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What is financial forecasting?

Financial forecasting definition

The way to define financial forecasting is as the estimating of the future financial performance of a company. Businesses that list their shares on exchanges are required to regularly report their financial results, and some publish their forecasts of financial metrics for the coming reporting period.

Where have you heard about financial forecasting?

If you are an investor or trader, you will have heard about financial forecasting in reading a company’s reports or media coverage of the company’s financial results. You will also see financial forecasts in analyst notes. Forecasts will typically cover metrics such as the company’s revenue, costs, profit or loss, cash flow and earnings per share.

What do you need to know about financial forecasting?

A company’s financial performance affects its share price as it indicates how well the business is doing and whether it can afford to return capital to shareholders or invest in its growth. As a result, investors look closely at the financial forecasts that companies publish. Analysts also produce their own forecasts for the financial results of the companies they cover, typically for the next several years, to inform their share price predictions. These also help investors decide whether to take a position in the company’s stock.

Financial forecasts enable businesses to outline how much income and expenditure they expect in the near future, which helps them to plan ahead. A forecast can flag up issues that need to be addressed, such as the need to cut costs or borrow money to fund operations.

When a company’s financial performance exceeds forecasts, the share price is likely to rise in response, whereas if it fails to meet expectations – the share price is likely to fall. Analysis of a company’s quarterly, interim or annual financial statements typically compares its reported results against its forecast performance.

The way companies and analysts forecast future financial performance is by considering historical results as well as expectations of upcoming events. The information that contributes to forecasts includes:

Financial forecasting definition

All these factors can influence a company’s sales revenues and costs over a given period.

For example, a retail company could forecast an increase in revenues in the next quarter because it will release a new product during the period that it expects to sell well. The share price might increase in response to the positive forecast. If the product sells even better than expected and in its next quarterly statement the company reports that it beat the forecast, the share price would likely rise further. If the company pays dividends, it might even choose to pay a one-time special dividend to shareholders from the additional income.

Financial modelling

Advanced financial forecasting uses mathematical models to compute different scenarios to predict the outcomes of different situations and the impact on the company’s financial performance. Comparing these potential outcomes can help companies decide on a particular course of action over their other options.

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