Methods of financial forecasting

Financial forecasting is predicting a company's financial future by examining historical

performance data, such as revenue, cash flow, expenses, or sales. This involves
guesswork and assumptions, as many unforeseen factors can influence business performance.

1. Cash budget

What Is a Cash Budget? A cash budget is an estimation of cash inflows and outflows over a
specific period of time. Cash budgets are useful in that they can be produced for long-term
and short-term goals, sometimes for as little as one week.
The cash budget represents a detailed plan of future cash flows and is composed of four
elements: cash receipts, cash disbursements, net change in cash for the period, and new
financing needed.
A cash budget is a budget or plan of expected cash receipts and disbursements during the
period. These cash inflows and outflows include revenues collected, expenses paid, and loans
receipts and payments. In other words, a cash budget is an estimated projection of the
company's cash position in the future.

2. Percentage of sales method

What is the Percentage-of-Sales Method? The percentage-of-sales method is used to develop

a budgeted set of financial statements. Each historical expense is converted into a
percentage of net sales, and these percentages are then applied to the forecasted sales level in
the budget period.

The percent of sales method is a financial forecasting model in which all of a business's accounts
— financial line items like costs of goods sold, inventory, and cash — are calculated as a
percentage of sales. Those percentages are then applied to future sales estimates to project each
line item's future value.

The percent of sales method is one of the quickest ways to develop a financial forecast
for your business — specifically for items closely correlated with sales. That's its major
advantage. If your business needs a very rough picture of its financial future
immediately, the percent of sales method is probably one of your better bets.

Even then, you have to bear in mind that the method only applies to line items that
correlate with sales. Any fixed expenses — like fixed assets and debt — can't be
projected with the percent of sales method.

The method also doesn't account for step costing — when the cost of a product
changes after a customer buys a quantity of that product over a discrete volume point.
For instance, if a customer buys a product from a business that has a step cost at 5,000
units, then every unit beyond those first 5,000 comes at a discounted price.