Assess the financial performance forecasting process, identifying the assumptions made that are most likely to cause a gap between the forecast and actual performance. Indicate how these gaps may be minimized. Provide support for your rationale.
A financial forecast is an estimate of future financial outcomes for a company (for futures and currency markets). Using historical internal accounting and sales data, in addition to external market and economic indicators, a financial forecast is an economist’s best guess of what will happen to a company in financial terms over a given time period—which is usually one year.
The problem that is most likely to cause a gap between the forecast and actual performance is the accounting errors.
A realistic financial forecast for a corporation depends on quality accounting information which fairly and completely reflects the corporate economics, and minimizes measurement errors and bias. High quality accounting information also could minimize the volatility of the stock price by avoiding the restatement which is due to accounting errors. To minimize this gap, I suggest that corporation management should develop effective internal controls to provide a reasonable assurance that its accounting information is relevant and reliable.
Create an argument supporting the value of forecasting to an organization. Provide support for your argument.
The purpose of the financial forecast is to evaluate current and future fiscal conditions to guide policy and programmatic decisions. A financial forecast is a fiscal management tool that presents estimated information based on past, current, and projected financial conditions. This will help identify future revenue and expenditure trends that may have an immediate or long-term influence on government policies, strategic goals, or community services. The forecast is an integral part of the annual budget process. An effective forecast allows for improved decision-making in maintaining fiscal discipline and delivering essential community services.
Investors utilize forecasting to determine if events affecting a company, such as sales expectations, will increase or decrease the price of shares in that company. Forecasting also provides an important benchmark for firms which have a long-term perspective of operations.
In essence, a budget is a quantified expectation for what a business wants to achieve. Its characteristics are:
The budget is a detailed representation of the future results, financial position, and cash flows that management wants the business to achieve during a certain period of time.
The budget may only be updated once a year, depending on how frequently senior management wants to revise information.
The budget is compared to actual results to determine variances from expected performance.
Management takes remedial steps to bring actual results back into line with the budget.
The budget to actual comparison can trigger changes in performance-based compensation paid to employees.
Conversely, a forecast is an estimate of what will actually be achieved. Its characteristics are:
The forecast is typically limited to major revenue and expense line items. There is usually no forecast for financial position, though cash flows may be forecasted.
The forecast is updated at regular intervals, perhaps monthly or quarterly.
The forecast may be used for short-term operational considerations, such as adjustments to staffing, inventory levels, and the production plan.
There is no variance analysis that compares the forecast to actual results.
Changes in the forecast do not impact performance-based compensation paid to employees.
Thus, the key difference between a budget and a forecast is that the budget is a plan for where a business wants to go, while a forecast is the indication of where it is actually going.
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