What is Forecasting?
Forecasting refers to predicting what will happen in the future by taking into consideration the 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 using historical data and trends. It is as much a planning tool that enables businesses to plan their next moves and create budgets that will offset whatever uncertainties that may occur.
Budgeting vs. Forecasting
One thing that is definitely true is that budgeting and forecasting are both tools that help businesses plan for their future. However, the two are also different in many ways. Let’s consider the following points:
- Budgeting involves creating a statement that consists of numerous financial activities of a company for a specific period, such as revenue, expenses, cash flow, and investment. It is not done by only one department, say by the finance department, because it needs the input of all of the other 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.
- While budgets are usually made for the entire year, forecasts are usually updated monthly or quarterly. Through forecasting, a company is able to adjust its budget and allocate more funds into a department, as needed, depending on what is foreseen. In summary, budgets depend on the forecast.
Businesses choose between two basic methods when they want to predict what can possibly happen in the future, namely the qualitative and quantitative methods.
1. Qualitative method
Otherwise known as the judgmental method, qualitative forecasting results in subjective results because they consist of the personal judgments by experts or forecasters. They are also 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 the finals of 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 not based on opinions and intuition but on facts, figures, and other relevant data. All of them are necessary because they represent what happened to the business in the past and are pertinent to predicting 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 the process in order to yield accurate results. Here are the steps in the process:
1. Develop the basis of forecasting
The first step in the process is developing the basis of the investigation of 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 analyzing how the company will fare.
3. Regulate the forecast
This involves looking at different forecasts in the past and comparing them with the actual things that happened in the business. The differences in the results and forecast are analyzed, and the reasons for the deviations are determined.
4. Review the process
Every step is checked, and refinements and modifications are made.
Sources of Data for Forecasting
1. Primary sources
They take time to gather because they are first-hand information, but they are also considered the most reliable and trustworthy. It is the forecaster himself who does the collection, and he does it through interviews, questionnaires, and focus groups.
2. Secondary sources
As secondary sources, they’ve already been collected and published by other agencies. They are useful in the sense that these are just compiled and analyzed, making the process quicker.
Thank you for reading CFI’s guide to forecasting. CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful: