FORECASTING

Managers use forecasts for budgeting purposes. A forecast aids in determining volume of
production, inventory needs, labor hours required, cash requirements, and financing needs. A
variety of forecasting methods are available. However, consideration has to be given to cost,
preparation time, accuracy, and time period. The manager must understand clearly the
assumptions on which a particular forecast method is based to obtain maximum benefit.

Management in both private and public organizations typically operates under conditions of
uncertainty or risk. Probably the most important function of business is forecasting, which is a
starting point for planning and budgeting. The objective of forecasting is to reduce risk in decision
making.

In business, forecasts form the basis for planning capacity, production and inventory, manpower,
sales and market share, finances and budgeting, research and development, and top
management’s strategy. Sales forecasts are especially crucial aspects of many financial
management activities, including budgets, profit planning, capital expenditure analysis, and
acquisition and merger analysis.

Which Area and Why Use Forecasts

Forecasts are needed for marketing, production, purchasing, manpower, and financial planning.
Further, top management needs forecasts for planning and implementing long-term strategic
objectives and planning for capital expenditures.

More specifically, here are who and why they need to forecast:

 Marketing managers – They use sales forecasts to determine optimal sales force
allocations, set sales goals, and plan promotions and advertising. Market share, prices,
and trends in new product development are also required.
 Production planners – They need forecasts in order to: schedule production activities,
order materials, establish inventory levels and plan shipments. Other areas that need
forecasts include material requirements (purchasing and procurement), labor scheduling,
equipment purchases, maintenance requirements, and plant capacity planning. As soon
as the company makes sure that it has enough capacity, the production plan is developed.
If the company does not have enough capacity, it will require planning and budgeting
decisions for capital spending for capacity expansion. On this basis, the manager must
estimate the future cash inflow and outflow. He or she must plan cash and borrowing
needs for the company’s future operations. Forecasts of cash flows and the rates of
expenses and revenues are needed to maintain corporate liquidity and operating
efficiency. In planning for capital investments, predictions about future economic activity
are required so that returns or cash inflows accruing from the investment may be
estimated. Forecasts are needed for money and credit conditions and interest rates so
that the cash needs of the firm may be met at the lowest possible cost. Forecasts also
must be made for interest rates, to support the acquisition of new capital, the collection of
accounts receivable to help in planning working capital needs, and capital equipment
expenditure rates to help balance the flow of funds in the organization. Sound predictions
of foreign exchange rates are increasingly important to managers of multinational
companies. Long-term forecasts are needed for the planning of changes in the company’s
 capital structure. Decisions on issuing stock or debt to maintain the desired financial
structure require forecasts of money and credit conditions.
 The personnel department – It requires a number of forecasts in planning for human
resources. Workers must be hired, trained, and provided with benefits that are competitive
with those available in the firm’s labor market. Also, trends that affect such variables as
labor turnover, retirement age, absenteeism, and tardiness need to be forecast for
planning and decision making.
 Managers of nonprofit institutions and public administrators – They also must make
forecasts for budgeting purposes.
 Hospital administrators – They forecast the healthcare needs of the community. In order
to do this efficiently, a projection has to be made of: growth in absolute size of population,
changes in the number of people in various age groupings, and varying medical needs
these different age groups will have.
 Universities – These forecast student enrollments, cost of operations, and, in many
cases, the funds to be provided by tuition and by government appropriations.
 The service sector – Today accounts for two-thirds of the U.S. gross domestic product,
including banks, insurance companies, restaurants, and cruise ships, needs various
projections for its operational and long-term strategic planning.
 The bank – Banks have to forecast too. Demands of various loans and deposits Money
and credit conditions so that it can determine the cost of money it lends.

Qualitative Forecasting Methods

The qualitative (or judgmental) approach can be useful in formulating short-term forecasts and
can also supplement the projections based on the use of any of the quantitative methods.

Four of the better-known qualitative forecasting methods are executive opinions, the Delphi
method, sales-force polling, and consumer surveys:

1. Executive Opinions

The subjective views of executives or experts from sales, production, finance, purchasing, and
administration are averaged to generate a forecast about future sales. Usually this method is used
in conjunction with some quantitative method, such as trend extrapolation. The management team
modifies the resulting forecast, based on their expectations.

 The advantage of this approach: The forecasting is done quickly and easily, without
need of elaborate statistics. Also, the jury of executive opinions may be the only means of
forecasting feasible in the absence of adequate data.
 The disadvantage: This, however, is that of group-think. This is a set of problems inherent
to those who meet as a group. Foremost among these are high cohesiveness, strong
leadership, and insulation of the group. With high cohesiveness, the group becomes
increasingly conforming through group pressure that helps stifle dissension and critical
thought. Strong leadership fosters group pressure for unanimous opinion. Insulation of the
group tends to separate the group from outside opinions, if given.

2. Delphi Method

This is a group technique in which a panel of experts is questioned individually about their
perceptions of future events. The experts do not meet as a group, in order to reduce the possibility
that consensus is reached because of dominant personality factors. Instead, the forecasts and
accompanying arguments are summarized by an outside party and returned to the experts along
with further questions. This continues until a consensus is reached.

 Advantages: This type of method is useful and quite effective for long-range forecasting.
The technique is done by questionnaire format and eliminates the disadvantages of group
think. There is no committee or debate. The experts are not influenced by peer pressure
to forecast a certain way, as the answer is not intended to be reached by consensus or
unanimity.
 Disadvantages: Low reliability is cited as the main disadvantage of the Delphi method,
as well as lack of consensus from the returns.

3. Sales Force Polling

Some companies use as a forecast source salespeople who have continual contacts with
customers. They believe that the salespeople who are closest to the ultimate customers may have
significant insights regarding the state of the future market. Forecasts based on sales force polling
may be averaged to develop a future forecast. Or they may be used to modify other quantitative
and/or qualitative forecasts that have been generated internally in the company.

The advantages of this forecast are:

 It is simple to use and understand.

 It uses the specialized knowledge of those closest to the action.
 It can place responsibility for attaining the forecast in the hands of those who most affect
the actual results.
 The information can be broken down easily by territory, product, customer, or salesperson.

The disadvantages include: salespeople’s being overly optimistic or pessimistic regarding their
predictions and inaccuracies due to broader economic events that are largely beyond their control.

4. Consumer Surveys

Some companies conduct their own market surveys regarding specific consumer purchases.
Surveys may consist of telephone contacts, personal interviews, or questionnaires as a means of
obtaining data. Extensive statistical analysis usually is applied to survey results in order to test
hypotheses regarding consumer behavior.

Quantitative Forecasting Methods

It is a statistical technique to make predictions about the future which uses numerical measures
and prior effects to predict future events. These techniques are based on models of mathematics
and in nature are mostly objective. They are highly dependent on mathematical calculations.
1. Time-series models – These models examine the past data patterns and forecast the future
on the basis of underlying patterns that are obtained from those data. There are many types of
time series models like Simple and weighted moving average, seasonal indexes, trend
projections, simple mean and exponential smoothing.
2. Associative models – are also known as casual models. The model assumes that the variable
that is being forecasted is associated with other variables The predictions are made based on
these associations. The linear regression is one of the simplest forms of an associative model of
forecasting. This regression line forecasts the dependent variable based on the selected value of
the independent variable.
Quantitative forecasting methods are very easy to predict based on the underlying information.
The data can be used to forecast automatically without many complications. Any person can
easily forecast on the basis of available data.
One of the main disadvantages of this method is its dependence on the data. The entire
forecasting depends on the data of the underlying model. An error in the available data can lead
to wrong forecasting. These methods can also be used only if the proper data is available. This
method cannot also evaluate the effect of changes in the other variables involved.

Technological Forecasting Methods

Technological Forecasting (TF) is concerned with the investigation of new trends, radically new
technologies, and new forces which could arise from the interplay of factors such as new public
concerns, national policies and scientific discoveries. Many of these forces are beyond the control,
influence and knowledge of individual companies.

Technology Foresight is a combination of creative thinking, expert views and alternative scenarios
to make a contribution to strategic planning.

The future is almost by definition unknown, but in both forecasting and foresight activities the
judgements or opinions of experts are used. Experts can be used singly, or in numbers. Different
techniques can be applied to provide either a consensus view, a range of opinions, or maverick
views. The kinds of exercises that can be carried out vary enormously in their complexity and
structure and in the ease with which they can be managed.

The simple expedient of subscribing to a technical journal, or belonging to a network or

collaborative R&D project, or finding out what research is being done by a relevant research
organisation, can all be the first stage towards setting up a more structured approach. Some
techniques involved are:

Exploratory techniques are primarily concerned with the analysis of historical data. Selected
attributes such as functional performance, technical parameters, economic performance etc. are
plotted against time. Since it is usually assumed that progress is evolutionary and that
technological progress is not random, it is possible to generate characteristic curves or patterns
from the data and from these patterns forecasts can be made with varying degrees of certainty

Normative techniques start by proposing a desired or possible state, such as the satisfaction of
a market need or the achievement of a technological development, and work backwards from this
to determine the steps necessary to reach the required outcome. The number of foreseeable
paths of development from the present position to the objective could range from ‘none’, implying
a completely new technology, to ‘several’. Each feasible path to the objective is analysed for its
relevance and difficulty.