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Financial Forecasting – What & Why ?
Background:
The purpose of the financial forecast is to evaluate current and future fiscal conditions to guide policy and strategic decisions. A financial forecast is a management tool represents estimated information based on past, current, and projected financial status. It helps identifying future revenue and expenditure trends that may have an immediate or long-term impacts based upon government policies, strategic goals, Or organization objectives . The forecast is an integral part of the annual budget process. Main objective of an effective forecast is to improve decision-making in maintaining fiscal discipline and delivering essential target activities with hygene.
Key steps in a Sound forecasting process :
Define Assumptions. The first step in the forecasting process is to define the fundamental issues. There are four key questions to consider :-
1. What is the time horizon of the forecast?
2. What is the objective of the Organizations’ forecasting policy? For example, a conservative forecast underestimates revenues and builds contingencies for expenditures. This might make it harder to balance the budget. On the other hand, an objective ( not aggressive) forecast seeks to estimate revenues and expenditures as accurately as possible, making it easier to balance the budget. Therefore, an organization should be transparent concerning its own forecasting policy and underlying assumptions.
3. What are the political/legal issues related to the forecast? Be aware of current statutory norms & forthcoming laws or expected changes in laws that affect forecasts.
4. What are the major revenues and expenditure categories?
Gather Information. To support the forecasting process, use statistical data as well as the accumulated judgment and expertise and perhaps also outside the organization.
Preliminary/Exploratory Analysis. The analysis should include an examination of historical data and relevant economic conditions. This improves the quality of the forecast both by giving the forecaster better insight into when and what quantitative techniques might be appropriate for supplementing forecasting methods. The forecaster is looking for consistent patterns or trends. In particular, the forecaster should look for evidence related to:
1. Business cycles.
2. Market Trends of the specific Industry under which the organization belongs to.
3. Historical anomalies. Does the data contain any extreme values that need to be explained?
4. Relationships between variables. Are there important relationships between variables ?
Select Methods. Determine the quantitative and/or qualitative forecasting methods that will be used.
Three basic models of forecasting to consider include:
1. Extrapolation. Extrapolation uses historical revenue data to predict future behavior. Trending is very easy to use and is commonly employed by forecasters. Moving averages and single exponential smoothing are somewhat more complex, but should be well within the capabilities of most forecasters.
2. Regression : . Regression analysis is a statistical procedure based on the relationship between independent variables and a dependent variable (expenditure source being predicted).
3. Hybrid forecasting. Hybrid forecasting combines knowledge-based forecasting with a quantitative method of forecasting. Hybrid forecasting methods are very common in practice and can deliver superior results.
Use Forecasts. The purpose of a forecast is to inform and assist in decision-making. Three items that are essential to a compelling and informative forecast presentation include:
1. Credibility of the forecaster.
2. Have a transparent forecast process.
a. Address how the forecast compares to widely accepted economic or financial forecasts from outside organizations.
b. Describe forces acting on your revenues or expenditures
c. Stay within acceptable accuracy tolerances for forecasts.
d. Avoid over promising on the level of forecast accuracy to set appropriate expectations. Note to the audience in detail for understanding.
e. Be careful about using forecasts to raise an alarm about an impending crisis.
f. Presentation approach. A good forecast presentation revolves around a clear message. A clear, simple, and reasoned statement of the forecast message is vital.
3. Linking forecast to decision-making. In order to maximize decision makers interest in the forecast, it will be important to emphasize the importance of the forecast as a key factor in the planning and budgeting process.
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A financial forecast is a framework that presents estimates of past, current, and projected financial conditions. This assists the business in several ways. It helps identify future costs and revenue trends that may influence strategic goals, policies, or services in the near- or long-term.
lead to better financial outcomes, more stable cash flow, and better access to the credit and investment that can help your business grow. Forecasting also serves as an important barometer for the overall health of your financial organization.
to see what will happen in the predicted future in short and long term , the management use the methods to calculate the forecasting 1) learning curve 2) exponential smoothing
finally, it's important for any company and for any sector
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