Financial forecasts and projections both play important roles in managing a business’s finances. While these terms are often used interchangeably, there are some differences between them. Every business owner should understand the difference between a forecast vs. projection and when to use each one.
Before we look at the differences between forecasts and projections, let’s explore what financial forecasts are, their components and how they’re created.
A financial forecast is an estimate of a company’s future financial outcome based on:
Forecasts are what a company’s management reasonably expects to happen in the forecasting period and the expected financial impact. They use concrete data to create reliable estimates of what will happen in the future.
For financial forecasts to be useful, they must be accurate and use relevant, up-to-date data. Historical data is a good indicator of what will happen in the future, so businesses will look at their past financial data to build their forecasts, including their:
The purpose of creating a financial forecast is to give the business insight into its future. Estimating future outcomes allows management to make data-informed decisions.
Financial forecasts consist of several components, including:
These documents are classified as “pro forma,” which means they are based on assumptions.
Forecasting plays an important role in financial planning because it helps businesses allocate their resources more effectively. They're created using quantitative and qualitative techniques as well as statistical models.
It’s important to note that the outcome of a forecast is shaped by assumptions and variables.
Now that you have a better understanding of financial forecasting, let’s look at what financial projects are, their applications and the factors and influences that affect them.
Financial projections are also pro forma documents, which means that they are based on assumptions.
However, they are different from forecasts in that they focus on hypothetical scenarios.
Businesses use projections to explore various market and business scenarios before making any adjustments to the company’s plans.
Think of a projection as a snapshot of what could happen in a particular scenario. For this reason, businesses often use them for planning and decision-making.
Unlike forecasts, projections aren’t based on complex quantitative models and are generally not as reliable. However, they provide management with insight into what-if scenarios, allowing them to make more informed decisions about the company’s future direction.
Financial projections are influenced by several factors, including but not limited to:
Because projections are focused on hypothetical scenarios (what-if situations), they're more flexible and adaptable to various scenarios compared to financial forecasts.
Financial forecasts and projections have very unique differences and use cases that you should consider when creating them:
A financial projections meaning can go overlooked if you don’t use the right time horizon. What is a time horizon? It’s the timeframe that you set for the scenario. For example, it’s not uncommon for:
Financial projections show what could transpire over the time horizon, but most of the long-term projections are inaccurate and rarely spot on.
Due to the length of a forecast vs projection, you’ll find:
If, for example, projections show that your revenue is up 33% in the next three years, it may not show you why. You may not be able to look at specific customers to determine how their growth impacted your own, nor would you know that seasonal upticks year-over-year were responsible for your growth.
Forecasts have a lot of details that you can sift through to learn more about your business’s growth or contraction.
Adversely, projections will show you the end result of the time period with less overall information included. Your projection will show you where your business may be while leaving out some important details.
Investors, owners and lenders will rely heavily on the forecasts and projections definition that you provide. You'll need to supply a time horizon for both as well as your data sources. Why? Because it’s important to remember that:
Forecasts and projections are tools that execs, owners and all stakeholders can use to make better decisions. Long-term planning is easier when you have projection and forecast data that shows the potential benefits of each decision you make.
Is a forecast or projection better?
Both have their place in running a business and making smarter decisions. If you need to make short-term decisions and have a forecast, you can have a better understanding of the ramifications of the choices you make.
Data-based decisions pose less risk and allow you to keep investors and stakeholders happy.
A financial forecast and business projections have very subtle differences, but they are crucial for you to understand. Both help you estimate the future financial outcomes of your company, but they can vary by:
You can add your own variables into financial forecasts, such as assuming that sales will be 10% higher than average due to market conditions. Businesses should use tools to better understand the trajectory of their business to make smarter decisions.
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