What is financial forecasting and why is important to business? Explain and give an example.

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pohnpei397 eNotes educator| Certified Educator

A financial forecast is a financial plan or budget for a business. A financial forecast is derived by trying to estimate two things.  These are the income that the business is expected to receive and the expenses that it is expected to have to pay.  Of course, it is impossible to know for sure how much income a business will get or how much its expenses will be.  However, it is possible to make educated guesses on these issues.  These guesses make up a financial forecast.

While financial forecasts are not likely to be perfect, they are important.   There are two main reasons why it is important for a business to engage in financial forecasting.  First, financial forecasting allows a business to plan ahead.  Imagine, for example, that you work for an airline.  One of the major expenses that an airline incurs is the price of fuel.  If you foresee that fuel costs will rise dramatically two years from now, you will want to take steps to raise revenues to offset the cost increases that you are predicting.  Second, financial forecasting can be important if you think that your business is going to need loans or other inputs of capital from outsiders.  For example, imagine that you are going to open a small business and that you need a loan to do so.  You will need to have plausible financial forecasts that show when you believe that you will start to make a profit.  Any bank will want to see such forecasts (and to analyze them) before they will be willing to risk lending you any money.

In these ways, financial forecasts are a vital ingredient in the planning process for any business, whether it be a start-up or an established firm.