Forecasting

What is Forecasting?

Forecasting refers to the practice of predicting what will happen in the future by taking into consideration events in the past and present. Basically, it is a decision-making tool that helps businesses cope with the impact of the future’s uncertainty by examining historical data and trends. It is a planning tool that enables businesses to chart their next moves and create budgets that will hopefully cover whatever uncertainties may occur.

Budgeting vs. Forecasting

Budgeting and forecasting are both tools that help businesses plan for their future. However, the two are distinctly different in many ways:

• Budgeting involves creating financial statements for a specific period, such as projected revenue, expenses, cash flow, and investments. It is usually conducted with input from many different departments, because it requires input from multiple departments in order to come up with a holistic and detailed report. Therefore, the budgeting process takes time to complete. The company uses the budget to guide it in its financial activities. In other words, a budget is a plan for a company’s future.
• While budgets are usually made for an entire year, forecasts are usually updated monthly or quarterly. Through forecasting, a company can project where it’s going, and it may adjust its budget and allocate more or less funds to an activity, depending on the forecast. In summary, budgets depend on the forecast.

Forecasting Methods

Businesses choose between two basic methods when they want to predict what can possibly happen in the future: 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, making the process non-mathematical.

One example is when a person forecasts the outcome of a finals game in the NBA based more on personal motivation and interest. The weakness of such a method is that it can be inaccurate and biased.

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 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.

The Process of Forecasting

Forecasters need to follow a careful process in order to yield accurate results. Here are some steps in the process:

1. Develop the basis of forecasting

The first step in the process is investigating the company’s condition and identifying where the business is currently positioned in the market.

2. Estimate the future operations of the business

Based on the investigation conducted during the first step, the second part of forecasting involves estimating the future conditions of the industry where the business operates and projecting and analyzing how the company will fare in the future.

3. Regulate the forecast

This involves looking at different forecasts in the past and comparing them with what actually happened with the business. The differences in previous results and current forecasts are analyzed, and the reasons for the deviations are considered.

4. Review the process

Every step is checked, and refinements and modifications are made.

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 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.

Additional Resources

Thank you for reading CFI’s guide to Forecasting. To keep learning and advancing your career, the following CFI resources will be helpful:

• Forecasting Methods
• Prediction Market
• Regression Analysis
• See all valuation resources
• See all accounting resources