The Basics of Financial Forecasting

Financial forecasting is one of the most important functions for growing businesses to master. Accurately forecasting your budget can help your company allocate resources strategically while ensuring that you do not stretch resources too thin. This article will discuss the basics of financial forecasting in 2024 and how a fractional CFO may be able to help your business improve its forecasts.

What is Financial Forecasting?

Harvard Business School defines financial forecasting as predicting a company’s financial future by examining historical performance data, such as revenue, cash flow, expenses, or sales. This process often involves guesswork and assumptions, as many unforeseen factors can influence business performance. This is why it’s important to work with a professional who has an inside perspective on your business and industry.

Financial forecasting is important because the company’s leadership team will use it to influence important decisions. For example, if the company expects revenue to accelerate quickly over the coming months, then it can hire and expand more quickly. But if it expects the opposite, then it may choose to hold off on opening new offices and even put a hold on hiring.

Types of Financial Forecasting

There are two primary types of financial forecasting: qualitative and quantitative forecasting.

1. Qualitative Forecasting: This method is most useful when there is limited historical data and relies on expert judgment and market research. Standard techniques include the Delphi Method or conducting market research.
2. Quantitative Forecasting: This method relies on mathematical models and historical data to predict future financial performance. Common techniques include Time Series Analysis or more common tools like moving averages, exponential smoothing, ARIMA models, or regression analysis.

These techniques can be a bit complicated to the untrained eye, which is why it’s advisable to work with an industry expert who has extensive experience with financial forecasting.

Steps in Financial Forecasting in 2024

Regardless of the type of forecast that you choose, there are five basic steps to the process:

1. Data Collection: Gather historical financial data, market trends, and relevant economic indicators. Generally, the more data you have, the more accurate your financial forecast will be.
2. Choosing the Right Model: Select a forecasting method that aligns with the nature of your business, the availability of data, and the specific financial metrics you need to project.
3. Developing the Forecast: Using the chosen method, create the financial forecast. This involves calculating projected values for key financial metrics.
   Validating the Forecast: Assess the accuracy of the forecast by comparing it with actual outcomes. You can also adjust the model over time as needed to improve reliability.
4. Monitoring and Updating: Financial forecasting is an ongoing process. It is a good idea to regularly update forecasts over time to reflect new data, changes in market conditions, and evolving business strategies.

We hope that you’ve found this article valuable when it comes to learning about the basics of financial forecasting. Interested in learning more? Consider bringing a fractional CFO to your team. A fractional CFO will be able to help your company put together financial forecasts, often on a short-term or contract basis.