Top 6 Methods of Business Forecasting

This article throws light upon the top six methods of business forecasting. The methods are: 1. Bottom-up Method 2. Top-down Method 3. Historical Method 4. Deductive Method 5. Joint Opinion Method 6. Scientific Business Forecasting.

Business Forecasting: Method # 1.

Bottom-up Method:

Under this method various departments of an enterprise collect their own information/data and prepare their own forecasts. On the basis of these forecasts, the forecast for the firm as a whole is then undertaken. Thus, the responsibility of successful forecasting lies directly with various departments and people in the organisation.

Business Forecasting: Method # 2.

Top-down Method:

This method is just reverse of the direct or bottom-up method. In this method the forecast for the industry/business as a whole is ascertained first and then the particular forecasts for the various activities of the business are established. The process of forecasting is, thus, indirect and the responsibility for success in forecasting mainly lies with the top levels of management.

Business Forecasting: Method # 3.

Historical Method:

This method refers to the projection of trends on the basis of past events. The historical sequence of events is analysed as a basis for understanding the present situation and forecasting the future trends. The past recurring trends are associated with the corresponding cause and effect phenomenon in the future.

The important advantages of this method include:

(i) The past information or records can be easily obtained; and

(ii) Present information is also not ignored.

However, the main limitation of this method is that the future trends may deviate drastically from the normal path indicated by the past events. Further, it may not be possible to find trend or develop correlation between cyclic movements of past data and other variables which have bearing upon them.

Business Forecasting: Method # 4.

Deductive Method:

Under this method future trends are based on observation and investigation. In addition to the critical analysis of the past events to draw future inferences, the subjective evaluation and conclusions for deducing discretion, experience and intuition of the forecaster.

This method can be regarded as more dynamic in character as it takes into consideration not only the historical sequence of events but also the latest developments. However, the main drawback of this method is that it relies more on individual judgement and initiative appraisal than on actual record.

Business Forecasting: Method # 5.

Joint Opinion Method:

As the name suggests, this method utilises the collective opinion, judgement and experience of various experts. A committee for business forecasting is formulated to take the joint view of various members. An attempt is made to evolve consensus for predicting future events on the basis of their views.

The main advantages of this method include:

(i) It encourages co-operation and co-ordination and also utilises the services of various experts;

(ii) There is no need of detailed statistical analysis, and

(iii) It is simple and easy to operate.

However, the main disadvantage of this method is the joint responsibility which may ultimately result into no-body’s responsibility. The members of the committee may also not take active interest as they know that their judgement may not be finally accepted. This may degenerate the entire forecasting process into a mere guess work.

Business Forecasting: Method # 6.

Scientific Business Forecasting:

Under this method, forecasting is done on scientific lines by making use of various statistical tools, such as, business index or barometer, extrapolation or mathematical projections, regression and econometric models. Past statistical data modified in the light of changed present conditions provides the basic raw material for drawing more accurate conclusions for the future.

The following are some of the most important statistical tools used for business forecasting:

(a) Business Index or Barometer.

(b) Extrapolation or Mathematical Projection.

(c) Regression

(d) Econometric Model.

(a) Business Index or Barometer:

The term ‘business index’ refers to a series relating to business conditions. It is also known as ‘barometer’, ‘indicator’ or ‘economic forecaster.’ Such a business index number may relate to general conditions of business or to a particular trade or industry or to an individual business.

The index number may measure changes in business activity during the changes of cyclical variations, i.e. boom, decline, depression and recovery. It is called business barometer because it helps in making forecasts for future business conditions.

The indices of production, wages, trade, finance, stocks and shares, etc. are plotted on a graph paper to obtain the curve showing trend of long-period and seasonal movements. The various index numbers relating to different activities of business may be combined into a general or composite index of business activity.’

This general index is an indicator of future conditions of trade and industry in general. However, the behaviour of individual trade or industry might show a different trend from that of general index, As such, the study of general index should be supplemented by separate studies of individual trade or industry.

The following are some of the important series which are considered by businessmen for forecasting:

(i) Index of Wholesale Prices

(ii) Index of Consumer Prices

(iii) Index of Industrial Product

(iv) Gross National Product

(v) Employment

(vi) General Aggregate Consumption

(vii) Volume of Agricultural Production

(viii) Stock Exchange Index.

The different figures may be converted into relatives on a certain base. The weighted average of these relatives may be computed to ascertain the business index called the barometer.

These business barometers guide the businessmen in taking decisions on many problems like expansion of production activity, diversification, undertaking of a new project, exploring new markets, launching as sales campaign rising of funds through issue of shares or debentures etc.

The reports on general business and trade conditions are published by the Chamber of Commerce, industry and some trade associations. Important journals and newspapers also publish index numbers relating to various industries and trades. The Reserve Bank of India also publishes various index numbers and indicators of general economic conditions.

The business barometers are very useful in business forecasting, but sometimes these barometers give misleading conclusions due to inaccurate construction of index numbers or changed conditions. As many factors may prevent history to repeat it, it is necessary to modify the trend revealed by business barometers in the light of specific conditions influencing the judgement.

(b) Extrapolation or Mathematical Projection:

Extrapolation is the process of estimating a value for some future period, based on some assumptions.

The basic assumptions underlying this statistical tool of business forecasting include:

(i) There should not be sudden jumps in figures from one period to another; and

(ii) The conditions in the future will not change materially.

(c) Regression:

The regression equation, y=a+bx, can be used as an instrument to predict the value of y for a given value of x. The regression equation is highly used in physical sciences where the data are related functionally. However, in business forecasting it may be very difficult to establish functional relationships and hence the use of regression equation is also limited.

(d) Econometric Models:

Economic activities describe in terms of mathematical equations are referred to as econometric models. These models show the way of inter-relationships amongst the various aspects of the economy. The econometric models are not very popular because it is not possible for every business to develop his own model of the economy.