Financial forecasting techniques can help CFO makes critically important decisions.
Qualitative and Quantitative Techniques for Financial Forecasting
Today’s market is constantly changing with complex business models and intriguing workflows, forcing management to make faster and better decisions. Modern business dynamics have made it mandatory to have flexible and reliable forecasting methods. Management faces a constantly shifting business landscape; hence, they need a tool that will empower them to make informed decisions.
Future planning is a key component for management decisions, and it is vital to the overall success of businesses. This is what is known as forecasting. Forecasting is all about estimating important elements of businesses, such as sales volumes, expenses, investments, and profits, which can easily impact business outcomes.
Financial forecasting techniques consist of two broadly categorized methods:
- Qualitative techniques
- Quantitative techniques
Let’s look at each category to find out how to do financial forecasting.
Qualitative Financial Forecasting Techniques
In this method, management makes decisions based on opinions shared by various department heads and key personnel of various departments in an enterprise, such as sales, production, purchasing, operations and so forth. Management does its calculations and estimations based on inputs from these important members.
Reference Class Forecasting
In this method, enterprises make decisions based on reference cases or similar scenarios in a different timeframe. This forecasting method is completely based on human judgment.
In this method, a questionnaire is provided to experts who share their answers in isolation. Once responses are in place, a second questionnaire is shared with them to re-evaluate their responses to the first one. This process goes on until the responses are narrowed down to a short list of important opinions.
Sales Force Inputs
Sales representatives are closest to the customers. They are in a better position to share insights about a customer’s behavior. In this method, based on inputs shared by sales representatives, management prepares estimates.
Inputs in the form of consumer feedback or customer surveys help enterprises to define and derive financial forecasts. This feedback can be taken in the form of telephonic conversations and personal interviews.
Quantitative Financial Forecasting Techniques
Proforma statements are financial statements that consist of data related to sales figures and costs from the last two to three years. This forecasting method is generally used in mergers and acquisitions, or when a new company is to be formed and statements need to be presented in front of the investors.
In this method, enterprises conduct a comparative study of variable factors such as consumers’ disposable income, interest rate, consumer confidence and even unemployment level. This is compared over a period of time, and then estimates are drawn.
Beyond these two methods, there is another popular method called time-series forecasting, where businesses gather financial data over a period of time to identify patterns and trends and forecast based on these patterns.
Financial forecasting is a very challenging task, and it is critical to select the right forecasting technique to derive the right forecasts. The technique that is chosen for one objective may be different for another one. It may also change from organization to organization and department to department. Irrespective of the technique, financial forecasting is an essential process and helps decision-makers in driving business growth.