Financial Forecasting: How it Helps Manage Financial Risk?

Do you know how financial forecasting assists businesses in managing risks? Delve into the following points to understand the importance of financial forecasting in financial management.

What is Financial Forecasting?

Financial forecasting is the way a company predicts the financial future. It involves examining historical performance data, like cash flow, revenue, sales, or expenses. It informs business decision-making based on recruiting, budgeting, strategic planning or preparation, or predicting revenue.

Financial forecasting plays a significant role in business planning. It allows companies to make well-informed decisions about budgeting, risk management, and resource allocation. It helps the organization anticipate changes in demand for services or products so that it can adjust its strategies in accordance with the customers’ needs.

Read more about financial risks here: What is Financial Risk – Meaning, Types & Tools

Importance of Financial Forecasting

Robust financial forecasting strategies contribute to an improved financial outcome in a business. Besides offering a stable cash flow, it delivers better access to investment and credit, thereby helping the business succeed.

Common Types of Financial Forecasting

The 5 common types of financial forecasting are mentioned below:

• Revenue forecast
• Balance sheet forecast
• Expense forecast
• Profit forecast
• Cash flow forecast

Benefits of Financial Forecasting in Risk Management

Financial forecasting can have multiple benefits to businesses, some of which are mentioned below:

• Improves the cash flow control
• Offers accurate forecasting that sets outstanding performance expectations
• Well-informed budgeting decisions
• Identifying the gaps in cash-flow

Predictive Analysis for Identifying Potential Risks

Predictive analytics is a type of advanced analytics that predicts future outcomes with the help of historical data and statistical modeling. It also uses ML and data mining techniques. The most important implementation of predictive analytics in companies is to discover patterns in data to recognize potential opportunities and risks.

Click on this link to learn further about financial analysis: Financial Analysis: Meaning, Importance & Functions

Scenario Planning to Assess the Impact of Different Risks

Scenario planning helps explore various possible futures and the way it affects the organization. It also helps assess the impact of various risks within an organization. Scenario planning allows finance leaders to comprehend the influence of factors that drive fluctuations in the organization’s performance.

Sensitivity Analysis to Evaluate the Sensitivity of Outcomes to Changes in Variables

Sensitivity analysis assesses how the values of independent variables affect a dependent variable under a series of assumptions. It evaluates the sensitivity of the outcomes to changes in variables. 

Roles, Responsibilities and Opportunities for a Financial Analyst in India

7 Financial Forecasting Methods

In general, there are two types of forecasting: while one is qualitative, the other is quantitative.

Under the quantitative method, here are the methods to follow:

1. Percent of Sales: It includes examining the percentage of every account’s historical profits. This method calculates the forthcoming metrics of financial line items.
2. Straight Line: The method presumes an establishment’s historical growth rate remains constant. However, it does not account for supply chain issues or market fluctuation.
3. Moving Average: This method closely assesses the business’s low or high demands. It encompasses taking the weighted average of the past periods to forecast the future.
4. Simple Linear Regression: The metrics are based on two variables: independent and dependent variables.
5. Multiple Linear Regression: It involves more than one variable directly impacting the establishment’s performance.
6. Delphi Method: It encompasses consulting professionals analyzing market conditions to anticipate the performance of the company.
7. Market Research: This method is a prerequisite for any organizational planning.

How to do Financial Forecasting in 7 Steps?

Follow these steps to perform financial forecasting easily:

• Define your purpose 
• Collect historical data and financial statements
• Select a time frame 
• Consider a method for the financial forecast 
• Document and monitor your results
• Analyze the data
• Repeat the process depending on the defined time frame

What is the Difference Between Financial Forecasting and Modeling?

Tabulated below is the difference between financial forecasting and modeling:

Read more about Financial Analysis, Valuation, & Risk Management.

Conclusion

So, this post has given an analysis of financial forecasting in financial management, its benefits, types, methods, and more.