Accounting & Audit Alert- 4 questions to guide your prospective financial statements
CPAs don’t just offer assurance services on historical financial results. They can also prepare prospective financial statements that predict how the company will perform in the future. This list of questions can help you make more meaningful assumptions for your forecasts and projections.
1. How far into the future do you want to plan?
Forecasting is generally more accurate in the short term. The longer the time period, the more likely it is that customer demand or market trends will change.
While quantitative methods, which rely on historical data, are typically the most accurate forecasting methods, they don’t work well for long-term predictions. If you’re planning to forecast over several years, try qualitative forecasting methods, which rely on expert opinions instead of company-specific data.
2. How steady is your demand?
Sales can fluctuate for a variety of reasons, including sales promotions and weather. For example, if you sell ice cream, chances are good your sales dip in the winter.
If demand for your products varies, consider forecasting with a quantitative method, such as time-series decomposition, which examines historical data and allows you to adjust for market trends, seasonal trends and business cycles. You also may want to use forecasting software, which allows you to plug other variables into the equation, such as individual customers’ short-term buying plans.
3. How much data do you have?
Quantitative forecasting techniques require varying amounts of historical information. For instance, you’ll need about three years of data to use exponential smoothing, a simple yet fairly accurate method that compares historical averages with current demand.
Want to forecast for something you don’t have data for, such as a new product? In that case, use qualitative forecasting or base your forecast on historical data for a similar product in your arsenal.
4. How do you fill your orders?
Unless you fill custom orders on demand, your forecast will need to establish optimal inventory levels of finished goods. Many companies use multiple forecasting methods to estimate peak inventory levels. It’s also important to consider inventory needs at the individual product level and local warehouse level, which will help you ensure speedy delivery.
If you’re forecasting demand for a wide variety of products, consider a relatively simple technique, such as exponential smoothing. If you offer only one or two key products, it’s probably worth your time and effort to perform a more complex, time-consuming forecast for each one, such as a statistical regression.
Plan to succeed
You may not have a crystal ball, but using the right forecasting techniques will help you gaze into your company’s future with greater accuracy. We can help you establish the forecasting practices that make sense for your business.