What is Financial Analysis and Forecasting
Finance forms the core of all industries. Under this broad category comes Financial analysis and forecasting. The act of planning also includes the act of estimating the future of a business. Finance is an umbrella term that has several branches. In this article, we will learn about one such branch- Financial Analysis and Forecasting.
What do Financial Analysis and Forecasting mean?
Financial analysis and forecasting form an essential part of any business. The major task here is ‘prediction’. You as a financial analyst would need to predict and estimate the business outcome of your company. This outcome involves revenue and losses.
For example, think of yourself as a restaurant owner. To run a restaurant, you would need several things like a place where the restaurant would be situated, chairs, tables, interior decoration, etc. Then you would need to decide on the type of cuisine that would be available like Chinese, Italian, Mexican, Indian, fast foods, etc. But before all these, comes the financial concerns. How much you can spend, where should you invest, what should be the investment, etc.
While for us finance might be just one task, in reality, it has several small branches that join together to make this complete whole. The work of an accountant would be very different from that of a financial analyst. Though both work under the same branch the objective of their work would differ.
Forecasting refers to the task of creating an estimation of how much profit the company can perhaps make or the losses it will incur, in the future. The analysis plays a critical part here. The analyst has estimated the future loss or profit that an organization is going to bear by analyzing the current market rates, the current business standing of the organization, its past history of profits, and the changes in the market that are likely to occur in the near future.
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Financial Analysis and Forecasting in Details
Forecasting is an essential part of any business. Forecasting today has turned out to be a necessity in a business. What will be the repercussions of taking a particular decision, how one could increase the revenue, decrease the chances of losses, etc. Any business depends upon forecasting.
For example, what products would be of use during a particular season or festival is also part of the business. During the pandemic situation, companies started mass manufacturing masks, face shields, sanitizers, gloves, etc. With the risk of falling oxygen levels in covid patients, rose the increase in the purchase of oxymeters. Just think about the pre-pandemic time, did you ever hear anyone buying oximeter for domestic spaces? No.
Based on the new demand and ‘forecasting’ these products were introduced. Not only medical companies, but companies that produced completely different things, started manufacturing sanitizers. This is a kind of business strategy where one tries to produce products by predicting the market demands. This prediction includes the cost that would be incurred to produce these products, the average revenue that the company is expecting, the eligible consumers, the funds available, etc.
Financial analysis and forecasting is a very critical sub-part of the finance department because it also helps in creating the annual budget. While we as general consumers are only concerned about the product we want to purchase, a business enterprise has a number of other factors that need to be kept in mind for the business to run smoothly. A common everyday example would be the best.
During the summer season, certain new kinds of instant refreshing drinks are introduced by companies. While they continue producing their common soft drinks, these additional refreshments are introduced based on the season. A financial analyst would be partly responsible for this forecasting. The analyst will make a survey about the rate of profits made from soft drinks in the summer months, the type of consumers, the expected revenue through the introduction of a new product, company funds, etc.
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Types of Forecasting Techniques
There are broadly two techniques used in financial forecasting. They are:
A. Qualitative Techniques: This type of technique is used for a newly introduced product in the market. Based on the response of the consumers in the market, the estimation is generated. The response includes the number of consumers who purchase the product and keep on purchasing it. For example, a newly introduced moisturizing lotion or sunscreen. Based on the reviews and the rate of purchase, certain predictions are made. Two of the most used qualitative techniques are:
1. Market Research: This type of research would include predicting various kinds of situations that a company or a firm can face in the future but has not faced till now. Market research would usually provide data to financial forecasts to further their analysis. A good example of market research would be to survey the best time to introduce a product in the market. The greater the market research, the better would be the forecasting. But many a time such kind of data is unreliable due to the change in the public demand or the personal biases. Since the research has no concrete data, predictions in such cases may or may not hold true.
2. Delphi Method: This method is a popular kind of method where analysts of a company seek expert advice. This kind of expert advice can come from internal or external sources. The company can take the help of senior, experienced members of their company to arrive at a particular prediction. Or many times the company seeks expert help from experienced members from external sources, who have knowledge in this area. This type of method is quite beneficial for long-term forecasting. Those involved in the real estate business usually go for this type of method. The reason is the change in the value of a property and space over the years.
B. Quantitative Techniques: As the name suggests, quantitative techniques use concrete data that is available to make forecasts. This is a less complicated and more direct approach to making financial forecasts. This type of approach is considered to be more reliable in any business as it helps to make predictions on future revenue, profits, etc. Some of the most used quantitative techniques are:
1. Straight Line Method: This is probably the easiest and most used method in any business. Basic knowledge of mathematics is enough for this type of calculation. This method is usually used by a firm or a business when they are expecting a profit or revenue in the near future. This method can be used while planning budgets. Based on past profits and revenue percentage, the future revenue can be predicted.
2. Moving Average: This method is great when you are trying to understand the financial trend of a particular company. While most of the methods used for forecasting, usually predict for a minimum time period of 1 year. But this method is used for making financial forecasting for 1 month. This method of forecasting usually takes place every month. The estimation of revenues, stocks, changes in prices, etc are all done through this method. In a business with a fluctuating trend, a moving average of 6 months would help you to make forecasts about the times of high and lows that happen in a particular month.
3. Linear Regression Method: This method uses the form of a graphical representation of data of any two points and thereby uses that relationship to create a trend chart. One simple example that could be used to explain this would be the relationship between sales and the profit received. Usually, this type of variable has a positive relationship- with the increase in sales, the profits earned by a company also increase. But if the sales have increased by 4 times with no significant rise in the profit rate, then the company can understand and make predictions about other factors like tax. Strategic decisions can be made by analyzing the trend line produced through this method.
4. Time Series Method: This type of method is a completely data-driven method used to make predictions for the future. The strategy behind this data is to predict future trends by studying past trends. There are several kinds of approaches that come under this method. Based on the type of the company, the products it manufactures, the market rates and demands, etc financial forecasting uses the most appropriate approach.
Thus, under the broad categories of quantitative and qualitative methods, we have several approaches and methods that are selected and used by the financial expert based on the type of the company.
Financial Forecasting vs Financial Modeling
Both these terms are related to the field of finance. Finance is an umbrella term under which multiple smaller categories are involved. Though Financial forecasting and financial modeling might sound the same to any layman, the purposes of these two are quite different.
Financial forecasting is the process of making predictions and estimations on the growth prospect of a company by studying past data, records, and trends of the company. Financial modeling, on the other hand, uses the pieces of information and data collected through the forecasts and makes spreadsheets to record the earnings and expenditures of a company. Through this spreadsheet, they analyze the future growth of the company.
Financial Modeling usually uses tools like excel to record data and thereby analyze them. Forecasting uses past data along with current market conditions to gather knowledge and then arrive at a logical forecast.
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5 Main Components of Financial Analysis
The process of financial analysis is extremely important to determine the company’s financial health. Finance is a prime area of concern for firms or businesses, and hence the process of financial analysis becomes crucial. Some of the most important areas that a financial analyst looks into are:
- Revenues: Revenues refer to the total income that your company earns through the sale of its products. The revenue generated by your company forms the backbone of any company. The bigger the business, the higher would be its revenue. A financial analyst would analyze the quantity and quality of the revenue that a company generates. If more than 50% of the revenue generated by the company comes from 1 particular client, then it might be dangerous in the long run. If the company has a fallout with that client, or the client’s investment level drops, etc. This analysis is done by a financial analyst.
- Profits: Profits are one of the most important factors responsible for the running of a business. No business would run if there was no scope for any profit. The profit refers to the surplus cash that a company has after it has finished all kinds of payments. The profit is one of the main components of the funds that a company has.
- Operational Efficiency: Operational refers to the company’s resources. Efficiency refers to the proper usage of those resources. The better one is able to utilize the resources of the company, the greater would be the growth of the company. The financial analyst observes and analyzes data to understand if the resources are utilized to their full extent.
- Capital Efficiency: Capital efficiency refers to the amount a company is willing to spend on revenue generation. The analyst is the one who judges and analyzes the current status of a company and also the amount it can spend for revenue.
- Liquidity: Liquidity is the liquid cash that a company has. The assets, profits, and capital of a company that can be converted into liquid usable cash in a very short time refers to the liquidity of a company. The higher the ability to convert the assets to liquid cash in a short time, the better would be the financial stability of a company.
Major Types of Financial Analysis
- Vertical Analysis
- Horizontal Analysis
- Liquidity Analysis
- Ratio Analysis
- Trend Analysis
- Profitability Analysis
- Solvency Analysis
- Scenario and Sensitivity Analysis
- Variance Analysis
Importance of Financial Analysis and Forecasting
Financial analysis and forecasting form one of the most crucial parts of any business. In even our day-to-day life, we make several assumptions. In our own house, we do an analysis of the money we get in a month, places where we have to pay, our savings every month, etc. What happens in our house is like a simple miniature version of what happens in a professional space.
The work of financial analysis and forecasting is done by expert professionals trained in the field of finance. In a business, this forms one of the key bases upon which the entire structure of the business stands. Proper analysis and forecasting would help the company grow and develop. The better the forecasts, the greater would be the revenue and profits.
A financial forecast while analyzing and creating predictions takes a number of things into consideration like market conditions, taxes, products, profits, investments, additional costs, etc. Any company whether small or big understands the complex nature of work involved in financial analysis and forecasting. Thus, if you are from a commerce field, and want to get into the financial department of a company, this is a very demanding career with great opportunities. Your position in any company would be of utmost importance.
Financial Modeling Course by IIM Skills
If you are looking for a specific course that deals with finance and modeling, then you could probably have a look at the course Financial Modeling Training course provided by IIM Skills.
- Basic and Advanced Excel
- Introduction and understanding of the Ribbon
- Keyboard shortcuts
- Regular use functions- Vlookup, Index, etc
- Rules of Conditional Formatting
- Concepts of freezing of cells, rows, and columns
- Data Validation
- Table functions
- Pivot tables, Pivot Charts, and Slicers
- Different types of charts and graphs
- Sensitivity analysis
- Delimit and Flash Fill
- Return functions
- What-If analysis
- Accounting Concepts and Financial Statements
- Key Accounting Fundamental concepts
- Understanding the Income statement, balance sheet, and cash flow
- Concepts of keyline items
- Concept of comprehensive Income
- Relevance of Notes
- Preparing common size financial statements
- Reading of Annual Report
- Ratio/KPI Analysis
- Types of Ratios
- Activity Ratios
- Liquidity Ratios
- Solvency Ratios
- Profitability Ratios
- DuPont formula
- Valuation Ratios
- Basic and diluted EPS
- Financial Summary
- Basics of Financial Modeling
- Structure for a financial model
- Creating Scenarios
- Building Revenue
- Preparing different schedules
- Projecting financial statements
- Error tracking skills
- Formatting tips
- Addition of cover page
- Types of Financial Models
- LBO Model
- Three-Statement Projection Model
- M&A Model
- Private Equity Return Model
- 13-Week Cash Flow Model
- Business Valuation
- Relative Valuation
- DCF Valuation
- NAV Approach
- Football field analysis
- Valuation Output
- Valuation Report
- Pre-money and Post-money valuation
Being an online course, you can do it from anywhere. Many of the concepts used in financial analysis and forecasting are covered in this course. To get a fair idea, doing this course could prove to be beneficial to you. Within 3 months, you would have a certificate as well as a good knowledge of financial analysis and forecasting.
Check out Top Online Financial Modeling Courses
Frequently Asked Questions
Q1. Is Financial Analysis and Forecasting an important job?
A. Yes. You can estimate the importance of a job based on the importance of its role in a company. Financial forecasting and finance form an extremely important role in a business. If a financial analyst analyzes certain data wrongly, or the forecasting is completely wrong, then a business can get ruined. You can hence understand the importance and crucial position that this kind of a job holds.
Q2. Will I get a good salary if I go for Financial analysis and forecasting?
A. These kinds of jobs have a very high demand. The greater the demand, the greater would be the salary scale. In India, this kind of job offers extremely good salary packages. The greater your skills and efficiency, the better would be the salary packages. With the rise in the start-up culture, more and more businesses are on a rise. Thus anyone choosing to enter this field would not regret the decision.
Q3. Do I need to be from a commerce background to get into financial analysis and forecasting?
A. Being a very technical field, companies in most cases hire candidates from commerce or a finance background or any other related field. A person from a completely different educational background would not be welcomed for this kind of complex and critical work.
Q4. Are there any Financial analysis and forecasting courses?
A. Yes. There are courses on financial analysis and forecasting that are available in the market. Most of the courses of this kind are available in the online mode. There are courses that offer financial modeling and analysis together. Any person who fulfills the basic eligibility requirement can join this course and acquire the skills.
Q5. Is doing a course help me understand the concepts in a better way?
A. Most of the courses which are skill-based, provide the students with the practical knowledge that they require in a workplace. While your traditional institutes usually have no scope for practical application of knowledge, a course will give you the scope of application. Most of the professional courses would mix theory and practicals in an intrinsic way.
While you would get a better and clearer idea of the conceptual terms and their functions and utility, the assignments and case studies given to you would allow you to transform that conceptual theoretical knowledge into practical application. Doing a course related to your job would increase your efficiency and thereby your rate of employability.
Companies and businesses today are engaged in more critical ways of working than in the bygone days. Today due to technology and the rise of the digital world, the market conditions have changed significantly. The way a market used to function before has now gone a tremendous change, all due to the digital world.
With the change in market conditions, the business mechanisms have also undergone a huge change. Profits, losses, revenues, investments, etc have all undergone a change. In this complex world, the work involved in financial analysis and forecasting has also gained more importance. In a space where market conditions and consumers’ choices are fluctuating, financial analysis and forecasting play a very important role here.
The following article was an attempt to give you in-depth knowledge about this field. I hope you found the article informative.