Top Financial Forecasting Methods in a Nutshell

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Top Financial Forecasting Methods in a Nutshell

CFO Tech Outlook | Tuesday, May 31, 2022

Every forecasting method has its strengths and weaknesses, so businesses must select the one that best suits their needs and their goals in projecting future finances.

Fremont, CA: Businesses have a wide range of options for selecting a financial forecasting model that offers accurate, reliable data to inform strategic decision-making. You can use simple forecasting options or complex forecasting methods that require business software depending on the variables considered.

Every forecasting method has its strengths and weaknesses, so businesses must select the one that best suits their needs and goals in projecting future finances.

It's important to remember that no financial forecast is foolproof. As your organization attempts to make future predictions based on information and insights rooted in the past, there is always a margin of error, no matter how robust the forecasting method you use. Companies are instead looking for a forecasting method that can be used to frame and inform financial decisions, such as budgeting and hiring.

Forecasting methods typically fall into two categories: qualitative or quantitative. Here are some of the most common forecasting methods used today, along with an overview of each school of thought.

Quantitative forecasting methods

In quantitative financial forecasting, hard data is used to generate forecasts. For example, quantitative forecasting tends to be more effective when dealing with data points like future sales growth or tax topics rather than subjects with less concrete data to guide forecasts.

Quantitative forecasting takes out the guesswork , but it can also be limited by a lack of human expertise, resulting in a missed context that significantly alters forecasts. However, it continues to be a useful tool in a number of business scenarios, especially when your historical business data is a reliable resource for projecting future results.

Following are some of the top quantitative forecasting models used by businesses.

Straight line

This method is one of the easiest to use because it requires only basic math and provides reasonable estimates for what businesses can expect in future scenarios. When a business anticipates revenue growth in the future, straight-line forecasting is commonly used.

You may use your company's past revenue growth rate as a benchmark for future growth. According to the straight-line method, if revenues have grown by an average of seven percent over the past three years, you can assume a similar growth rate for the next three to five years.

During that period, many variables will affect not only your revenue growth but also your net profits. You can still use this method for setting financial goals and budgets and planning for the future based on where you expect your company to go in the future.

Moving average

A moving average is the average performance of a particular metric over a certain period of time. Among other things, it's often used to evaluate revenues, profits, sales growth, stock prices, and other financial metrics.

A moving average is good for smoothing out performance over time to better understand your company's financial trends. For example, in industries where sales and revenue fluctuate over time, a three- or five-month moving average can help you identify the peaks and valleys.

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