What is Forecasting?
Forecasting is a technique that uses historical data as inputs to make informed estimates that are predictive in determining the direction of future trends.
Businesses utilize forecasting to determine how to allocate their budgets or plan for anticipated expenses for an upcoming period of time. This is typically based on the projected demand for the goods and services offered.
How forecasting works
Forecasting is usually a collaboration between a company or department manager and a designated forecaster. Before forecasts are made, they need to work together and attempt to answer the following questions:
What is the goal of the forecast?
This determines the required level of accuracy and helps identify the most appropriate forecasting techniques. A broad decision, like deciding whether or not to enter a new market, can be done by roughly estimating the future size of that market. On the other hand, a more delicate decision, such as determining the right budget for each department, requires a more detailed and accurate approach.
What are the main components and variables of the forecasted system?
Before making a forecast, all different elements of the system that needs to be forecasted need to be reviewed and their relative values analyzed. Depending on the required forecast, this can imply an in-depth analysis of any relevant elements of the sales system, distribution system, marketing process, production system and other elements being studied.
How important are past events to future estimations?
Major changes occurring from the time in the past when the data was gathered can diminish the forecast’s relevance. The implementation of new products, strategies, sales channels, as well as new industry developments, have the potential of making data gathered in the past obsolete and irrelevant.
Businesses choose between two basic methods when they want to predict what can possibly happen in the future, namely, qualitative and quantitative methods.
1. Qualitative method
Otherwise known as the judgmental method, qualitative forecasting offers subjective results, as it is comprised of personal judgments by experts or forecasters. Forecasts are often biased because they are based on the expert’s knowledge, intuition, and experience, and rarely on data, making the process non-mathematical.
One example is when a person forecasts the outcome of a finals game in the NBA, which, of course, is based more on personal motivation and interest. The weakness of such a method is that it can be inaccurate.
2. Quantitative method
The quantitative method of forecasting is a mathematical process, making it consistent and objective. It steers away from basing the results on opinion and intuition, instead utilizing large amounts of data and figures that are interpreted.
Features of Forecasting
Here are some of the features of making a forecast:
1. Involves future events
Forecasts are created to predict the future, making them important for planning.
2. Based on past and present events
Forecasts are based on opinions, intuition, guesses, as well as on facts, figures, and other relevant data. All of the factors that go into creating a forecast reflect to some extent what happened with the business in the past and what is considered likely to occur in the future.
3. Uses forecasting techniques
Most businesses use the quantitative method, particularly in planning and budgeting.
Why is forecasting important?
Being able to accurately predict future trends and events is useful in many contexts, including business management. Forecasting is important because it can be used for:
Estimating the success of a new business venture
When starting a new business, proper forecasting can reveal crucial information that may determine the company’s future success. Forecasting reveals some of the risks and uncertainties that a new business faces and can offer an entrepreneur the right tools to anticipate elements such as the strength of the competition, demand potential for a product or service and future industry development.
Estimating financial necessities
Estimating a company’s future financial requirements is one of the most important uses of forecasting. It can help a company determine its financial future by estimating future sales, the capital needed for future product development, the costs of future expansions and other estimated expenses that are used to estimate future costs.
Ensuring the company’s operational consistency
Proper forecasting can reveal important information regarding future earnings and spending. By having an estimate of the funds going in and out of the organization over a certain period of time, the company’s management can make more efficient and accurate plans for the future.
Helping managers make the right decisions
A significant proportion of management decisions are made by relying on accurate forecasting. Most businesses, regardless of size, face several potential uncertainties — such as seasonal rises and falls in sales, changes in personnel and changes in raw material prices — depending on the exact nature and purpose of the organization. Forecasting plays a major role in providing managers with the information they need to make informed decisions regarding the company’s future.
Increasing a business venture’s odds of success
The success of a business often depends on fine margins and correct fund allocation. Forecasting can predict important metrics, like the amount of needed raw materials, the right budget for each company department and the number of future sales. These figures help management allocate funds and resources and prioritize one product or service over another, depending on the type of company and the forecasted data.
Formulating effective plans for the future
All planning implies the use of forecasts, making forecasting a very important element of formulating realistic and helpful plans. Any form of planning, from short-term to long-term, is heavily reliant on forecasting, creating a direct link between accurate forecasting and adequate planning.
Promoting workplace cooperation
Gathering and analyzing the data required for forecasting typically requires coordination and collaboration between all the company’s department managers, as well as other employees. This makes the whole process a collaboration, increasing team spirit and cohesion.
Helping an organization improve
Forecasting gives managers information that they can use to spot any weakness in the organization’s processes. By discovering potential shortcomings ahead of time, the company’s managers have the proper tools to correct any weakness before they affect the profits.
Sources of Data for Forecasting
1. Primary sources
Information from primary sources takes time to gather because it is first-hand information, also considered the most reliable and trustworthy sort of information. The forecaster himself does the collection, and may do so through things such as interviews, questionnaires, and focus groups.
2. Secondary sources
Secondary sources supply information that has been collected and published by other entities. An example of this type of information might be industry reports. As this information has already been compiled and analyzed, it makes the process quicker.