Business accounting involves evaluating the past performance of your business and determining how well your business is thriving. However, peeking into your business's future performance is equally essential. It allows you to plan accordingly to ensure that your business runs smoothly and can withstand potential issues along the way.
Financial forecasting is a way of predicting a business's future financial position using historical data gathered from reports like cash flow statements, revenues, expenses, and sales data. We'll talk about the various forecasting techniques in this article to assist you in evaluating the performance of your company.
Financial Forecasting Methods for Every Business
Many factors can affect your business, some of which you have no control over. However, financial forecasting allows you to see potential scenarios, so you are ready when they happen. There are two types of forecasting methods: qualitative and quantitative methods.
We go over some of the most popular techniques in each area so you can better comprehend them.
Qualitative Forecasting Methods
Qualitative forecasting bases its predictions on experts' and customers' responses rather than using historical data. This method is valuable for new businesses with no data to begin with.
Here are some examples of qualitative methods.
An expert's opinion is simply asking an individual or group of experts about the subject matter, which they will give predictions on according to their knowledge. In order to make the most accurate prediction possible, an expert should offer opinions without bias. From there, business executives will decide if they want to go 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 expert opinion to follow. They can solely rely on experts for future planning, or they can do 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, analyses of metrics 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 a lot of time, effort, and resources to deploy. However, if done correctly, you'll get the most accurate financial forecast possible.
The Delphi method is similar to experts' opinions, except it is more systematic and structured. In this method, you will still need experts for their insight, but instead of giving them the freedom to make predictions according to their knowledge, they will need to answer several questionnaires until the business comes up with a forecasting model.
Why Do You Need Qualitative Forecasting?
Qualitative forecasting helps executives make informed business decisions like determining how much of their inventory to keep, hiring more people for their company, or applying adjustments to 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 here are some industries that will greatly benefit from qualitative forecasting.
- Healthcare: Healthcare can use this method to determine trends in public health so they can prepare their services for the future.
- Education: Schools and colleges use this method to predict the number of enrollees in the coming school year.
- Sales: It helps companies make decisions, such as determining the number of products to produce and which of their inventory should be the priority to get more sales.
- Construction: Forecasting helps construction and manufacturing determine the approximate number of resources they need for their upcoming projects.
- Agriculture: Forecasting can help study sales of crops over the season so farmers can plant the produce most in-demand by customers.
- Pharmaceutical: This helps pharmaceutical companies see which medications are more popular with users, so they can increase the production of those medications.
Quantitative Forecasting Methods
Quantitative financial forecasting is a data-driven forecasting method that businesses use to make accurate predictions for big decisions. This form of forecasting uses historical 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 quantitative forecasting methods.
Straight-Line Forecasting Method
The simplest quantitative forecast you can use is the straight-line method. This method only needs an approximate projected growth rate of your business which is usually based on your past performance.
The straight-line method predicts your business's future by calculating your previous and projected performance. For 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
So, 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. The naive method suggests that your business performance will be the same as in the past. For example, if your business made $500,000 in sales last year, according to the naive method, your business will generate the same amount of sales this year.
This prediction does not consider any seasonal trends or other factors that could affect your business. So this type of prediction 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. For example, 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)
After getting the projected seasonal index scores, you can go on with creating a forecast for your business performance.
Revenue Run Rate Method
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 that you will generate the same amount for every quarter. Hence, your total revenue for a year will be $200,000.
Importance of Quantitative Methods
Gathering data and creating inferences using quantitative methods help you draw more accurate predictions. More than accuracy, using the quantitative method provides:
- Predictability: When businesses have access to their past data, it is easier to spot trends and patterns within the business. This makes predicting the performance easier and more accurate than other methods.
- Objectivity: Using numbers and data means your results will be free from bias. Opinions gathered from experts are still beneficial, but they can be twisted to achieve your desired results. With data, it's more realistic and accurate.
- Transparency: As they say, numbers don't lie. Data reflects the exact state your business is in. This data transparency will help business owners make better business decisions.
Be Future Ready With Unloop
There is no doubt that business forecasting methods help administrators and stakeholders make better business 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 doing business predictions, Unloop offers forecasting for businesses. Our service gives you a tailor-made forecasting model to drive your business to success. So what are you waiting for? Book a call with us today!