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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.

The Role of Financial Forecasting in Risk Management

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 & ToolsFinancial Forecasting

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:

Differentiating Parameters Financial Forecasting Financial Modeling
Definition Determines expectations of the future results Takes the assumptions of the forecast and calculates the numbers using the financial statements of the company
Specificity Offers a general overview of the sales and other aspects considering the company's performance Created for specific purposes, for example: gives the business representation.
When to Use It appears on the cash flow or income statements and even balance sheets. So it is available for the public. Financial modeling is available only for internal decision-makers
Source of Data A financial forecast requires an array of data: wider industry and economic trends, current position, and past business performance. In the financial modeling stage, the forecast is only the key data source that assists you in making the right decision.

Financial Forecasting

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.

FAQ's

Financial forecasting offers benefits to every business. Following are some of the:
  • Improved control of cash flow
  • Accurate forecasting can set excellent performance expectations
  • Make budgeting decisions in an informative manner
  • The capability of predicting trends Identifying cash-flow gaps
  • Boosts the confidence of investors while making the deal
Financial forecasting aims to assess future and current financial conditions to guide programmatic decisions. For financial forecasting, one can follow these steps:
  • Defining assumptions
  • Collecting the required information
  • Preliminary and Exploratory Analysis
  • Selecting and implementing the right method
  • Using forecasts
The sole objective of risk analysis is to recognize troublesome areas in a company. For this purpose, these methods can be followed:
  • Identifying hazards
  • Assessing risks
  • Controlling the risks
  • Recording findings
  • Reviewing the overall controls
Forecasting in financial risk management is paramount because it can update and inform business decision-making concerning budgeting, recruitment, revenue prediction, and tactical planning. Besides, it helps an organization's founder maintain a progressive mindset.
Financial forecasting comprises four methods:
  • Straight line
  • Moving average
  • Simple linear regression
  • Multiple linear regression
A financial forecast is an effective tool, presenting estimated information depending on specific parameters like current, past, and projected fiscal conditions. Financial planning and forecasting helps identify the forthcoming revenue as well as expenditure trends that might have a long-term and direct impact on strategic goals, government policies, community services, and more.

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