In a nutshell, financial forecasting is the process of estimating and projecting your company's future performance and trends. Financial forecasting is an important activity, whether you utilise it as part of a business plan or as a regular tool for your strategic planning.
Consistent financial forecasting helps established organisations plan and budget for growth and strategy, as well as secure future investment. A sound financial forecast considers both short-term and long-term macroeconomic and microeconomic aspects, as well as the business's specific market circumstances.
Only one in five organisations produce reliable future projections, which implies that many companies still do not utilise financial forecasting to their advantage. Whether a business is facing a crisis or an opportunity, forecasting may provide significant insight into how to proceed.
Thus, in this article, we will examine some of the most prevalent issues surrounding financial projections and how company owners may use forecasting as a guiding principle for strategy and business decision-making.
Signs That Your Financial Forecasting Is Not Effective
For businesses, the use of forecasting gives valuable information that aids in identifying and correcting weaknesses in their strategies, ultimately being in a better position to adapt to the changing environment and continue with the company's operations.
In spite of this, not all companies use forecasting to its full potential, andOn the other hand, external financial consultants are often specialised and able to provide budgeting, forecasting, and other financial analysis services. Besides, contracting an external consultant could be more cost-effective, as they can offer forecasting systems that are scalable and can be directly applied to your business, helping you realise your long-term vision. these are some of the indicators.
An Overly Optimistic Financial Forecast in Comparison to Actual Results
One of the reasons why your financial forecasting could be distorted is the overly optimistic projections. It was shown that over-optimistic financial prognosis is particularly widespread during turbulent times, such as the Covid-19-induced recession.
However, an optimistic sales projection is simply a result of setting a high sales target to motivate the sales team to reach it. But how does that work in practice?
Assume that you are a manufacturer, and your sales are predicted to grow by 30% next year based on the optimistic projections. To satisfy the projected demand, you put your cash into additional inventory, but your sales only climbed moderately by 10%, leaving you both with excessive inventory and depleted cash reserves.
As it is demonstrated in the example, having overly ambitious estimations that deviate could be troubling, resulting in inaccurate forecasting and skewed predictions of the company's performance.
Lack of Real-Time Data for Effective Forecasting
Real-time insight into company performance and projections can assist business owners in making strategic decisions. Statistically, 50% of businesses believe that the reliability of their financial data is merely adequate. Consequently, the lack of reliable information leads to inaccurate financial predictions.
During market uncertainty drawing predictions on real-time data is essential, as this enables agility within financial planning. Unfortunately, to date, many businesses still depend on the disintegrated local network-level systems, failing to leverage the advantages of technology-powered financial data insight.
Likewise, spreadsheet systems cannot accommodate the complexity required for accurate financial forecasting, restricting your capacity to make sound business decisions.
Consequently, the lack of automation in finance functions means that organisations do not have access to real-time metrics and accurate performance figures, limiting the management's ability to implement all-important leadership discussions along with effective and resilient forecasting models.
Irrelevant and Departmentally Misaligned Forecasting
A systematic approach to forecasting is vital; otherwise, it has little use for various stakeholders across the company. A solid future financial projection should produce data that is relevant to multiple teams and departments.
Both horizontal and vertical forecasting alignment is important. Suppose forecasts are not created at every organizational level and across all teams and divisions, your company may face various risks, from inadequate budgeting and ineffective resource allocation to a detrimental impact on a company's health and viability.
Therefore, as a company owner, how can you use financial forecasting to your advantage?
Ways to Make Financial Forecasting Work for Your Business
1. Align With the Company’s Long Term Vision and Strategic Goals
First and foremost, financial forecasting necessitates a clear alignment with the company’s long-term vision and goals. Having an overarching picture of where the company intends to go in the coming years is vital because it enables projections focused on the company's future path.
Equally, if the company’s financial projections align with the short, medium, and long-term goals, forecasting can guide the allocation of resources. In other words, financial projections provide a strategic roadmap to anticipating headwinds ahead of the competitors and maximising the value of your business.
2. Leverage Digitalisation for More Accurate and Effective Forecasting
Modern businesses need information gathering, modeling, and utilisation solutions that go beyond spreadsheets. Nevertheless, companies still fail to use AI-powered financial software, seeing technology more as a hindrance.
However, effective forecasting requires sophisticated software that can automatically collect all the financial and operational data, including KPIs and real-time analytics, which can be then used to make more accurate predictions and run a leaner business.
Besides, financial software solutions can be easily integrated with existing business systems. For this reason, management can be equipped with precise, real-time visualisations of a company's performance, facilitating faster and informed strategic decision making.
3. Consider Contracting an External Financial Partner
Finally, companies should also consider tapping into external sources of financial expertise, whether they need new financial software or more effective financial forecasting and budgeting solutions.
Forecasting is a critical business activity that could bring tangible benefits to the organisation. Often internal employees' poor judgment or lack of expertise or particular skills might lead to difficulties in financial forecasting.
On the other hand, external financial consultants are often specialised and able to provide budgeting, forecasting, and other financial analysis services. Besides, contracting an external consultant could be more cost-effective, as they can offer forecasting systems that are scalable and can be directly applied to your business, helping you realise your long-term vision.
Poor financial forecasting may bring down even the most well-run companies. On that account, precise estimates are critical to ensuring your company's resilience and preparedness for unforeseen circumstances in the future.