarterly, biannual, or annual forecast is appropriate. Or, you may find it most helpful to use a rolling financial forecast to continually reassess as new information comes in.
Your time frame may be affected by the business’ agility and how much lead time it needs to make adjustments to its planning. Some companies may be able to make quick changes and can work within a small time frame, while others may have long-term needs such as hiring or financing.
2. Decide on a Qualitative vs. Quantitative Forecast
When developing a financial forecast, it may be useful to create either a qualitative or quantitative forecast. Qualitative forecasts use information that cannot easily be measured, like customer service or sponsorships. These forecasts may also rely on in-house expertise or market research when data is unavailable, such as when businesses are still new. This method is often used for long-term forecasting.
Quantitative forecasting relies on data and statistics and works well for short-term forecasts. This method brings in historical data and looks at exactly how it relates to business performance.
3. Gather Historical Data
In order to plan for the future, companies need to remember the past. Going over past financial statements and analyzing historical data is key to developing an accurate forecast. Income, balance, cash flow, and other relevant statements provide important historical data that will help shape the forecast. Using information from the company’s past performance ensures that the forecast is an educated prediction rather than wishful thinking.
4. Sort Through New Data
Thanks to automation, accountants can rely on more than just historical data to develop financial forecasts. Real-time data can be brought in and analyzed along with past financial statements to make the forecast as accurate as possible. Up-to-the-minute information is especially useful for a rolling forecast that is continually being updated and giving executives current insights to aid their decision making.
With accurate historical and real-time data in hand, accountants must analyze the data and how it impacts the company. It is critical that CPAs have clear, unbiased vision as they assess the data and how it will shape the company’s future. An overly rosy or cloudy forecast is not beneficial. CPAs should examine the good and the bad and present it in a way that does not cloud company leaders’ judgment.
The company’s internal data is, of course, not the only information to take into account. External factors such as economic conditions and industry trends play a major role in how the company will perform.
6. Present the Forecast
With an accurate, informative forecast in hand, accountants must present the data to decision makers. This information can help a company plan for the highs and lows ahead, and it is imperative that it is received and utilized. A financial forecast is only as good as business leaders understand it. CPAs can use visual reports to ensure the information presented is concise, accurate, and understandable to the audience they are targeting.
7. Compare the Forecast to Reality
The work of forecasting is not done once the report has been presented. A company’s actual performance should be compared to the forecast as time goes on. Comparing real data to the forecast helps pinpoint where the business didn’t quite measure up to expectations and where it was on track or did better than expected. These comparisons enable executives to make adjustments when needed, and they also help keep future forecasts accurate.
A financial forecast is one of the most important and informative stories accountants can tell business leaders. Creating an accurate, easy-to-understand forecast ensures that the story hits home and helps executives plan and guide their business successfully.
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