This article is in continuation of my previous articles- Management Discussion and Analysis (posted on 21 Sep 2016) and Financial Planning & Analysis (posted on 24 Mar 2017). Financial planning & Analysis (“FP&A”) article already discussed the insights of importance of analysis in FP&A in today’s scenario. However, this article aims at providing insights solely on forecasting & budgeting part of FP&A.
Forecasting & Budgeting both play an important role in business as it helps in strategizing the business, formulating the strategies based the assessment of trend & latest developments in industry. Hyperion like forecasting tools helps the organization to achieve this goal. However, there is a thin difference between forecasting & budgeting. Budgeting is what you want to achieve, i.e. expectations of business. Forecasting is what you are about to achieve taking care of your latest developments & current trend & scenario, i.e., basically whether we are in alignment with expectations & understanding the deviation whether could be achievable or not. Various forecasting models & approaches make our life easy by giving right directions to us to do the forecast.
Top Down & Bottom Up Forecasting
Forecasting need to be done of almost every factor- whether it’s external factor like GDP growth & industry forecast or internal factors including every financial statement components, like net income, sales, working capital, cash flow etc. In order words, it’s all about top down or bottom up financial forecast. In case of top down approach, organizations start with external factors then see its impact on own industry & then depict its own true picture in light of current scenario. In case of bottom up approach, organization depicts its current position & then depicts its future financial performance considering the external factors.
Simple & Complex Forecasting Models
There are different forecasting models as well. Some historical average or trend adjusted measure of profitability like operating margin, EBT margin or net margin can be used in case of simple forecasting model to forecast earnings. However, in complex forecasting models, each item on income statement and balance sheet can be estimated based on separate assumptions about its growth in relation to revenue growth.
Cash Flow Forecasting
In case of cash flow forecasting, sources & uses of cash are forecasted. This will indicate cash requirement in future which could be further met by projecting necessary borrowings/ investment depending upon shortage or surplus. Outside research or in-house economics group supplies generally forecast reports of GDP growth which helps the organization in depicting the industry growth with the help of understanding historical relationships.
Planning ahead always aid in not only improving company performance but also assess the more accurate picture of the organization in the light of present scenario. Managing cash flows, sales growth & overheads are important for efficient running of business. Having a good roadmap & history of past experience is a boon in doing effective forecasting and budgeting for any organization.
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