Financial forecasting is based on financial relationships from the past and on expectations about the future. The typical model is a "sales driven" model. If a company can not forecast its future sales, this model may not be appropriate. Finding financial relationships allows us to complete pro forma financial statements and to perform simulations for decision making.
The purpose of forecasting is to make financial plans for the future. But, there are so many uncertainties that precise predictions might not be possible. However, forecasting can help us understand the relationship between financial decisions and financial consequences. By planning we can reduce some of the uncertainty about the future.
The forecasting process starts out with a “base case." In this forecast we make the most basic assumptions. In other words, we postulate what would happen if the company were to maintain the financial relationships on the current financial statements.
Once the base case is prepared, simulation will be conducted. For example, we try to see the effects of reduced inventory to financial conditions. Conducting simulations we can answer the question, what if? What business opportunities is our company facing? If we take these opportunities how will this affect our company's financial statements?
Every forecasting technique requires the assumptions. When we can not make reasonable assumptions, we can use sensitivity analysis. This means rerunning the forecasting model under different assumptions or varying assumptions. Sensitivity analysis can help us understand which variables are critical for our company. For example, if we realize that a change in raw material prices could significantly affect the future financial outcome, this understanding may lead us to engage in hedging activity such as the purchase of forward and future contracts on raw materials.
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(1) English Grammar in Use
・Unit 122 On time and in time At the end and in the end
・Unit 123 In/at/on (position) 1