What Is Financial Forecasting? Methods, Tools & Best Practices

Okay, confession time

Who hasn't thought about taking a glimpse into the future?

Yeah, as far-fetched as it might sound, knowing what's going to happen next can be quite useful.

Especially for businesses 

The good news? 

It's kind of possible. 

At least for your finances 

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As our world keeps changing and on some occasions not necessarily for the better, it's absolutely important to have a clear picture of where your business is heading. 

What's happening with your revenue? What could change in the next quarter?  Are your expenses piling up? Can your profit levels withstand a sudden crisis in the market?

Those are the kind of questions financial forecasting helps you answer.

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What's Financial Forecasting?

So it's really looking into the future?

Well, not quite 

Financial forecasting is the process of using past data and current trends to guess what's going to happen next with your company's finances.

For example, you could look at your records from the last couple of years, analyse the current situation in the industry, and the world-geopolitical changes might have an impact after all, and appropriately assume the changes you could see in the near future in your finances.

Some of the doubts you can clear off with financial forecasting include:

• How much revenue can we expect next quarter?
• Will we have enough cash to cover payroll and expenses?
• Are we on track to meet our financial goals?
• What sort of backup plan do we need?

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Depending on your goals, you could create short-term forecasts, 3 months or so, or develop others with longer time extensions.

They're usually done by financial experts, but it's not uncommon to include the feedback of other relevant business areas. 

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Forecasting vs Budgeting vs Modeling

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Okay, so we know what forecasting is, but should you get confused by other concepts like financial budgeting or financial modelling?

Not at all

While closely related, forecasting, budgeting, and modelling are far from being the same thing.

Budgeting 

Do you want to know what the main difference between forecasting and budgeting is?

Forecasting bases its results on changing situations.

The latter is rigid

You work with budgets to set the expectations you've got for your business. 

Determining how much you plan to make in revenue, what financial goals you aspire to achieve are all part of budgeting practices.

Budgets are also a critical part of keeping your finances on the positive side of things by setting spending limits.

Modelling 

A financial model is a system that helps you simulate different business situations. 

Want to know what happens if your costs go up 10%? Or if you hire 5 new people next quarter? 

A model can show you the raw effect on cash flow, profit, growth, and more.

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Elements of Financial Forecasting

It doesn't matter what your goals are; if you are ready to do a financial forecast, there are three basic documents you are going to need. The income statement, the record of cash flow, and your balance sheets.

Income statement 

Some companies also call it the profit and loss statement. Basically, it's the document that showcases how your business is faring over a period of time. 

The date comes from the following sources:

• Sales and other income streams
• Cost of goods sold, COGS.
• Operating expenses, salaries, marketing, rent, etc.

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Whatever happens in the world, your business needs to keep running. Basing your forecast on these documents helps you answer the question: Are we going to be able to remain profitable?

Cash flow

Okay, so you have the money.

But do you really have it when you need it?

This part of your forecast focuses on money coming in and going out, not just profits on paper, but real, bank-account cash. 

When doing a forecast, you want to know how much your cash liquidity changes over certain periods. 

You’ll want to account for:

• Payment delays from customers
• Loan repayments
• Recurring bills
• Seasonal dips or peaks

Balance sheet

Think of it as the report where you can find all your assets and liabilities at a specific time 

Here’s what that includes:

• Assets: what you own, like cash, inventory, or equipment.
• Liabilities: what you owe, loans, credit, and unpaid bills.
• Equity: what’s left for you or shareholders

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Popular Forecasting Methods 

In businesses?

There are a lot of rules and practices to consider.

But businesses operate in the real world, so it's quite common to find that there's no size that fits all models. 

Forecasting isn't the exception.

Maybe you prefer to rely solely on numbers, or maybe your internal capabilities can't work with more than that. 

Are you a person who prefers to see the big picture? 

Yeah, your own preferences could determine what financial forecasting model works best for you. 

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That being said, here are the most popular ones. 

Quantitative 

It may be ideal not only if you feel more comfortable basing your calculations on exact numbers, but also if you've been in the market for a while and have a record to show it.

Time series analysis 

Do you fancy working with patterns?

This method looks at patterns in your historical data over time, like monthly revenue or quarterly expenses. 

It’s great for spotting trends, seasonality, or cycles.

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Regression analysis

Here, you’re identifying relationships between variables. 

For example, you might find that advertising spend predicts sales. 

It’s useful for understanding cause and effect, but it has its limitations.

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Econometric models

This one’s a bit more complex. You combine economic theories and statistics to forecast based on multiple interrelated variables.

It’s often used in larger businesses or industries tied to broader economic trends.

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Moving averages

Do you have values that move with a certain speed?

The moving average method is simple but powerful. 

You work with short-term fluctuations to see the overall trend. This is especially helpful if your numbers bounce around month-to-month.

Qualitative 

Prefer to base your estimations on research and experiences?

Are you partially new to the market and don't have sufficient historical data?

Let's discuss qualitative methods for a minute.

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Delphi method

A structured process where a panel of experts anonymously shares predictions, revises them, and builds consensus. 

Perfect for industries with a lot of uncertainty.

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Market research

We are all familiar with this one.

At its core, it requires you to go deep into the market.

Gathering customer feedback, competitor analysis, and consumer trends to shape your forecast. It might be most suitable if you're about to launch a new product.

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Scenario planning

Instead of one forecast, you build multiple ones: best-case, worst-case, and most likely. This helps you prepare for a range of possible futures.

4 Tips for Financial Forecasting 

Now that we have covered the theory, we are free to move to the allegedly fun part: Try to figure out the best ways to perform a financial forecast.

Automate

Yes, we are going to be pretty straightforward with this one.

Excel is fine, but if you are looking for an accurate financial forecast outcome, you need an error-proof system, and that usually comes in the shape of a digital platform. Procurement software, for example, consolidates all your purchasing activities into a single dashboard, making it simpler to collect important information.

Update and keep updating. 

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We did say that financial forecasting is a dynamic business. 

Try using a rolling forecast. This means you regularly update your projections, usually monthly or quarterly, to reflect the latest data and business conditions.

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That way, your forecast is always aligned with what's happening now.

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Plan for multiple possibilities

One forecast is good. Three is better. Create a base case, for what you know has a lot of possibilities to happen, a best case, and a worst case scenario 

Scenario planning helps you stay agile and honestly feel 100% better knowing you know what your chances are should something sudden happen.

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Collaborate with other departments 

Bring in team leads from sales, operations, and marketing. Their insights will make your assumptions stronger and your forecast more grounded in real business activity.

The Lesson

Financial forecasting might sound intimidating at first, but once you get the hang of it, it becomes one of the smartest moves you can make for your business.

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While no system can predict what the future will look like- remember the COVID-19 pandemic?

Having some insights into how much your business is going to be impacted definitely helps you to build resilience. 

And that's a key value these days. 

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