Business accounting involves evaluating the past performance of your business and determining how well it is thriving. Peeking into your business's future performance is equally essential. Financial forecasting methods come into play here, enabling you to anticipate challenges and plan accordingly, ensuring a smooth business operation.
Unfortunately, many small business owners don't pay much attention to their organization’s future performance. But forecasting is a key factor that makes a venture successful. So let Unloop help you look closely at business forecasting, its importance for small businesses, and how to do accurate forecasts using different methods.
Forecasting is looking into your business's historical and present financial data and market trends to predict its future financial performance. Forecasting can predict sales and potential expenses for a specific period. Due to the financial aspect, many business owners confuse forecasting with budgeting.
They go hand in hand to help your business grow, but they are very different. A forecast predicts your company's future revenues, while budget forecasting involves allocating money to different business units to help you reach your revenue goals.
Forecasting is more about business financial planning. There are several reasons forecasting is essential to a business.
Forecasting is an ongoing exercise. Adapt your assumptions as your business evolves.
Many factors can affect your business, some of which you cannot control. However, financial modeling allows you to see potential scenarios and be more prepared when they happen. There are two types of forecasting methods: qualitative and quantitative methods.
We go over some of the most popular types of financial forecasting techniques in each area so you can better comprehend them.
Qualitative forecasting bases its predictions on experts' and customers' responses rather than using historical data. This method is valuable for new single or multi-channel ecommerce businesses and traditional businesses with no operational data, to begin with.
Here are some examples of qualitative methods.
An expert's opinion involves asking an individual or group of experts about the subject matter, and they provide predictions according to their knowledge. An expert should offer opinions without bias to make the most accurate prediction possible. From there, business executives can evaluate and decide if they will push through with the suggested actions.
Business owners may bring more than one expert to collaborate on their predictions. But, of course, it is up to the administrators to decide which opinion to follow. They can rely solely on experts for future planning or try other methods and consider other factors that may affect the business.
Market research is commonly used to determine the market needs of a certain product or service. The entire addressable market and the company's current clients are used in this strategy to collect data. Market research uses customer surveys, metrics analyses for current campaigns, testing, and research on your competitors' marketing strategies.
Market research needs large data as much as possible to eliminate human bias. This method requires much time, effort, and resources to deploy. However, you'll get the most accurate financial forecast if done correctly.
The Delphi method is similar to experts' opinions, except it is more systematic and structured. In this method, you will still need experts to gain insight. But instead of giving them the freedom to make predictions based on their knowledge, they must answer several questionnaires until the business comes up with a forecasting model.
Qualitative forecasting helps executives make informed business decisions like determining how much of their inventory to keep, hiring more people for their company, or adjusting their sales operations. Qualitative forecasting methods are also used to develop projects and marketing campaigns highlighting the business's products and services.
All businesses can perform qualitative forecasting, but some industries will greatly benefit from qualitative forecasting.
Quantitative financial forecasting is a data-driven forecasting method that businesses use to make accurate predictions for big decisions. This method uses historical financial forecasting data to analyze patterns to determine what the business performance will be like in the future.
Quantitative forecasting results are affected by past data, relevant variables, and time parameters. You can do this financial forecasting for budget, sales, or projected expenses for a future time period. Here are some examples of key financial forecasting methods using the quantitative approach.
The simplest quantitative forecast you can use is the straight-line method. This method only needs an approximate projected growth rate of your business, usually based on your past performance.
The straight-line method predicts your business's future by calculating your previous and projected performance. Here’s an example:
|In the last three months, your sales have been $300,000 in total, and for the coming three months, you are projected to increase by 5%, so you can calculate your future revenue by:|
300,000 x 1.05 = $315,000
For the next three months, you predicted sales growth would go up to $315,000.
The naive method is the best financial forecasting method if you want calculations to be as simple as possible. This method suggests that your business performance will be the same as in the past. So if your business made $500,000 in sales last year, your business would generate the same amount this year.
This prediction does not consider dependent and independent variables, seasonal trends, or other factors that could affect your business. It can easily change when something major happens within a specific period.
The seasonal index method analyzes patterns in data points by separating months of the year into seasons. In most cases, seasons are divided into four quarters:
Q1: January, February, and March
Q2: April, May, and June
Q3: July, August, and September
Q4: October, November, and December
Experts calculate past seasonal index scores to determine how your business will perform in the future.
In the last two years, your seasonal scores were:
2021: Q1 (58) Q2 (60) Q3 (55) Q4 (70)
2022: Q1 (62) Q2 (54) Q3 (65) Q4 (60)
Your projected seasonal index score from the two data points will be:
2023: Q1 (60) Q2 (57) Q3 (60) Q4 (65)
Once you get the projected seasonal index scores, you can create a forecast for your business performance.
This method is used to forecast the revenue of a business in a specific period. Revenue run rates are calculated based on previous data and assuming your sales rate will continue at a certain pattern given a specific period.
For example, your business made $50,000 in the first quarter of the year. Using the revenue run rate method, you will assume to generate the same amount for every quarter. Hence, your total revenue for a year will be $200,000.
Gathering data and creating inferences using quantitative methods help you draw more accurate predictions. More than accuracy, using the quantitative method provides the following:
Small businesses have various financial forecasting methods to choose from to predict their future financial performance. While budget forecasting aims to estimate future income and expenses, other popular methods include multiple linear regression, moving average forecasting methods, and simple linear regression.
Simple linear regression is a forecasting method for analyzing independent and dependent variables. It's a simple way to project company performance trends and inform business decisions in the near or far future.
Multiple linear regression is a more complex version of the simple linear regression. It uses one dependent variable against two or more dependent or independent variables.
The moving average forecasting method is a simple technique that involves averaging data points from a specified period. This method is often used to forecast short-term trends in financial data, such as sales or revenue.
Financial forecasting is a crucial aspect of any business, several tools are available to help with the process. In this section, we will discuss three primary financial forecasting tools: Excel, financial forecasting software, and the role of executives in financial forecasting.
Excel is a widely used tool for financial forecasting due to its flexibility and versatility. It allows users to do financial modeling, simple to complex formulas, and churn out forecasts. Excel is also flexible and allows users to tailor their forecasting graphs models based on their business needs.
One of the best things about using Excel for financial forecasting is its ease of use. There's little to no training involved, especially for most finance professionals, and it's widely available and affordable, making it a cost-effective solution for businesses of all sizes.
In recent years, financial forecasting software has become increasingly popular. These tools are designed to streamline the forecasting process without sacrificing accuracy. Many financial forecasting software solutions offer advanced features such as real-time data integration, scenario modeling, and predictive analytics.
One of the key benefits of using financial forecasting software is its ability to automate many of the manual tasks associated with financial forecasting. This can save businesses resources, giving them more space to focus on the crucial aspects of their business.
There is no doubt that business forecasting methods help administrators and stakeholders make better financial decisions. Whether you choose a qualitative or quantitative method, taking a peek into your future ensures that you will be ready to take on your business's future.
If you're serious about making business predictions, Unloop offers forecasting for businesses. Our service gives you a tailor-made forecasting model to drive your business to success. Get access to top-tier features, from recurring projections to insightful commentary. So what are you waiting for? Book a call with us today and learn more about our forecasting services.
Unloop is the first and only accounting firm exclusively servicing ecommerce and inventory businesses in the US and Canada. With the power of people and technology, our team dives deep into COGS and inventory accounting. You are paired with a dedicated bookkeeping team that prepares accurate financial statements, financial forecasts, and can also pay bills or run payroll for you. Come tax time, everything is organized and ready to go, so you don't need to worry. Book a call with an ecommerce accountant today to learn more.