What Is Financial Forecasting? The 7-Step Guide to Predicting Business Performance

FP&A teams are under pressure to develop financial forecasting processes that deliver fast, reliable, data-driven results. Guided by solid estimates of future business performance, they can make more informed, agile financial decisions and navigate periods of uncertainty.

How can you increase your financial forecasts' speed, accuracy, and value? This guide will explore the seven steps of financial forecasting and cover the different financial forecasting types, components, methods, best practices, and software.

Table of Contents

• What Is Financial Forecasting?
• Why Is Forecasting in Financial Planning Important?
• Types of Financial Forecasting
• What Are the Key Components of Financial Forecasting?
• 7 Financial Forecasting Methods
• How to Do Financial Forecasting in 7 Steps
• Example of Forecasting in Finance
• What Are the Disadvantages of Financial Forecasting?
• How Does Software Improve Financial Forecasting in Business?
• Best Practices For Effective Financial Forecasting
• Simplify Your Budgeting and Financial Forecasting Process in One Single
• Platform With OneStream
• FAQs About Financial Forecasting

What Is Financial Forecasting?

Financial forecasting analyzes historical data, financial statements, current market conditions, and other key factors to estimate a company’s future financial health and performance. This could include estimating sales, cash flow, budgets, or income.

Forecasting plays a key role in financial modeling and planning. It lays the foundation for Chief Financial Officers (CFOs) and financial planning and analysis (FP&A) teams to make educated financial decisions that drive the success of strategic, long-term plans.

Now that we’ve answered “What is forecasting in finance?”, let’s move on to another common question—is forecasting the same as budgeting?

Forecasting vs. Budgeting

Forecasting and budgeting are somewhat interrelated but are distinct processes with different goals. Here’s a table that lays out the key differences:

Why Is Forecasting in Financial Planning Important?

The ability to anticipate future income, expenses, cash flows, and risks has numerous benefits.

1. Strategic Decision-Making and Planning
   The aim of financial planning and analysis is to set realistic future goals and create achievable roadmaps. But FP&A professionals can’t rely on gut feelings. They need a data-backed perspective of the future—complete with the most likely scenarios and unexpected twists and turns—to make more informed, forward-thinking decisions.
   Financial forecasting provides teams with an enhanced view of potential future trends and market conditions, such as pricing trends and demand fluctuations, enabling them to make proactive and strategic decisions.
2. Better Risk Management
   Without comprehensive finance forecasts, businesses expose themselves to critical risks, such as liquidity issues, overspending, economic downturns, market fluctuations, and issues securing loans.
   While financial forecasting doesn’t completely eliminate uncertainty, it gives financial planning teams deeper insight into what the future holds and how today’s decisions will impact tomorrow’s finances on a continuous scale.
   They can factor in circumstances like inflation, supply chain disruptions, and changing market trends to develop contingency plans and mitigate risks.
3. Enhanced Cash Flow Control
   One of the main advantages of financial forecasting is the ability to predict cash inflows and outflows. The more insight you have into where and when cash enters and leaves your businesses, the more proactively you can secure lines of credit, adjust budgets, and ultimately prevent cash shortages.
4. Instilling Stakeholder Confidence
   Businesses seeking additional funding for their financial plan must provide investors and other stakeholders with transparent and accurate financial documents. This includes past pro forma statements and data-backed financial forecasts that project future revenue, expenses, and cash flow.
   Using financial forecasts, investors can determine potential revenue and growth and use this data to make confident decisions. Companies that meticulously forecast are more attractive to investors, as it reassures them of the company’s long-term sustainability.
5. Optimized Resource Allocation
   Financial forecasting gives you a clearer idea of where to allocate resources and how much should be allocated to meet your financial goals. Whether it be capital, labor, or time, FP&A teams can leverage forecasts to optimize resources and make more informed budgeting decisions for long-term value.

Types of Financial Forecasting

There are four primary types of finance forecasting: sales, cash flow, budget, and income. Each one serves a different purpose and reveals distinct insights.

Sales Forecasting

Sales forecasting predicts future product sales revenue during a projected fiscal period. Drawing from historical sales data, seasonality, demand fluctuations, economic conditions, and other factors, sales forecasting estimates how many sales a company will likely make in a month, quarter, or year.

Sales forecasts assist in budgeting, planning production, inventory management, and revenue goal-setting.

Cash Flow Forecasting

Using income and expense data, cash flow forecasting estimates the flow of cash traveling in and out of a business, usually over short-term periods, to maximize accuracy.

By projecting cash flow, companies can evaluate whether they can meet cash obligations. It’s also used to manage liquidity, make better budgeting decisions, and identify immediate funding needs.

Budget Forecasting

Once a budget has been set, finance teams can use budget forecasting to predict the ideal outcome of the budget for the upcoming fiscal period, assuming that the budget is followed exactly. At the end of the period, variance analysis is performed to compare actual financial outcomes with the forecasted budget figures.

Budget forecasting drives more accurate budget performance projections, increasing the reliability of corporate budget planning.

Income Forecasting

Income forecasting aims to estimate future income. It uses historical data to analyze past revenue performance and compare it to the company's current growth rate to project net income during a specific period.

Income forecasting helps finance teams make knowledgeable decisions about cost management, pricing, budgets, resource allocation, and investments. They also instill confidence in suppliers and investors.

What Are the Key Components of Financial Forecasting?

There are three core pro forma documents that you’ll need when forecasting finance: income statements, balance sheets, and cash flow statements.

• Income Statement: An income statement details the revenue, expenses, gains, and losses incurred by a company within a specific time frame. They're the key document used to determine profitability.
• Balance Sheet: A balance sheet reports three crucial financial details: assets, liabilities, and shareholder equity. It's used to determine your business's overall financial health and performance.
• Cash Flow Statement: Cash flow statements document how much cash flows in and out of your business during a given period, illuminating exactly where your money goes and when.

7 Financial Forecasting Methods

The seven methods of creating a finance forecast can be split into quantitative and qualitative.

Quantitative Methods

Quantitative forecasting methods use large quantities of historical data to inform forecasts.

1. Percent of Sales
   This simple method calculates future financial metrics, such as the cost of goods sold (COGS), as a percentage of sales. This makes sense for financial line items that are consistently relevant and proportional to sales, as they can be projected accurately in alignment with historical data.
   To forecast the percent of sales for a specific line item, such as COGS, divide it by your total sales and multiply the results by 100.
2. Straight Line
   The straight-line method projects future revenue by assuming that growth rates will remain consistent over time. It can be calculated by multiplying your company’s previous annual revenue by its growth rate, giving you a projected estimation of future revenue.
   Simple and efficient, the straight-line method is useful for inexperienced teams or companies with stable growth rates. That said, by failing to account for the external factors that commonly cause growth rate fluctuations, this method has issues with accuracy.
3. Moving Average
   The moving average method uses the average of previous periods to reveal underlying patterns and trends, leveraging them to make short-term forecasts.
   Companies tend to use three-month or five-month moving averages. This is because they generate more accurate and reliable forecasts for values that experience lots of movement, such as stock prices.
4. Simple Linear Regression
   Simple linear regression takes two variables—a dependent variable, such as sales, and an independent variable, such as digital advertising spend—and analyzes the historical relationship between them to forecast financial performance.
   This method works when the independent variable directly and linearly affects the dependent variable. For example, if you increase your digital advertising spending, your sales can be projected to increase.
5. Multiple Linear Regression
   An extension of simple linear regression, multiple linear regression may be used when two or more independent variables directly affect the dependent variable.
   For example, if you wanted to project how digital advertising spending, seasonality, and market conditions affect sales, you’d use multiple linear progression to get a more accurate forecast.

Qualitative Methods

To make predictions, qualitative methods use non-quantitative data, such as expert opinions, market research, and experience.

1. Delphi Method
   The Delphi method gathers data from market experts. These experts conduct intricate research into market conditions and leverage their experience and knowledge to forecast business performance.
   This method operates iteratively. Market experts submit their forecasts to company leaders, finance professionals, and others, who review the forecast, comment, and circulate the analyses in rounds until a consensus is reached.
   In times of rapid evolution and change, the Delphi method can provide insight when quantitative data is lacking.
2. Market Research
   Market research collects data from customers, competitors, and third-party resources to obtain perspective on market demands and conditions. For example, you might use customer surveys, focus groups, and competitive analysis to understand customer needs and preferences in a new market.
   Market research is invaluable for companies looking to enter new markets and startups that lack the historical quantitative data needed to make predictions.

How to Do Financial Forecasting in 7 Steps

The financial forecasting process can be split into seven steps, which include the following:

1. Define the Purpose of a Financial Forecast
   Start by defining what you hope to achieve with your financial forecast. For example, are you trying to estimate revenue, expenses, or cash flow or determine the impact of your budget or investment strategies?
   A clear objective will help you understand which forecasting methods and financial data you should use.
2. Gather Past Financial Statements and Historical Data
   Along with pro forma financial statements, gather the relevant historical data you need to create an accurate forecast. The more comprehensive your historical data, the more accurately you can identify trends, patterns, and correlations.
3. Choose a Time Frame For Your Forecast
   Are you looking to make short-term estimates (e.g., weekly, monthly, or quarterly) or long-term estimates (e.g., over a year or multiple years)? Your forecasting goals will heavily influence the time frame you choose.
   Short-term forecasts are more accurate and illuminate immediate needs before they become critical. Long-term forecasts are less accurate, but they’re invaluable to strategic planning and help you fuel long-term growth and competitiveness.
4. Pick a Financial Forecast Method
   The financial forecast method you choose will depend on your forecasting goals, preferred time frames, and data availability.
   An established enterprise looking to forecast revenue and growth will have enough historical data to leverage quantitative methods like moving averages and percent of sales. A small company with minimal historical data may leverage qualitative methods.
5. Document and Monitor Results
   Document financial forecasts for future reference, noting the methodologies used and the results collected. Regularly monitor forecasts to evaluate their accuracy and update them to reflect business transformations, market developments, economic changes, etc.
   Developing a rolling forecast process is advantageous, giving you better agility, data accuracy, and risk management.
6. Analyze Financial Data
   Analyze financial data to identify significant variables between outcomes and/or unexpected or external factors impacting results.
   Analysis provides insights into your current financial performance and informs your future forecasting methodologies and figures to improve the accuracy of later projections.
7. Repeat Based on the Previously Defined Time Frame
   To derive maximum value from financial forecasting, repeat the process based on the time frame you used previously. Once the forecasting period ends, start again from step one, leveraging the previous period’s forecast to influence projections on an ongoing basis.

Example of Forecasting in Finance

Let’s quickly run through a real-world example of how a business might forecast in finance.

Manufacturing service INW leveraged OneStream to conduct a budget forecast. They easily consolidated historical data from disparate divisions into OneStream’s platform and leveraged the built-in, AI-driven forecasting capabilities to implement driver-based rolling forecasts and access visual analytic data for accurate actual-to-budget comparison.

The result? INW streamlined monthly budgeting and forecasting, using consistent reporting across divisions to align budgets with performance accurately.

What Are the Disadvantages of Financial Forecasting?

The effectiveness of financial forecasting is threatened by poor data quality, labor intensity, and a lack of historical data.

• Poor Data Quality
  Financial forecasting relies on accurate data. When you use qualitative forecasting or manual data collection and analysis methods, you risk basing forecasts on data that’s inaccurate, inconsistent, incomplete, or biased.
• Complex and Inefficient
  Preparing a financial forecast requires a dedicated FP&A team and extensive collaboration with marketing, sales, HR, and procurement.
  Error-prone manual tasks, poor collaboration, and data silos can make financial forecasting lengthy. Fortunately, FP&A software can significantly boost efficiency.
• Challenging for Startups
  Startups and new businesses won’t have the historical data to develop accurate forecasts. While using qualitative data is an option, it’s less accurate when not supported by quantitative data.

How Does Software Improve Financial Forecasting in Business?

Advanced FP&A software helps businesses navigate the challenges of FP&A while driving significant, competitive benefits.

1. Centralizes Data
   Financial forecasting software unifies disparate financial data from various sources into one system, improving data accessibility and providing a single source of truth.
2. Improves Forecast Accuracy
   Leveraging software, finance teams can automate error-prone tasks like data entry. And AI in forecasting software can uncover patterns and trends, increasing accuracy.
3. Drives Faster Insights
   Thanks to AI and automation, forecasts can be quickly generated, giving businesses a competitive advantage. Plus, finance professionals have more time to spend on strategic initiatives.

How to Choose the Best Financial Forecasting Software For Your Business

Different businesses will have varying software needs and requirements. How do you go about choosing the right solution for you?

1. Identify Your Holistic Forecasting Needs
   Define your forecasting goals and establish the solution to meet these objectives successfully.
   For example, do you need to forecast across multiple or single entities? Are you looking for a standalone forecasting tool or an all-in-one solution that facilitates different types of forecasting?
2. Calculate Your Budget
   The price tags of financial forecasting software vary. Compare packages and quotes from different providers to establish a realistic budget in alignment with your needs.
3. Evaluate Automation Capabilities
   One of the biggest advantages of financial forecasting software is its ability to automate manual tasks. Identify particularly error-prone and productivity-draining tasks and verify whether the software can help automate these processes and to what extent.
4. Consider Integrations
   Your forecasting tool must integrate with all of your existing data sources. Check what integrations the solution offers to align with your current and future needs.
5. Leverage Demos and Free Trials
   Perhaps the best way to assess whether a solution is right is to try it out yourself. Many providers offer a product demo or free trial that you can use to test the features and functionalities as well as the solution’s ease of use, compatibility, and performance.

Best Practices For Effective Financial Forecasting

To derive the maximum value from financial forecasting, make sure to implement these best practices into your process:

1. Identify and Integrate Your Data Sources

Businesses—particularly enterprises—sit on vast volumes of data that can quickly become siloed and inaccessible, causing critical forecast gaps. You build a unified data foundation where FP&A professionals can easily access and analyze data by identifying and integrating your data sources into one centralized solution.

2. Automate the Forecasting Process

According to research, FP&A employees spend 75% of their time gathering and sorting data, leaving little time for value-based analysis.

AI in finance has evolved to eliminate this challenge, empowering teams to work strategically and valuably. AI and automation-enriched forecasting technologies should be leveraged to gather and standardize data, build forecasting models, simultaneously run complex scenarios, identify inconsistencies and errors, and generate comprehensive reports.

3. Leverage Driver-Based Metrics

Driver-based financial forecasting strategies enhance projections with “driver-metrics”—i.e., metrics that are fundamentally important to overall bottom-line performance—to create complete forecasts that are more accurate and forward-thinking.

Different businesses have different drivers, but common metrics include customer acquisition, market share, and retention rates.

4. Contemplate Multiple ‘What If’ Scenarios

Sophisticated financial modeling considers every potential option and builds scenarios—preferably using machine learning—for each one. This enables leaders to understand the influence of various factors and circumstances, such as economic, market, and political conditions, on financial performance.

Forecasting for possible scenarios can prepare you for potential risks and equip you with the insights needed to jump on arising opportunities.

Simplify Your Budgeting and Financial Forecasting Process in One Single Platform With OneStream

Effective financial forecasting is comprehensive, consistent, and driven by data. But it’s far from easy. OneStream’s unified financial planning and forecasting software simplifies the process, empowering FP&A teams to execute and accelerate sophisticated forecasting strategies and reports.

For example, you can:

• Configure and deploy powerful predictive models and automatically generate forecasts.
• Leverage top-down and bottom-up planning, driver-based planning, rolling forecasts, and other advanced techniques to gain a holistic view of profitability.
• Use allocations speed data collection and entry to accelerate planning, analysis, and forecasting at scale.

Request a demo to see how FP&A teams can make their lives easier with financial forecasting software.

If you’d like to know more about how OneStream can help take your business to the next level, why not sign up for our weekly live demo webinar? This takes place every Friday and it’s completely free to participate. Check out our resources library, too.

FAQs About Financial Forecasting

What Is the Role of Forecasting in Financial Planning?

Forecasting guides financial planning, budgeting, and forecasting by providing data-backed estimates about future sales, revenue, expenses, economic conditions, and market fluctuations. This enables financial planners to develop more realistic, risk-aware roadmaps.

Who Is Responsible For Financial Forecasting?

Financial forecasting is usually led by the Chief Financial Officer (CFO) and executed by financial planning and analysis (FP&A) teams.

What Is the Difference Between Financial Forecasting and Planning?

Financial forecasting is making estimates about a company’s financial future, whereas financial planning sets actionable, long-term goals and strategies for the future.

What Is the Difference Between Financial Forecasting and Modeling?

Financial forecasting provides base predictions and estimates for future success, while financial modeling leverages the data in forecasts to simulate scenarios and enrich forecasts with more value.

What Are the Three Pro Forma Statements Needed For Financial Forecasting?

The three key pro forma statements used in financial forecasting are income statements, balance sheets, and cash flow forecasts.

What Are Financial Forecasting Tools?

Financial forecasting tools are technology applications that automate and simplify forecasting. They offer AI capabilities, automation, and other powerful features and functionalities.