A financial forecast is simply an estimate of your company's future revenues and costs. A forecast may be either short- or long-term in nature. It is a component of the business plan and the primary document required to get external finance.
For start-ups or new businesses, a short-term financial forecast is important in providing a base projection for planning a long-term forecast. It is a critical part of the business plan and the most essential document with which to obtain external funding. Building your financial forecast for start-ups or new businesses involves:
Market research - This is a reoccurring process in your business journey. As a start-up without previous data on income and expenses, you need to gather information from the industry on the items that constitute expenses and revenues.
Creating a financial projection - Based on the information from your market research, input your estimated expenses and revenues in a spreadsheet that will show your monthly inflow and outflow.
Preparing a projected profit and loss statement and balance sheet.
Being realistic while using your projections to plan - This entails planning based on different scenarios i.e., best-case scenario, a most likely scenario, and worst-case scenario.
Updating your financial forecast - Once your company starts operating, it is imperative to keep track of how things are doing and compare it to your estimates to see if you are on track. The financial forecast may need to be modified in most circumstances.
Methods of financial forecasting
There are several methods used in preparing a financial forecast. However, the four basic forecasting methods are:
Straight line method - Growth may be forecasted easily using straight-line forecasting. This method illustrates prospective future outcomes based on current growth rates using historical financial data and simple maths. The simplicity of the method is a plus but unfortunately forecasts for the future are risky since it doesn't take shifting market circumstances into account.
Moving average method - Standard financial measures including revenue, profit, sales growth, and stock prices are evaluated using the moving average forecasting method. It generates an ever-changing average value using short-term computations to assist companies in spotting underlying trends. This method has the advantage of enabling trend identification more quickly. Unfortunately, if used for extended periods of time, it might lag. As a result, it works best as a tool to identify short-term changes.
Simple linear regression method - Based on past values, the simple linear regression approach predicts future values of dependent variables. A trend line is created by the linear connection between the independent and dependent variables. This method has the advantage of being simple to use, inexpensive, and trendspotting. Its limited ability to handle complicated interactions between variables and vulnerability to outlier effect are the disadvantages.
Multiple linear regression method - This is the most sophisticated and accurate method of forecasting. Compared to straightforward linear regression, it can account for complicated interactions between dependent and independent variables and produce findings that are more accurate. However, it uses more data and resources than the other methods and be used only when you have enough data to reliably forecast performance.
In summary, having a solid understanding of maths, precise data, consumer behaviour, and market trend analysis that might influence future outcomes are all necessary for good forecasting.
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