Thanks to a robust forecasting process, organizations should be able to better comprehend what their financial future holds on their present intentions and actions. With this information, finance professionals may identify and act on growth possibilities and risks to strategic goals. This enables them to reallocate resources throughout the year, and ensure KPIs are met, among other actions.
There’s no one optimal path for achieving this, instead, a successful financial forecast depends on the traits of the organization, the sector, and the application of the said forecast.
Nonetheless, there are effective financial forecasting methods and characteristics that are virtually always applicable to businesses and their important goals.
Why Should We Focus on Having a Highly Accurate Financial Forecast?
A company must be able to adapt quickly to shifting consumer and market trends to succeed. This is especially true for industries where consumer habits can change quickly.
The fact is – financial forecasting is particularly tough for large, dynamic businesses since it might be difficult to predict where the company will be in a year. However, every business decision involves a high degree of risk, making it difficult to balance the decision's value and the potential threat it may pose.
With a rolling forecast, they can continuously adjust to changing market and industry conditions, which lowers their risk exposure. They can use the information to determine which parts of the company need to be improved and then spend more resources appropriately.
They also help meet this crucial criterion by enabling the company to react quickly to changes and trends in the market, resulting in a much more dependable and practical plan.
A rolling forecast offers pertinent and up-to-date information about the internal and external markets, tightly linking it with the company's strategic goals. The ability to access this source of useful data enables key decision-makers to adjust their financial and business plan.
Besides, various other forecasting techniques help analyze the results of your efforts to ascertain the activity's long-term viability or value. You can then scale your performance to fulfill the company's objectives by using it to help you define benchmarks.
What KPIs Should You Consider For Successful Financial Forecasting?
Tracking the correct KPIs and setting attainable targets that are monitored can help ensure a firm is making decisions that’ll produce value and profitability.
Your predictions are no longer based on prior outcomes with rolling forecasts. Instead, your system is supplied with data on your metrics, such as category growth, market share, human capital, and customer happiness. Other business metrics to consider can be:
- Burn rate
- Churn rate
- Total expenses
- Budget variance
- Average revenue per account (ARPU)
- Gross margin
- Customer lifetime value (LTV)
- Customer acquisition cost (CAC)
- CAC payback
Any variations in operational operations might be taken into consideration periodically throughout the year rather than all at once. You may raise the caliber of your rolling forecasts by being able to incorporate these important business drivers.
What Financial Forecasting Best Practices Should You Follow?
Financial forecasting is never a sure thing, but it’s essential for making good business decisions. Regardless of your company's industry or stage, maintaining a forward-thinking perspective is critical—learning from past trends is a fantastic approach to planning for the future.
Internal teams may work very hard, but they’re challenged to make optimal operational decisions in the absence of definite goals and objectives. Remarkably, many firms continue to function without forecasts due to the time required to generate them or a lack of understanding of the business value predictions drive.
However, forecasting is not a luxury for successful organizations, it’s a requirement. Here are some best practices for financial forecasting methods to make your life easier:
Automate Sourcing Data from Cross-functional Business Applications and Other Data Sources
What financial planning tools do you now employ? Are you making the most of them? Studying your system completely and out is worth your time and money, whether you're using spreadsheets or another budgeting or forecasting application.
It’ll vary depending on the business model, what the organization is attempting to measure, the analytical insights required, the company's size, the industry, and various other internal and external factors.
Yet, the fact that there’s a great volume of data involved in such a short time frame could be quite concerning.
A 2020 research survey revealed FP&A teams generally spend 46% of their time collecting, integrating, cleansing, and modifying data manually. Finance teams should strive to remove this job, so actual data is readily available or generated automatically.
This could imply automating the forecasting of each base-level driver using the best statistical technique available before allowing managers to analyze and change the results based on their local knowledge. Alternatively, it could imply applying the 80/20 rule and automating forecasting for most consumers. This lets managers focus on a limited number of large accounts that generate significant revenue.
Gather Input from Stakeholders to Get an Accurate Picture of Current Environment and Organization Objectives
Enable various sections / teams within the company to share assumptions and update data in real-time. This includes including sales and operations (rather than just the finance team) in the forecasting process. Only through the engagement of sales and operations in the forecasting process can various business functions realign their plans and capacities to shifting demand levels.
The ideal approach is to encourage healthy communication and offer a narrative to back up the numbers. Identify key operational variables that directly impact a company's performance and add them into the system to highlight and account for changes in operational activities throughout the year.
Different parts of leadership will frequently have opposing viewpoints on how to build the organization. It helps to develop many prediction views for discussion to think about what path to take or what outcome to expect.
Set Realistic Long-term Objectives and Review Them Regularly
Whatever length of time you choose, the goal is to strive for near perfection in the current time while also understanding the implications of future developments.
Consequently, the forecasting process must be as efficient as possible. This can be achieved with a clear, standardized method for revising the forecast aligned with the business goals. Bigger organizations may use a centralized support team to manage routine / transactional items, while smaller organizations think about using other systems / methods, such as cloud planning tools.
Documenting and tracking the results of your forecast over time is critical, especially after big internal and external developments. Keeping your projections up-to-date with current events is also crucial. A regular forecast review rhythm ensures the business doesn’t deviate from its course.
Factor in Unexpected Market Changes and Adjust Forecasts Accordingly
In an unpredictable market, substantial changes in resource levels, budget limits and tactics are unavoidable. The emergence of the COVID-19 pandemic is a huge indicator of how markets can be affected suddenly without any prior warning.
A flexible budget that considers what-if scenarios will serve your organization better than one that overlooks the future and is based on past events.
After you grasp the desired business outcomes for the firm, build a base forecast using conservative assumptions. But consider forecasting the risks and impact if the firm fails to meet even the most basic goals.
When considering the worst-case scenario, ensure you have cash reserves and a plan for reducing expenses. In contrast, many business leaders are unaware of the implications of large expansion for cash flow and capital requirements. Increasing cash requirements are a regular source of frustration when budgets are exceeded.
It’s critical to anticipate this and to arrange flexible credit and other facilities to accommodate it. Having more revenue is nice, but it could be fatal if the company can't keep up with the essential cash flow. Many other factors, such as the availability and cost of employees and materials, are sensitive to scenario variances, but cash is one that you must always be prepared for. At that point, ensure your projection is accrual-based rather than cash-based.
Track and Document Progress to Compare Against Original Projections
The appropriate cadence of your finance indicators should be in accordance with the need to make choices; nevertheless, for most, monthly forecasting is ideal for establishing accountability across business divisions.
If finance cannot unite on KPIs across the firm, you’ll spend most of your time correcting differences and striving towards unity rather than focusing on high-impact strategic insight.
To remain informed and in control, smart businesses do frequent financial forecasting. As a result, it’s best to repeat the process once the time for the present financial forecast has passed. Continuously gathering, recording and evaluating data to boost the accuracy of your financial forecasts is also a good idea.
Monitor accuracy over time and prioritize activities to enhance the accuracy of forecasting model components that lag. The forecasting process must be swift to help managers make quick and timely decisions that optimize financial performance in the short term.
Key Takeaways For Effective Financial Forecasting Methods
Operating a business without forecasting is similar to flying blind. Financial predictions are required to help identify probable future influences that can affect and shape strategies, programs and goals.
Following the best practices outlined helps construct a successful financial forecasting model.
In short, it maintains an objective, evidence-based link between an organization's strategy and tactics. Predictions must be revisited regularly and shared with key stakeholders throughout the organization to facilitate debate and alignment. Most importantly, regularly test your assumptions and their impact on future prediction periods.