Question

Our Chapter 4 discussion will focus on the purpose and benefits of financial forecasting.

Commonly, financial forecasting is being used in a variety of businesses to control any upcoming risks, thereby assisting in making essential adjustments before issues will occur. In order for companies to efficiently accomplish their goals, whether it is a short or long-term one, the need for a capable strategy to manage the desired outcome is required. In general, short-term forecasts are formed for tactical reasons in a seasonal period of time (6 months or less). For example, Mr. Smith, who just established his own start-up smoothie shop 4 months ago. The business did not bring any profit and only increased its debts because of old operated equipment and salaries that the owner had to pay for his vast network of employers. Based on the poor performance, Mr. Smith decided to reconsider the production planning and control over the products manufacturing in advance to receive sales fluctuations. He invested in almost brand-new equipment, updated the menu for smoothies, and convinced his family to work in his business until the inventory occupies its expenses within 3 months. This strategy can be very significant for further production and business growth, while the general trends may be of less consequence. However, if the smoothie business would not still reach its financial goal after 3 months and receive poor sales return, the business will expect a negative impact on losing its credibility. Moreover, if businesses are unable to meet demand, it causes the unsatisfactory experience of customers, which eventually leads to further loss of sales down the line.

As for long term forecasting, business individuals are accountable for moving forward its mission and vision and can be accomplished from planning ahead from 6 months to years and more. Objectives may include detailed improvements in the company’s competitive position, profitability, return on investments, etc. All in all, the main criteria in following the forecast is for businesses to have an accurate and realistic management process along with implementing an effective decision making based on the planning.

Using the discussion area, describe how forecasting can effect the short and long term goals of the organization. In answering please give some thought to how the lack of forecasting can negatively affect a business.

Answer 1

FINANCIAL FORECASTING

What is it?

Financial forecasting involves estimating future financial outcomes of business operations. Financial outcomes would mean a cumulative result after considering estimates of various factors influencing profitability of the business proposition under consideration, few of them as mentioned below:

• estimates of sales volume and prices,
• cost estimates (probable escalations and reductions)
• estimates of impact of likely changes in regulatory environment,
• estimates of availability of raw material and other resources like manpower required for production or service delivery,
• estimates of pattern of customer demand etc.

Why forecast?

Forecasting is looked upon in a business environment as a tool to address or mitigate various risks associated with running a business. For example, risk of rise in cost of borrowed fund due to changes in regulatory policies may lead to a major impact on profitability of business. Forecasting impact of this rise in cost would help in making necessary estimates of overall costs and deciding a right pricing model for the products or services offered.

Hence, forecasting allows management of any organization to be prepared for various situations that might emerge in future and to keep the business going in those conditions.

Impact of forecasting and not forecasting on short and long term goals

Organization's short and long term goal would involve various financial and non financial goals of the founders. Financial goals would involve improving the profitability of business, increasing wealth of business, improving liquidity of the business assets, reduction in cost of borrowed funds etc. Non financial goals would involve building goodwill in economy, providing employment to local youth, pioneering a technology or a unique product etc. Short term would generally mean within one business cycle while long term would mean multiple business cycles.

In short term financial forecasting would help in estimating the likely sales volume, customer choices, labor cost etc. that would have an impact on the financial results of the organization. For example, for a company producing hand sanitizers; financial forecast of high demand for its products during the covid pandemic would help them plan their production and to make available necessary resources for the same. This would not only help in meeting demands of their customer base but also build a repute of good market reach in times of shortage of supplies. Lack of forecasting would not only mean loss of business to their competitors but also a bad impression in minds of consumes of the company's inability to fulfill their demands.

In long term financial forecasting definitely would provide great help in directing the performance graphs of the company to take the business to a good long term sustainable model. For example, for a company in healthcare industry producing health drinks financial forecasting of demand for its product will help in taking necessary business decisions after considering the competition it will face after likely government's aid to boom this sector and increasing customers demand after the pandemic. The company might not only have to consider extensive advertising but also diversification to assess likely drop in demand due to new competitors demanding market share. lack of forecasting would mean high risk of drop in revenue affecting the continuance of business with good financial viability.

Hence, financial forecasting is an essential step in business planning and modelling to enable timely and strategic business decisions. Financial forecasting should not be a one time activity but should be updated and reviewed periodically to incorporate changes in business environment and reassess the likely result of business operations. Financial forecasts should be compared with actual results and the differences should be assessed from time to time to help the management in assessing the projects's viability and sustainability in future by citing flaws in planning and forecasting if any that these differences would elaborate. Lack of planning and forecasting would put the business in difficult times by its inability to face changes in business environment.