Classroom – Why do We Forecast With Financial Modeling

By August 25, 2016 No Comments

Before we learn about Financial Modeling, it’s critical to understand why we forecast. This will allow us to appreciate the importance of Financial modeling and why, contrary to public opinion, it is a skill set that is used across Corporate Finance, Equity markets, Industry, Banking, and Consulting. It is not just for Investment Bankers which is why FMVC, our financial modeling and valuation, a leading Corporate Finance and Financial Modeling course in Mumbai, attracts such a variety of students across age groups and job roles.
Forecasting is trying to predict/model the future to help make decisions now, more often than not, the decision centers around – should I buy or make this right now? Everything can be forecasted. From the price of oil to the price of a Raza painting 10 years down the line. Why? Well to understand the chances of our investment in any asset appreciating. While forecasting gives us the end game as such, the scenario we paint, the set of rules that underlies the forecasting, the assumptions under which we operate all become part of a model we build to predict the future. The more accurate our model, the higher the chances are of our predictions coming true.  Which is why forecasting, and modeling the future, is not just a science but also an art.
So who uses these forecasts? Well for the purposes of this post, we are going to stick to Financial modeling the forecasting of financial statements. We will however discuss forecasting the prices of oil, gold etc in later forecasts.

Why do we forecast Financial Statements?

  • Financial Managers– This can be the Financial controller of a large firm, or the CFO of a small firm. Forecasting enables the finance manager help manage his funds better, both short term and long term. Understanding what working capital requirements he needs in the future, allows him to ask banks for limits that will actually help. Understanding what capex he will do in the future, helps him plan term loans, private equity fund raises or public market fund raises. It also helps him time his fund raises to suit both the market, interest rates as well as the company’s fortunes.
    • Helps plan the firms financial needs, particularly cash
    • Helps plan the timing of future financing, so you can plan better and save money
  • General Managers– But you can’t have a financial forecast without a production forecast. Unless the line manager tells you how many pencils are going to be made in the quarter ending December 2016, the financial manager won’t be able to calculate how much working capital is required to fund making those pencils. How does the General manager forecast how many pencils to make? That’s for our next post.
    • Helps in overall planning of production
    • Identifies potential trouble spot
    • Allows evaluation of performance versus actual
  • Investment Bankers– Financial forecasts help investment bankers value companies by helping them model out sales and profitability, thereby allowing them to forecast future cash flows which in turn helps us calculate future return once we discount those cash flows and bring them forward.
    • Valuation
    • Business Due Diligence
    • Showcase a projects viability

This will be continued in part two. For more details about financial modeling courses in India and Mumbai and Online courses in Corporate Finance or our Diploma In Corporate Finance (DCF) please visit our website.