On this blog, we talk a lot about financial predictions and developing best practises for accurate financial forecasts. And using historical data for financial forecasting is one of the most debated subjects in the industry. In this post, we discuss the benefits of accurate financial forecasts and what can historical data add to it.
Why are accurate financial forecasts important?
One of the most important tasks in the business is preparing accurate financial forecasts. Most of the business decisions are made from these predictions, anything from how much money the organisation can borrow, how many employees to hire to how to take advantage of expansion opportunities.
There are many advantages of accurate financial forecasts, from better cash flow management to more accurate and consistent pricing, which will add to higher profitability and a better chance at acquiring finance.
The most recognisable example of the importance of accurate financial forecasts is when a business is trying to acquire a bank loan or secure finance. An organisation needs to show that it can generate enough revenue to balance their books and repay the loan, which an accurate forecast would demonstrate.
Benefits of using historical data
Overtime forecasting has become a much more difficult and more complicated task consisting of a multitude of variables, therefore many forecasting techniques have been developed to help all business reap the benefits of forecasting. Among one of the most accurate forecasting techniques is projection based financial forecasting, which uses historical data, trends, and projections to predict the future. A great benefit of such forecasting is that it can provide an accurate representation of your business. Using ProForecast, you can now easily import your historical accounting data to your forecast with just a few clicks!
Additionally, historical data doesn’t have to be only from your business. You can use any economic variable you believe has an effect on your business based on your observations and business experience.
The pitfalls of using historical data
As everything in forecasting, there are some concerns that come with using historical data for accurate forecasting. Past performance is not necessarily a good indicator of future performance.
One of the main pitfalls when it comes to using historical data in your forecasts is that some research shows that different level of historical forecasting will lead to a different level of forecasting accuracy. This is partly due to the analyst’s understanding of a company’s business model, key customers, addressable market, competitive position, and sales strategy. Garbage in = garbage out.
Another problem with relying heavily on historical data for your forecasts is that you most often will end up with a naïve forecast. A naïve forecast has minimal amounts of effort and manipulation used to prepare a forecast. Most often naïve models used current data as a forecast for the next period and values from the same period of the prior year as a forecast for the same period of a forecasted year.
Historical data can be very beneficial for accurate financial forecasting, as long as you use such data with caution. Treat this data as an additional tool to make your forecasts more accurate, rather than rely solely on historical data to give you results.
Remember, the plan is always just as good as the data you put into it.