Businesses often consider the terms “financial forecast” and “financial projection” as synonymous. However, there are key differences when creating a forecast vs. projection. Financial forecasts predict future performance using historical company sales, revenue trends, and some external data to determine an expected outcome. Financial projections envision company performance based on the impacts of a specific decision or trend to determine an expected outcome.
When used together, financial forecasts and financial projections can help businesses better visualize their future and make more skillful business decisions.
Why Financial Forecasting is Important
Financial forecasting helps businesses predict revenue and profit margins for a specified set of time—usually the next quarter or year—under certain assumptions based on historical trends. This short-term financial outlook is often used to set expectations with company management if assumptions are accurate.
As businesses continue to grow or raise seed and series funding, financial forecasts become market-facing analyses, communicating expected business performance to investors, lenders, stock market analysts and other stakeholders.
There are different types of financial forecasts that a business can create to help them predict future performance, including:
- Cash flow forecasting: This estimates the expected cash inflow and outflow to predict a company’s expected cash position over a specific period of time. An expected cash shortage can signal a course correction, and an expected cash surplus can signal more money to invest back into the business.
- Demand Forecasting: This estimates the expected future demand for a company’s product or service using historical sales data. This forecast can be used for inventory planning, pricing, and promotion planning.
So why is forecasting important? Simple. It’s necessary for businesses to use financial forecasts to set baseline performance expectations and have realistic conversations about growth potential.
The Benefits of Financial Forecasting
When done correctly, financial forecasting empowers business decision makers by offering up-to-date visibility into performance and alignment on company-wide goals.
Forecasts Force a Company to Be Intentional
Once a company has an idea of what future performance will look like, they can have realistic conversations about whether the business is growing at the desired rate and what investments need to change to achieve its goals.
Forecasts Help Companies Make Faster Adjustments
Traditional financial forecasts are based on a set of assumptions about historical and current trends, expected company decisions and other factors. Inevitably, some of those assumptions will turn out to be incorrect, forcing company performance to veer from expectations. Regularly analyzing expectations vs. actual performance allows leadership to know when to adjust their assumptions and, subsequently, their strategy.
A key example of this came in the retail sector in 2020. With a large, unexpected shift to online retail and ecommerce during COVID, retail companies used financial forecasts to decide what level of investment to make in omnichannel and online capabilities. Online retail sales increased by a massive 44% in the U.S. in 2020, and finance professionals likely incorporated this into their updated financial forecasts during COVID to make informed decisions on how much to fund an omnichannel infrastructure.
Forecasts Provide Clarity with KPIs
Financial forecasts provide estimates for a number of financial metrics. In order to make a financial forecast palatable, every business needs to identify just a few KPIs to measure success within their organization. Then, the company can focus on those metrics in the financial forecast and adjust their strategy accordingly. Thus, analyzing forecasts requires management to orient the business around specific goals.
Why Financial Projections Are Important
The difference between a forecast vs. projection is the type of assumption it makes. A projection tells a story of what is expected to happen as a result of a specific market change or strategic decision. Companies often develop financial projections to predict how a certain event, such as changing economic conditions or technological investments, might impact an organization’s financial performance.
Projections Give Expected Outcomes for Specific Situations
Financial projections, like a scenario analysis, answer “what if” questions to understand how scenarios outside of historical performance will potentially impact outcomes. For example, a company could build a projection that measures the effect of a supply chain disruption or change in interest rates on future company performance. The resulting data would be just one scenario in a series that makes up the larger projection.
Projections Help Visualize Outcomes Based on Your Objectives
Forecasts are an expected prediction of how a company will perform based on its current or historical performance, which tells the business where they stand competitively and what they can do to improve. A projection, however, takes a desired goal and tells a business what is likely to happen if that desired event or investment takes place. This helps a business understand what they need to achieve the result that they want.
The Importance of Using Forecasts and Projections Together
In practice, businesses should have a strong understanding of financial forecasts vs. projections to answer the appropriate questions they’re asking. Using both effectively gives a business a deeper roadmap for driving growth.
Financial forecasts can help a business plan and predict performance for the next four quarters. Then, those forecasts can be used to build deeper projections that outline scenarios for the long term. With both analyses, businesses should have a clear understanding of where the company is headed and what they need to do to achieve their goals.
Is your business using forecasts and projections to their full advantage? Paro offers flexible financial forecasting consulting solutions to help companies define their goals, build complex forecasts and help drive business growth. Our freelance finance experts can supplement your institutional knowledge with subject matter expertise to help your business demonstrate control during uncertain times.
