Financial terms are easily confused and often used interchangeably. But phrases like “financial forecast” and “financial projection” that sound similar are quite different.
A financial forecast is an estimate of future financial outcomes for a company. It predicts what will likely happen in your company’s future based on things that have happened in the past. Financial projections explore different scenarios to reveal a variety of possible business outcomes, should your company choose to pursue them, or if the assumed circumstances become reality—or what your company hopes will happen in the future.
These methods are not guesses about your company’s future; rather, they use data to determine likely possibilities. These potential outcomes can then be used to plot a company’s future path based on the highest possible degree of financial and risk certainty. This information may be used to drive cash flow and inform pro forma financial statements, which include a balance sheet, cash flow statement and income statement.
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Where the business is likely headed.
Future financial target or goals, which may or may not be equal to the forecast.
A map of forward-looking business options in answer to “What would happen if”.
Pro Forma →
The effects of a future transaction on past financial statements. Answers the question “If we had made this transaction earlier—say, bought a competitor or key supplier—the effect on our financial statement(s) back then would have been”.
What is a Financial Forecast?
In short, a financial forecast is a statement of management’s expectations. A financial forecast is based on what top management reasonably expects will happen to and in the company and the expected financial impacts. This is the information that is published by publicly traded companies for stockholders and the general public’s review.
Publicly traded companies are not the only ones to use this forward-looking tool, but they are the only ones required to publish the resulting information. All companies, of any size, may use financial forecasts to develop their future budgets and financial plans and inform hiring needs.
What is a Financial Projection?
A financial projection essentially projects the likely outcome of one or more hypothetical scenarios or assumptions. It is a tool used to explore business and market scenarios and predict outcomes before adjusting the company’s plans.
A financial projection is a snapshot of a possible business outcome that is often weighed in terms of probability. Finance staff render the results of any given scenario in terms of likely financial impacts, such as the company’s expected financial position, operational results and cash flow situation.
Calculating several financial projections simultaneously is common in order to evaluate multiple options and an array of possible business actions.
One further point of clarification: Pro forma financial statements are a reconfiguration of earlier, historical financial statements to show a past potential impact of a future transaction. They are not financial projections because they look back, not forward.
Financial Forecast vs. Financial Projection
Both financial forecasts and financial projections are forward-looking statements. Both predict future outcomes based on specific assumptions. Further, both calculate outcome probabilities.
Even with those strong similarities, what they have in common does not end there. They are both glimpses of the future, and both produce results that are more reliable over the short term and less so over a longer term.
There’s little wonder then that the two are easily confused.
Even with all that in common, financial forecasts and financial projections are not the same thing. The terms are not interchangeable.
Financial forecasts reveal what is likely to happen based on expected events and business conditions. Simply put, financial forecasts are what management expects to happen. Financial projections are what might happen in any number of hypothetical scenarios. Budgets are what management wishes will happen. Often, the three differ significantly.
For example, given current market conditions, supply availability, historical buying patterns and seasonal trends, the CFO of a wholesaler expects sales to increase by 5% over the next quarter. Therefore, a 5% sales increase is his financial forecast for the period.
However, he wants the company to make more profit than that, so he aims for an 8% sales increase. Therefore, his budget calls for an 8% sales increase. The CFO still expects the company to achieve only 5%, but he hopes for 8%, so he budgets accordingly and aims the sales team at that number.
But rather than just crack a whip over the sales team, the CFO runs several financial projections to find a way to improve their odds of reaching an 8% or larger sales increase. If he finds such a scenario with acceptable risk levels, he can then direct the sales manager or sales team leaders on how best to take aim at the goals in the budget. All of these processes and steps can be simplified and managed in a single piece of financial management software, ideally one that is seamlessly integrated with your other software solutions, such as inventory management, accounting, warehouse management, and other platforms to give you a consolidated view.