Financial forecasting and financial projections are two critical processes that work hand in hand to help FP&A teams drive company strategy. Forecasting, rooted in historical and current performance data, informs decisions for the immediate future, while projections explore potential scenarios that lie ahead so companies can stay agile and prepared.
As we have learned over the past several years, the unexpected can happen at any time. To remain resilient, stay competitive and navigate uncertainty (which now seems to be a constant), organizations must be financially resilient. This means being able to look ahead to whats on the horizon and plan appropriately for whichever scenarios may occur.
In this post we'll walk through the essentials of both financial forecasting and financial projections. We'll cover their definitions, the key differences between the two, when to use them and how to enhance both with the right planning tools.
Financial forecasting is the process of estimating the most likely future financial outcomes for a company based on information available at the time. This usually includes:
To create financial forecasts, FP&A teams leverage corporate performance management, or budgeting & forecasting software to turn financial data into insights, then use those insights to make estimates about what will happen in the near futureusually the upcoming months, quarter or year.
Financial projections are predictive analyses that explore the potential business outcomes of various hypothetical events or decisions. Projections help FP&A teams and company leaders evaluate risk, compare strategy options and proactively prepare for situations that could impact the organization (should they occur).
Projections generally involve a scenario analysis to consider likely (or base) outcomes, best outcomes and worst outcomes as well as how the company would handle each one.
As with financial forecasting, projections require the use of CPM tools that can perform sophisticated analyses, analyze large datasets and give insights based on many variables.
The ability to develop data-driven projections has become more important than ever in recent years, amidst pandemic uncertainty and the ripple effects still being felt today. One McKinsey survey found that 70% of companies are now planning for at least three future scenarios and holding back budget for additional contingencies.
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Image Source: McKinsey
At first glance, forecasting and projections may seem quite similar, but the two processes are foundationally different in terms of goals.
Forecasting aims to inform strategic and operational decisions for the immediate future, while projections drive better preparedness for various hypothetical scenarios that could occur down the line.
Let's look more closely at three key components defining their differences.
While financial forecasting and financial projections are both predictive, they look at slightly different timeframes. More specifically, forecasts tend to look at the immediate future (as mentioned, the next months, quarter or year) while projections often look more than a year (or even several years) ahead to determine how a company will navigate certain events.
Financial forecasts always aim to predict the most likely outcome. While FP&A teams may look at a few potential scenarios, they are still focusing on things that are actually likely to happen in the future.
Projections, on the other hand, deal very much with hypotheticals. In an effort to be as agile and prepared as possible, companies may look at scenarios that have a wide range of likelihood to actually pan out including those that are not particularly likely but would make a significant impact if they did occur.
These key differences mean that financial forecasting and financial projections also have separate use cases. In general, forecasts drive fairly immediate decision making and action. Projections play a bigger role in driving long-term strategy and company resilience.
For example, companies typically look at financial forecasting as part of their annual budgeting process. They may look at projections to determine how an event outcome (the pandemic is a timely example) will impact their business and how they should react in turn several years down the line.
According to global consulting firm Korn Ferry, only about 25% of sales organizations are able to achieve forecasting accuracy of 75% or more.
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Image Source: DemandBase (via Slideshare)
This is largely due to outdated and overly manual forecasting methods as well as a lack of the right tools and technologies to manage todays massive data volume. The same applies for projectionsFP&A teams cant do it well without the help of automated, AI-powered data analytics tools.
A full-scale, business wide planning tool is the best solution to this challenge. Not only will it enable cross-team and cross-departmental collaboration on financial forecasts, projections and other initiatives, it will also typically integrate with the types of data management (i.e. Excel) and business intelligence (e.g.: Power BI) software tools you already use
In addition to investing in the right tools, FP&A teams can make their financial forecasts and projections more efficient by leveraging existing (and proven-to-work) templates rather than starting from scratch every time.
Venas Sales Forecasting Template and Revenue Projections Template (and others) can help you get started.
Financial forecasting and financial projections are different but equally critical contributors to a solid overall financial planning strategy the former driving smart decisions in an ongoing way while the latter helps companies prepare for potential scenarios they could encounter in the future.
Leveraging the right tools, templates, and processes to execute both at the same time is essential for modern businesses to navigate fast-changing environments and stay resilient amidst uncertain economic conditions.
With smart planning and a focus on data-driven decision making, companies can be ready for anything even situations and external factors out of their control.
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