Financial forecasting models are helpful in predicting the future of your business.
Based on the data you have, what you want to predict, and the type of business, several financial forecasting models can do the best for your business.
Business analytics are like a game. To become a pro player in this game, you need to know how to use numerous forecasting models and which one will do better in which conditions. In this post, we will delve into the details of the top 5 financial forecasting models and their use cases.
However, firstly we need to find the differences between financial forecasting and financial marketing. It will help you understand how these two things work collaboratively.
Financial Forecasting Vs. Financial Modeling
These two terms are often confused as these tasks are performed by the same people and use the same data as well. They are different but related functions.
Interpretation Financial Forecasting
It is often performed by CFO or controllers. They first gather data and catch a glimpse of internal trends such as revenue growth. Then they move towards exploring external factors including market situation and the behavior of customers. Then based on this information, they predict the future finances of your business or company.
As weather forecasting helps in predicting if the day will be sunny or not, financial forecasting will predict if the sales will go up or not.
Importance of Financial Forecasting
Any SaaS company must be able to predict how things will happen in the future to react appropriately. It helps you to locate opportunities and get benefits from them. You can also predict the risks and plan to deal with them.
Let’s say you observe the market will face a downturn in the upcoming few months, then you will focus on your cash holdings to improve your business’ condition and survive the upcoming few months of downturn. On the other hand, if you see the market is going to face a rise in the upcoming days, then you will focus on your hiring plan.
Financial Modeling
Let’s say if financial forecasting is the “why” then modeling will be the “how”. Companies want to get an idea about the future finances of their business to plan things accordingly. The best way to predict the future of the market is to go with some best financial models.
Importance of Financial Modeling
A single word that can explain the importance of modeling is uncertainty. As you are unsure how the market will respond in the future, you need to create different models to see how your company will deal with numerous different scenarios.
It permits you to work with the opportunities to predict the future of your company in a better way.
Strategic SaaS Growth: 5 Effective Financial Forecasting Models
Selection of the best financial forecasting model for your SaaS company is based hugely on the data you have, the results you want, the precession you are expecting, and other factors. The following are the top 5 financial forecasting models you can choose from.
1. Top-down financial forecasting models
This model is applicable only when you don’t have any historical data and are trying to avail some new opportunities. The top-down model will consider a market as a departure point and then predict how many shares of that market your company will be able to grab.
Use Case
Imagine you own a SaaS company and are willing to launch a new SaaS product in the market. However, you are unsure about the success rate. Here you have to use the top-down method. You will start with the total addressable market (TAM). It is simply the total shares in the market.
Then you have to look at the shareholders. If a major player is already in that category and holding most of the shares, then it will be hard for you to grab shares. However, if the market is small. players, then you can easily grab the shares with your hard work.
Now you have to take the last step. It’s calculating the revenues you will generate. You have to count shares you predict you can grab and multiply it with TAM to get revenue value. If the value is higher than the sum of the total amount you spend on launching the product and CAC then the launch is a good opportunity for you.
2. Bottom-up financial forecasting models
If you have access to historical data or financial statements, then you can go with a bottom-up model. The financial statements and history of your sales will serve as a base for this forecasting model.
As you are working with the actual number of your organization, you can get more accurate and dependable predictions.
Use Case
You have 1000 customers in total and get $10/month from each customer. You lose 10 customers every month and acquire 20 new ones. So your current revenue will be 10 × 100 = $10,000 for each month. And it will be increased by 10 × 10 = $100 every month as you manage to increase 10 customers/month.
3. Delphi forecasting models
When you rely on this forecasting model, you have to leverage the skills of experts. You take suggestions from a group of experts, and then continuously collaborate with them to make hypotheses until you reach a consensus point.
This model relies greatly on the survey, questionnaires, and focus groups. Every round of this model is based on the previous iteration. It ensures that all the groups and members have access to the information.
Use Case
Let’s say your product is managing to raise $10,000 as MRR. You bring some updates and add new features to your platform. However, most of your customers are not interested in paying you more.
In such a case, you decided to hire professionals who are experts in this field. You do so to conduct a focus group with your existing customers and other influential people.
After each round of focus groups, you have to present the findings to the group of experts. They will then conduct the next focus group and you did the same thing. This will continue until the problem is solved.
4. Correlation-based forecasting models
This model relies on using different variables and correlating them to predict the future of your business. As there are chances of the rise of big data, this model is suitable for even smaller businesses as well.
This type of forecasting model helps decision-makers in making decisions based on correlations. Relationships between price and cost, demand and supply, and other factors form the basis of the model.
Use Case
It is basically done in an academic setting. So, you can use this system in your company in various ways.
For example, if you want to start a marketing campaign, you will first understand your current customers. You will notice their behavior and try things in your campaign that can attract more customers.
Let’s say you deep dive into the customers’ personas and know that they love sharing memes. So, you will have to run your campaigns in a funny manner hoping that your customers will share them with others. It builds social proof of your products and will become viral. As a result, your sales may improve.
5. Statistical Forecasting Models
This model is often called a quantitative model as well. It creates a correlation between the finding of other disciplines. It helps in comparing your operations to other similar businesses. So, you can say it is benchmarking.
Use Case
Let’s say you are observing excellent exponential growth. However, you are well aware of the fact that it’s not going to last forever. You want to know when it will face a decline so you don’t hire.
Here you have to collect data from two major sources. One is from the trends from the last 20 years and the opinions and suggestions of experts about the market for the upcoming 10 years.
The second is to figure out how your opponents will grow in this period and when their growth curves start leveling off
Then you have to take the final step. You will incorporate the opponents’ growth rate and your model to figure out how long your company will enjoy exponential growth. Based on this finding, you can set your hiring plans.
Supercharge Forecasts with Flightpath by Baremetrics
SaaS companies wish to have an idea about the future of the market and how the business will change. You can call it the “why” of financial forecasting.
Companies don’t have an idea about the future events that are going to take place in the market. Therefore they use financial forecasting models to predict the situations. This is referred to as the “how” of financial forecasting.
To develop a financial forecasting model, you need to get the maximum amount of data. You can get this data internally from balance sheets or externally from the news.
The next thing you have to do is to track all the uncertainties in your predictions and find ways to eliminate them. Focusing on numerous scenarios can help in eliminating these uncertainties.
Now you are on the final step. Based on the data you have and the results you want, you have to pick a suitable forecasting model. The model that can give you desired results by using the data you have is the better option.
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