The Basic Methodologies of Financial Planning

There are two basic methods of financial planning and forecasting, each of which has a multitude

of variations to fit a company’s specific requirements and situation. The two methods are the

trend and ratio method (percent-of-sales method) and the financial modeling method. The trend

and ratio method is far too simplistic and inaccurate to be reliable for financial planning and is

seldom used in real-world decision making. Its major weaknesses are that it assumes everything

in the business varies as a constant percent of sales and that all business parameters have a linear

relationship to sales. In general, this approach becomes complex as you attempt to adjust the plan

to reality, and it is inferior in every respect to the alternative method of financial modeling.

Financial modeling uses powerful user-friendly computerized models and programs to model the

firm’s business and financial transactions. These models range from simple Excel spreadsheet

models to complex custom-designed stochastic-based models. When financial planning is

combined with a sound business model, this method allows rigorous and flexible financial

planning to any degree of detail with superior accuracy.