Knowing the differences between financial forecasting, provision and reserve is essential to correctly explore strategies. Understand each concept!
The success of an enterprise, with other factors aside, depends on sound management of finance. In such a scenario as this, strategies regarding the future of that company need to be decided by making strategic decisions to ensure its overall success. And some of those essential tools are provisions and financial reserve.
However, these terms easily confuse people — even financial professionals. Therefore, it is necessary to understand the main differences between the concepts in order to know how to operate with them.
In this content, you will learn what financial forecasting, provision and reserve are and how the strategies differ. Check it out!
What is financial forecasting?
First, it is important to understand the concept of financial forecasting . This is the process of projecting a company’s future economic performance. To do so, you need to consider its financial history and market behavior.
Moreover, the forecast is normally calculated in periods, either short or medium term. In this case, if the forecast applies to short term, then the analysis is done monthly, bimonthly, half-yearly, or yearly. However, in medium term, the time to project is longer and varies between 1 to 5 years.
Financial forecasting helps managers identify revenue and expense trends, thus deciding decisions that are geared toward organizational goals. It also allows them to anticipate all the potential problems that may be there to make action plans that overcome them.
This is made possible by taking into account a number of considerations that are relative to the firm’s financial data. For instance, sales forecasting is used in determining the quantity of items sold in a period, which relates to the firm’s revenue and profit.
What is corporate financial provision?
After understanding what financial forecasting is, it is necessary to understand the meaning of corporate financial provision. The term refers to events that will occur in the future or that have a high chance of occurring and generating an expense for the company.
Provisioning is done to estimate the amounts that will be disbursed in the future. With this, the manager can outline strategies to reserve the necessary amount and guarantee the payment of bills, avoiding the risk of default .
To make a financial provision, it is necessary to identify future expenses, based on the history of recurring payments. Expenses that can be provisioned include annual taxes and labor issues — such as thirteenth salary and vacations.
What is a financial reserve?
As you have seen, a financial forecast is a future estimate of a company’s finances. Financial provision, on the other hand, is related to expenses that are expected, but their occurrence is guaranteed even if there is no certainty about the amount to be paid.
It is through provisioning that a financial reserve is created to guarantee the payment of the company’s debts. Therefore, this term refers to an amount of money saved to ensure compliance with obligations and commitments already assumed.
In addition, there are other types of reserves for a company, such as opportunity reserves and emergency reserves. The difference between them lies in the purpose of each one. The opportunity reserve is an amount available to use when attractive investments arise for the business.
Meanwhile, the emergency reserve is an amount set aside for unexpected situations that may generate an imbalance in the company’s cash flow. This is the case of a sudden decrease in sales, lack of working capital and a high volume of customer loss, for example.
Why is it important to understand the differences between these terms?
So far, you have understood what forecasting, provisioning and financial reserves are. However, you may be wondering why it is important to know the difference between these concepts. Clarity about the terms is essential for the effective implementation of strategies.
This makes it easier to drive the business towards success. After all, based on forecasting and provisioning, the company can map out expenses and revenues for a given period, in addition to ensuring sufficient resources.
From this, it is also possible to design actions to make the company grow, avoiding financial risks. Therefore, the company owner or the professional responsible for financial management needs to understand the differences between forecast, provision and reserve — and know how to use each strategy.
How to make financial forecasts in your company?
Financial forecasting is a basis for provision and reserve, correct? That’s the reasons why it is necessary to learn how to carry out the procedure correctly.
Here are the step-by-step procedures to start making your company’s financial forecast. Check it out!
Establish financial forecasting objectives
First, set the goal of the financial forecast. With this, it will help one understand what kind of data shall be collected as well as what amount of information will be deemed valid for evaluation.
Define the method of financial forecasting
After establishing the objectives of the financial forecast, it is necessary to define the method to be used in the procedure. Among the methodologies available on the market, it is worth mentioning the linear (simple or multiple) and the mobile.
Gather the necessary information
The next step in making a financial forecast for your company is to gather the information that will be used to support the analysis. Some documents that can help with this task are the income statement ( DRE ) and the cash flow .
Design different economic scenarios
Now that the documents are available, it is time to project different economic scenarios for the company. At this point, it is interesting to make pessimistic, optimistic and realistic projections. This way, you can make plans to avoid problems or take advantage of opportunities that arise.
Monitor financial forecast
Monitor the data to see whether the business’s economic performance is according to your expectations. If not, then you have to readjust your projections to reflect the reality of the company and make a decision in the right direction.
In this article, you were able to understand what financial forecasting, provision and reserve are and why it is very important to differentiate between the two terms. Make sure to follow each of these procedures effectively enough to make a better management decision!