Financial Forecasting models are one of the most efficient methods to predict the future of your business or organization.
There are numerous types of financial forecasting models. They perform well in different situations based on the events you are trying to predict, the nature of the data you have, and the precision level you are expecting.
To become a champion of your analytical game, you need to understand financial forecasting models and the situations when they work the best for your business. In today’s post, we will delve into the details of the top 5 financial forecasting models and their current-day examples of use cases.
Before we move ahead, we need to catch a glimpse of how financial forecasting and marketing are different from each other and how they work together.
Decoding Financial Forecasting vs. Financial Modeling
Both financial and forecasting and modeling are two different things. However, these two terms are often interchanged because the same people perform these two tasks and use the same data. Even the goal set behind these two tasks is almost the same.
It is usually done by the chief financial officer or simply CFO. Financial controllers can also do this job. They do so by using the following steps.
First of all internal trends such as revenue growth, churn rate, etc. are noted. Then they pay attention to external trends such as changes in the market, customer behavior, etc.
Then the information from these trends is used to forecast future events and trends.
Let’s understand it in a simpler way. Financial forecasting is just like weather forecasting. In the case of weather forecasting, predictions are made about weather such as if it will rain tomorrow or not. In the case of financial forecasting, it is predicted whether sales go up or down in the future.
Financial modeling is similar to financial forecasting. If forecasting is “why”, modeling is “how”. Every company or organization wants to have an idea about the future so that it can make decisions accordingly. The best way to get useful and actionable information about your industry’s future is referred to as the financial model.
Unveiling the Significance of Financial Forecasting
As a company or business owner, you must have some idea about the upcoming changes in the market and your sales so that you can plan things accordingly. Anticipating new opportunities enables you to get maximum benefits from them. Similarly, seeing the risks and challenges before they appear is a promising way to navigate around them.
For example, if you predict that the market is going to turn down, then you will try to improve your cash holding so that you can survive the upcoming harsh months. On the other hand, if you predict the market will experience huge growth, then you may want to hire some new employees.
Why is Financial Modeling Crucial?
The single word that can answer this question is “Uncertainty”. When you predict the future, you are not sure about it. You can only make assumptions. Due to uncertainty, you need to create different models to see how your company will fare under different situations.
Financial modeling enables you to work with uncertainties about the future and improve financial forecasting.
5 Financial Forecasting Models for SaaS Companies
Best financial models based on the information you have, what you want to predict, and how you want to use that model. The following section is about 5 top listed financial forecasting software. Let’s delve into the details of these models.
Model 1. Top-Down Financial Forecasting Models
This model gets into play when you want to assess a new opportunity but don’t have any previous data as a base for your predictions.
This model can use the size of a whole market as a withdrawal point. Then it makes predictions based on how much market shares your company will be able to grab. Usually, a new market is considered in this model.
Let’s say you are planning to start a new SaaS company or launch a new product but have no idea about the size of the market. You can start by estimating the total addressable market that will be the size of the market as well.
The next thing you have to do is estimate the market shares. If you find a big player is present in the market and holding shares, then you may struggle to grow market shares. However, if the market is surrounded by smaller shareholders, then you can comfortably grow your part of the market shares.
Then you have to multiply your estimated shares with TAM value to find the total revenue you may generate in the market. If the value is larger than the expected costs of building and launching the product and CAC, then you are all set to take a good start.
Model 2: Bottom-Up Financial Forecasting Model
If you have some historical data, then you can opt for the Bottom Up model. You can use that data as the input for predicting different scenarios. The whole model will be based on your previous sales data.
The model will be relatively more accurate and reliable as it relies on some actual numbers. As a result, the assumptions or uncertainties are reduced to a greater extent.
Imagine you have around 200 customers who are spending $25/month on your products or services. 5 customers are churned every month and you manage to hit 10 new customers every month as well. So, the current revenue is 25 × 200 = $5,000. And the rise will be 25 × 5 = $125 every month.
Model 3: Delphi Financial Forecasting Model
When you opt for the Delphi method, you have to get assistance from a group of experts. Leveraging the facilitator and collaboratively iterating on a consequences opinion is also involved in this model.
Surveys, question forms, and focus groups are the base of this financial forecasting model. It is very efficient especially when you want to make sure the entire group has access to the useful information.
Let’s say one of your products is stuck at $1000 MRR. You have added new features after regular intervals but cannot improve MRR as your customers don’t want to pay more.
After continuous failures, you decided to hire a team of experts to conduct a series of focus groups using current customers and other influential people.
After the completion of the first round, the experts will show you their findings. Then you will make amendments based on their findings. Then you have to share the outcomes with the experts and they will present new findings. The process will continue till the problem is solved.
Model 4: Correlation-Based Forecasting Model
Tracking co-relatable variables and checking their interactions with each other can help you in forecasting finance. It gives rise to big data and creates possibilities for smaller SaaS companies as well.
This model helps decision-makers in making financial forecasting based on the relationships between different variables such as cost and expense, demand and supply chain, and numerous other factors.
Imagine you are planning to start a new paid campaign for marketing your products. To improve your sales campaigns, you need to understand your audience, the time when they convert into potential customers, and how they behave.
If you observe your customers are sharing funny memes, then you will tend to make your advertisements funny. As a result, your customers will share these advertisements in each others’ inboxes which makes your products visible on social media.
Model 5: Statistical Financial Forecasting Models
These are often referred to as quantitative forecasting models as well. It is based on developing relationships between other disciplines’ findings. It allows you to compare your business operations with other similar businesses. In simple words, you can consider it Benchmarking as well.
Imagine your growth rate is exceptionally high. However, you are well aware of the fact that this is not going to remain the same. Therefore, you need to estimate when the growth rate will observe a decline so you can design your hiring plan accordingly.
To do so, you need to get data from a couple of sources. Firstly, you will gather data from market growth in the previous 20 years. Secondly, you have to get the experts’ opinions on market trends in the upcoming 10 years.
After that, you have to use public data to compare your company with your most established competitors’ growth in the same period. You have to do so to just check out when their growth curves started leveling off.
Then you will use a statistical model to fit the growth rate of competitors to the growth rate of the model you forecasted. It will help you in predicting the time until your company can enjoy exponential growth.
Flightpath by Barometric: Get Help in Building Better Forecasts
Every SaaS company wants to predict future events in the market so that they can plan things accordingly. You can say it’s the “why” of financial forecasting.
However, companies don’t have exact information about the future. There are a lot of uncertainties. To deal with them, financial models are established. You can say it’s the “how” of forecasting.
Gathering as much data as possible is the first step you have to take in creating sound financial forecasting models. Then you need to track uncertainties in the upcoming days and plan to eliminate them. You can run multiple scenarios to eliminate uncertainties.
After that, you have to select the financial forecasting model. The model that can be used with on-hand data will be best for your firm.
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