Financial Forecasting vs. Financial Modeling: An Overview
Financial forecasting is the process by which a company thinks about and prepares for the future. Forecasting involves determining the expectations of future results.
On the other hand, financial modeling is the act of taking a forecast's assumptions and calculating the numbers using a company's financial statements.
Key Takeaways
- Financial forecasting is the process in which a company determines the expectations of future results.
- Financial modeling takes the financial forecasts and builds a predictive model that helps a company make sound business decisions.
- Financial forecasting and modeling can be used in budgeting, investment research, project financing, and raising capital.
Financial Forecasting
When a company conducts its financial forecasts, it seeks to provide the means for the expression of its goals and priorities to ensure they are internally consistent. Forecasts can also help a company identify the assets or debt needed to achieve its goals and priorities.
A common example of a financial forecast is forecasting a company's sales. Since most financial statement accounts are related to or tied to sales, forecasting sales can help a company make other financial decisions that support achieving its goals. However, if sales are to increase, the resulting expenses to produce the additional sales would also increase. Each forecast results in an impact on the company's overall financial position.
Forecasting helps a company's executive management determine where the company is headed. Calculating the financial impact of those forecasts is where financial modeling comes into play.
Financial Modeling
Financial modeling is the process by which a company builds its financial representation. The model created is used to make business decisions. Financial models are the mathematical models made by a company in which variables are linked together.
The modeling process involves creating a summary of a company's financial information in the form of an Excel spreadsheet. The model can help determine the impact of a management decision or a future event. The spreadsheet also allows the company to modify the variables to see how the changes could affect the business.
As a result of an expected to increase in sales, for example, a company must also forecast the resulting increase in raw material or inventory costs. If the company needs a new piece of equipment, the cost to purchase or lease must be estimated. Credit needs could also be forecasted based on the sales and the resulting expenses to produce the sales. A company might need to increase their working capital credit line with a bank, for example.
Forecasts are helpful, but at some point, the number-crunching must be done via a financial model. The modeling calculates the financial impact that a forecasted increase in sales has on the company's income statement, balance sheet, and cash flow statement.
Financial models are used for several reasons, including:
- Historical analysis of a company
- Projecting and budgeting the financial performance of a company
- Investment research, such as equity analysis
- Project finance analysis, which is the funding of long-term assets and industrial projects
- Purchase of another company or merger
- Raise capital or funding
- Create pro forma financial statements, which are statements created based on a company's assumptions and forecasts
Financial modeling takes the financial forecasts created during a company's financial forecasting and builds a predictive model that helps a company make sound business decisions based on its forecasts and assumptions.
[Note: Financial Modeling can be used to evaluate a number of businesses and investing decisions; if you are interested in learning to build these models yourself and get ahead on your career check out Investopedia Academy's Financial Modeling Course.]
FAQs
Financial forecasting is the process by which a company thinks about and prepares for the future. Forecasting involves determining the expectations of future results. On the other hand, financial modeling is the act of taking a forecast's assumptions and calculating the numbers using a company's financial statements.
What is the difference between financial analysis and financial forecasting? ›
Financial Analysis: Helps in making informed decisions by understanding a company's strengths and weaknesses based on its financial health. Financial Modeling: Assists in forecasting future scenarios and making strategic plan.
What is the difference between financial planning and financial modeling? ›
Financial modeling uses forecasts and other data to simulate the impact of specific decisions on business performance. The operations and financial planning teams create the forecasts to report planned expenses and revenues.
What is the difference between financial modeling and financial statements? ›
Financial analysis is typically carried out using ratio and trend analysis of relevant information taken from financial statements and other reports.” “Financial modeling, on the other hand, is essentially the task of building a model that represents a real world financial situation.
Why are financial models helpful in financial forecasting? ›
As a result, a financial model is not only a forecasting tool, but also a measuring stick to assess a company's current performance. Armed with this information, business leadership can analyze how the organization is performing relative to its current goals and expectations as well as develop a plan for future growth.
What does financial modelling include? ›
What Is Financial Modeling? Financial modeling is the process of creating a summary of a company's expenses and earnings in the form of a spreadsheet that can be used to calculate the impact of a future event or decision. A financial model has many uses for company executives.
What is financial forecasting in simple words? ›
Financial forecasting is the process of using past financial data and current market trends to make educated assumptions for future periods. It is an important part of the business planning process and helps inform decision-making. Effective forecasting relies on pairing quantitative insight with creative evaluation.
What are financial modeling techniques? ›
The most common techniques are discounted cash flow analysis, Monte Carlo simulation, linear programming, comparative analysis, and company valuation.
What does financial modeling look like? ›
A financial model spreadsheet usually looks like a table of financial data organized into fiscal quarters and/or years. Each column of the table represents the balance sheet, income statement, and cash flow statement of a future quarter or year.
Why do we do financial modeling? ›
The main goal of financial modeling is to accurately project a company's future financial performance. Modeling can be useful for valuing companies, determining whether a company should raise capital or grow the business organically or through acquisitions.
The financial modeling process is a step-by-step approach that starts with populating the historical financial data in an excel sheet, performing financial analysis, making assumptions and forecasting, and finally assessing risk by performing sensitivity analysis and stress testing.
What is the most widely used method for financial forecasting? ›
Moving Average
The most common types are the 3-month and 5-month moving averages.
Does FP&A use financial modelling? ›
Forecast budget and performance.
Financial modeling then allows FP&A analysts to build a forecast that includes revenue and cash flow projections, expenses, and more.
Is financial modelling difficult? ›
Learning financial modeling is challenging due to the complex formula logic and hidden assumptions involved. It requires technical and mathematical skills, as well as problem-solving and decision-making abilities. Financial modeling is more challenging to learn than accounting and investing.
Is forecasting part of financial analysis? ›
Financial analysis and forecasting form an essential part of any business. The major task here is 'prediction'. You as a financial analyst would need to predict and estimate the business outcome of your company. This outcome involves revenue and losses.
What is the difference between financial analysis and financial analytics? ›
The key difference between financial analysis and financial analytics is that one does not need a deep understanding of mathematics or statistics in financial analysis. On the other hand, in finance, you do need a background knowledge of mathematics/statistics.
What is the difference between financial analysis and financial statement analysis? ›
Financial analysis refers to assessing and analysing the financial statements of a company for enhancing economic decision-making. Financial statement analysis refers to comprehending what is essentially indicated by the financial statements like balance sheet, cash flow, income and the like.
What is the difference between financial planning and analysis and financial analyst? ›
FP&A professionals in general oversee a wide array of financial affairs that include financial statements, capital expenditures, expenses and taxes etc. financial analysts in particular are tasked with evaluating, examining and analyzing a corporation's financial activities and mapping its financial future.
