Basics Of Financial Forecasting

Basics Of Financial Forecasting

Financial forecasting is the estimating or predicting or estimating how the business would perform in future. Most common kind of forecast is the income statement. But in a complete financial model, all the important financial statements get forecasted. As the business grows, the lenders and investors are interested particularly in projections of the income statement, cash flow statement and balance sheet. You need to have efficient personnel in your team to make it happen and prepare the right forecasting report.

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Forecasting different statements

Forecasting revenue-

The first principle approaches one adopts is identifying various types of methods to model the revenues with great precision and in high degrees of detail. For example, whenever you forecast the revenue for the retail industry, you will have to forecast the expansion rate along with deriving income per sqm (square meter). And whenever you are predicting the revenue for the telecommunications industry, you could use the competitor and current market share analysis to predict market size.   Whereas, while you predict the service industry revenue you will be estimating the headcount and make use of income to predict employee trends.

Forecasting gross margins- Once the revenue forecasting is done, you will want to forecast the gross margins. Usually, gross margins are forecasted as a revenue percentage. Here one has to use the historical trends or figures to forecast the future gross margins. But, it is advised to take a much more detailed approach as one need to consider factors like economies of scale, learning curve and cost of input.  The second approach makes the model be much more realistic but it is quite harder to follow.

 Forecasting overhead cost- You need to forecast the selling, general, administrative costs and it is often done as a percentage of revenue. Even though these costs would be fixed in short-term, later on in long-term it would be variable. Hence, when one forecast for short periods, you need to use the revenue to predict the selling, general, administrative expenses. Few of the models would forecast gross and the operating margins.