When you refer to a forward-looking financial prediction, do you call it financial forecasting or a financial projection? Often, these terms are confused or used interchangeably. But there are some key differences that you should understand.
The main difference is in the timing. Financial forecasting addresses your immediate predictions, while projections focus on the long term. By understanding the nuances of these terms, you’ll be positioned to more accurately predict your future financial performance.
When we use the term financial forecasting, we are most often referring to predictions within the next four quarters. Forecasting is better for these nearer-term predictions because it uses recent data, growth rates, and trends to predict future margins and revenue. Essentially, forecasting projects your business results if your performance were to stay as it is now.
Let’s say you want to forecast your gross margins for the remainder of the year. You’ll evaluate the gross margin percentage for the last several quarters, looking for patterns and trends. If your gross margins have been cyclical or seasonal, you can forecast that your gross margin over the next several months will do the same.
In the example chart, we can see that a company used actual data from the first four months of the year (and the previous year, not shown) to predict financial performance over the next several months. Gross margins peak in the spring, hold steady through the end of the year, and fall a bit in the winter. So, their projections reflect a similar pattern.
The term “projection” is used within finance to predict financial results further out into the future, and oftentimes financial projections build upon the forecasting you’ve already done. Projections are a more in-depth way to predict future revenue and sales using high-level internal and external drivers like sales capacity, market growth rate, and historical market growth trends.
By factoring in these economic drivers, you’ll have data that lets you more accurately predict future revenue. For example, if you know the Federal Reserve has predicted interest rates rising over the next several quarters, you can use that data in your own financial projections.
What Internal Data to Include in Financial Projections
In addition to external data, financial projections require you to collect internal data from three financial documents: income statement, cash flow statement, and balance sheet. These three components have data that you can use to predict your business performance in a number of areas, aside from just revenue and sales.
An income statement shows your revenue, expenses, and profit for a certain period of time. Patterns in these elements will help you understand what you can expect your future revenue, expenses, and profit to look like.
A cash flow statement shows your incoming and outgoing cash so you can predict whether to save or invest. If your predictions show that you will have excess cash flow, you can invest some of that revenue and potentially increase your cash reserves even more. Alternatively, if you predict a more modest cash flow in your projections, you can save it.
A balance sheet shows your liabilities, assets, and equity. When you compare these components to balance sheets from previous years, you can see patterns that allow you to predict long-term trends.
Use financial forecasting when you need to plan for the next year. Then make projections to build on your forecasts for the next year and beyond.
Potential investors often want to see forecasts to know whether they should invest in your company. Forecasting is a quick way to show them your financial growth and near-future predictions. Use projections for predicting scenarios outside of performance history or for activities like budget planning, business continuity planning, and succession planning.
Whether you’re forecasting or projecting, Planful can help. Our technology makes it easy to collect the data you need and turn it into valuable information for the near- or long-term future of your business.