If the past few years have taught us anything, it’s that the market can change on a dime. And while businesses can’t necessarily do anything to change this themselves, the very least they should do is prepare for it.
Of course, nobody has a crystal ball – chances are, you wouldn’t be reading this if you did! So business leaders need something else to help them plan ahead, even when the financial market is constantly shifting.
This is where financial forecasting comes in. It comes in many different forms, but the point of it is the same – to help your business know where the market might be headed over a defined period of time.
In this article, we’ll discuss what factors lead to a market being volatile, the importance of financial forecasting to helping businesses manage volatile markets, and how business leaders can use financial forecasting effectively.
Understanding the Landscape of Volatile Markets
In the context of financial markets, volatility is how much and how quickly prices move over a time period. The factors that make a market more or less volatile are countless. One of the most constant widely accepted is supply and demand, but they can also include technological changes, regulation or deregulation, and government policy, to name just a few.
With all these factors in play at any one time, it’s not surprising that a volatile market can have a knock-on effect on businesses. Though the market doesn’t differentiate by size, often volatility impacts smaller businesses disproportionately. This is especially true when it comes to the prices of raw materials – due to less warehouse space, they’re often faced with a choice between lower profit margins or higher prices.
The Role of Financial Forecasting
Financial forecasting has been around since at least the 1930s, and since that time its goal has largely remained the same. Financial forecasting is the process of estimating or predicting how a business will perform in the future, with the findings hopefully helping the business make better decisions in the present day.
Good financial forecasting is essential for businesses who want to stay resilient in the face of volatile market conditions. Here are some ways it can help:
Annual budget planning
An inaccurate budget is no help to any business. Good financial forecasting can work in tandem with your financial planning, reducing the chance of budget overspend.
Establishing realistic business goals
With financial forecasting, data is able to help you predict levels of growth or decline in your business. Knowing this means you can manage your expectations, and tailor your goals to these peaks and troughs before they occur.
Identifying problem areas
Instead of dealing with problems as they happen, financial forecasting helps you be proactive – spotting potential snags by looking at what the future holds for your business. Additionally, it also allows you to stop historical problems from reoccurring, by looking at and learning from details of the business’ past performance.
Greater company appeal to attract investors
Financial forecasting isn’t just a useful tool within a business, but it can also help if you’re looking for new investors. They also use financial forecasts to predict a business’ future performance. By extension, these forecasts also give clues to what return on investment might be gained from a company. Keeping up regular forecasting also shows these investors that your company is forward-thinking.
Tips for Effective Financial Forecasting in Volatility
Despite all of the above being true, it isn’t guaranteed that you’ll get these benefits from financial forecasting. For that to happen, your forecasting needs to be effective – even when market conditions are changeable. There are a few general tips for how to make sure you get the most out of your financial forecasting:
- Know what you’re doing it for: Like any other business decision, financial forecasting shouldn’t just be done for the sake of it. Whether you’re scaling up the business as a whole, or investing in new equipment, you should have a clear goal in mind behind why financial forecasting matters for your business.
- Prepare multiple forecast views: Just as financial forecasting has varying benefits inside and outside a business, the people who look at those forecasts will also have varying perspectives on what’s best for growth. So that everyone sees what they need to, it may be best to create multiple views of the same report (something software is built to help you with).
- Start small (but plan for best and worst case scenarios): When first setting up a financial report, your starting point should always be a ‘base case’ with conservative assumptions about growth. Once this baseline is decided, you can move to considering the impact of significant success or drastic failure.
- Keep assumptions to a minimum: The nature of financial forecasting means some assumptions are unavoidable, but you should try not to make assumptions the entire base of your forecast. This can be done by using historical data, ranges over fixed values (e.g. revenue growth between 3%-6%), and focusing on drivers that clearly impact a business’ financials.
- Don’t wander too far into the future: Long-term planning is essential, but be sure not to look too far ahead. Shorter-term forecasts should have as much of a place in your strategy, and you should also make sure to regularly revisit and adjust your forecasts based on changing conditions.
Even the best financial forecasting will never be able to account for all business possibilities. However, having it in your arsenal means your business could be more agile – able to learn from the past and prepare for the future, staying ahead of the curve and its competitors.
Financial forecasting is easy with the help of Sage software. Contact PKF Smith Cooper Systems today to learn more about how our support team can make implementation easy.
Contact us on 01332 959008 or use the enquiry form.
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