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Types of Financial Forecasting Methods

Types of Financial Forecasting Methods

Financial Forecasting Methods

Planning for the future is one of the key aspects of organizational management and is critical to the success of all businesses, irrespective of their size. This technique is called forecasting, and it includes estimating important factors, such as sales volumes, expenses, investment and profit, that could influence outcomes for a business.

Financial forecasters employ various methods to arrive at their estimates. There are two types of forecasting – qualitative and quantitative.

Qualitative techniques are generally deployed where historical data is not available. These methods depend on the judgment of experts to generate forecasts.

On the other hand, quantitative forecasting methods are used when historical data across categories and periods is available, and can be analyzed to get estimates.

Some of the widely used financial forecasting methods that your business can use for effective financial planning are explained below.

Qualitative Techniques of Financial Forecasting

  1. Executive Opinions:

    In this method, the expert opinions of key personnel of various departments, such as production, sales, purchasing and operations, are gathered to arrive at future predictions. The management team makes revisions in the resulting forecast, based on their expectations.

  2. Reference Class Forecasting:

    This method involves predicting the outcome of a planned action based on similar scenarios in other times or places. This is used to defy predictions that are arrived at based only on human judgment.

  3. Delphi Technique:

    Here, a series of questionnaires are prepared and answered by a group of experts, who are kept separate from each other. Once the results of the first questionnaire are compiled, a second questionnaire is prepared based on the results of the first. This second document is again presented to the experts, who are then asked to reevaluate their responses to the first questionnaire. This process continues until the researchers have a narrow shortlist of opinions.

  4. Sales Force Polling:

    Some companies believe that salespersons have close contact with the consumers and could provide significant insights regarding customer behavior. In this method of forecasting, the estimates are derived based on the average of sales force polling.

  5. Consumer Surveys:

    Businesses often conduct market surveys of consumers. The data is collected via telephonic conversations, personal interviews or survey questionnaires, and extensive statistical analysis is conducted to generate forecasts.

  6. Scenario Writing:

    In this method, the forecaster generates different outcomes based on diverse starting criteria. The management team decides on the most likely outcome from the numerous scenarios presented.

Quantitative Techniques of Financial Forecasting

  1. Proforma Financial Statements:

    Proforma statements use sales figures and costs from the previous two to three years after excluding certain one-time costs. This method is mainly used in mergers and acquisitions, as well as in cases where a new company is forming and statements are needed to request capital from investors.

  2. Time-Series Forecasting:

    Time-series forecasting is a popular quantitative forecasting technique, in which data is gathered over a period of time to identify trends. Time-series methods are one of the simplest methods to deploy and can be quite accurate, particularly over the short term. Some techniques that fall within this method are simple averaging and exponential smoothing.

  3. Cause-Effect Method:

    Here, the forecaster examines the cause-and-effect relationships of the variable with other relevant variables such as changes in consumers’ disposable incomes, the interest rate, the level of consumer confidence, and unemployment levels.  This method uses past time series on many relevant variables to produce the forecast for the variable of interest.

Financial forecasting is tough and selection of the appropriate forecasting method is crucial to achieve the desired results. One needs to remember that the chosen method for one program may differ for another. While complex techniques may give accurate predictions in special cases, simpler techniques tend to perform just as well. Whatever may be the case, financial forecasting always helps to predict future performance and aids decision makers.

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Posted in: F&A
senthil.kumaran@Invensis.net'

About the Author: Senthil Kumaran, Operations Manager - Finance and Accounting, Invensis Technologies

Senthil brings 11+ years of experience in the outsourcing/off-shoring domain. He has expertise in streamlining the accounting, auditing and financial management processes of companies across verticals. With in-depth knowledge of GAAP, he has efficiently managed the requirements of bookkeeping, invoice processing, bills processing, general ledger reconciliation, subsidiary business accounting, underwriting and MIS reports for diverse clients. For more information on how Invensis’ Finance and Accounting services and solutions can add value to your business, please contact Senthil at sales {at} Invensis {dot} net today.

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