Forecasting: Elements, Techniques and Advantages

After reading this article you will learn about:- 1. Meaning of Forecasting 2. Features of Forecasting 3. Elements 4. Techniques 5. Advantages 6. Limitations.

Meaning of Forecasting:

Since planning is “a systematic economic and rational way of making decisions today that will affect tomorrow”, then forecasting becomes an integral part of the planning process, specially, strategic planning which is long-range in nature.

Lyndall Unrwick defined forecasting as, it is involved to some extent in every conceivable business decision. The man who starts a business is making an assessment of a future demand of its products.

The man who determines a production programme for the next six months or twelve months is usually also basing it on some calculation of future demand. The man, who engages staff, and particularly Young staff, usually has an eye to future organisational requirements.

Business forecasting refers to a systematic analysis of past and present conditions with the aim of drawing inferences about the future course of events. Louis Allen defines forecasting, as “a systematic attempt to probe the future by inference from known facts.”

Neter and Wasserman have defined forecasting as:

“Business forecasting refers to the statistical analysis of the past and current movement in the given time series so as to obtain clues about the future pattern of those movements.”

Features of Forecasting:

Based on the above definitions the following features are explained below:

1. Involvement of Future Events:

Forecasting relates to future events. Forecasting is the essence of planning because planning also aims at deciding what is to be done in the future.

2. Depends upon Past and Present Event:

Actually, forecasting is made by analyzing the past and present relevant data. It takes all the factors into account, which affect the functioning of the enterprise.

3. Happening of Future Events:

Forecasting defines the probability of happening of future events. Therefore, happening of future events can be precise only to a certain extent.

4. Makes use of Forecasting Techniques:

As can be gathered from what has gone before that forecasting is a systematic attempt to probe the future with a view to drawing certain useful inferness. Such a probing obviously demands a proper and full analysis of known facts with the help of various qualitative and quantitative forecasting techniques.

Elements of the Forecasting Process:

J.W. Redfield describes the following elements of forecasting process:

1. Prepare the groundwork.

2. Establishing future business.

3. Comparing actual with estimated results.

4. Refining the forecasts.

1. Prepare the Groundwork:

The group work preparation requires a thorough study, investigation and analysis of the company, its products, its market share, its organisational structure and the industry. The investigation will involve the past performance of all these factors, their growth over a period of time and the extent of their inter-relationships and inter-dependence. The aim is to build a foundation on which future estimates can be based.

2. Establishing Future Business:

The future expectancy of the business can be reasonably computed from the past data as well as the input from the key executives of the organisation, sales personnel and other specialists.

This forecast is developed with the participation of the key personnel and is officially communicated to all. Thus all these people assume responsibility for meeting these forecasts and accountability for any deviations from this forecast.

3. Comparing Actual with Estimated Results:

The forecast estimates over the future years provide benchmarks against which the actual growth and results can be measured and compared. If there are significant variations between the two, one way or another, the reasons for such deviations can be investigated and analysed.

4. Refining the Forecasts:

In the light of any deviations found, the forecast can be refined to be more realistic. If some conditions have changed during the periodic evaluation, then the new values of the variables can be incorporated in the estimates.

Thus, these constant revisions and refinements and improvements would add to the experience and skill in forecasting, since proficiency in forecasting can only be gained through practice and experience.

The above elements indicate a systematic approach to the problem of forecasting. As a materiality, these elements are found in any research procedure.

Techniques of Forecasting:

Forecasting technique can be classified into two major categories:

1. Qualitative forecasting technique.

2. Quantitative forecasting technique.

1. Qualitative Techniques:

i. Jury or executive opinion (Dolphi technique)

ii. Sales force estimates.

iii. Customer expectations.

i. Jury or Executive Opinion:

The jury of expert opinion sometimes referred to as the Dolphi technique; involves soliciting opinions or estimates from a panel of “experts” who are knowledgeable about the variable being forecasted.

In addition to being useful in the creation of a sales or demand forecast this approach is used to predict future technological developments. This method is fast less expensive and does not depend upon any elaborate statistics and brings in specialized viewpoints.

ii. Sales Force Estimates:

This approach involves the opinion of the sales force and these opinions are primarily taken into consideration for forecasting future sales. The sales people, being closer to consumers, can estimate future sales in their own territories more accurately. Based on these and the opinions of sales managers, a reasonable trend of the future sales can be calculated.

These forecasts are good for short range planning since sales people are not sufficiently sophisticated to predict long-term trends. This method known as the “grass roots” approach ends itself to easy breakdowns of product, territory, customer etc., which makes forecasting more elaborate and comprehensive.

iii. Customer Expectations:

This type of forecasting technique is to go outside the company and seek subjective opinions from customers about their future purchasing plans. Sales representatives may poll their customers or potential customers about the future needs for the goods and services the company supplies.

Direct mail questionnaires or telephone surveys may be used to obtain the opinions of existing or potential customers. This is also known as the “survey method” or the “marketing research method” where information is obtained concerning.

Customer buying preferences, advertising effectiveness and is especially useful where the target market is small such as buyers of industrial products, and where the customers are co-operative.

2. Quantitative Techniques:

Quantitative techniques are based on the analysis of past data and its trends. These techniques use statistical analysis and other mathematical models to predict future events.

Some of these techniques are:

i. Time series analysis.

ii. Economic models.

iii. Regression analysis.

i. Time Series Analysis:

Time series analysis involves decomposition of historical series into its various components, viz., trend, seasonal variations, cyclical variations and random variations. Time series analysis uses index numbers but it is different from barometric technique. In barometric technique, the future is predicted from the indicating series, which serve barometers of economic change.

In time series analysis, the future is taken as some sort of an extension of the past. When the various components of a time series are separated, the variations of a particular phenomenon, the subject under study stay say price, can be known over the period of time and projection can be made about future.

A trend can be known over the period of time, which may be true for future also. However, time series analysis should be used as a basis for forecasting when data are available for a long period of time and tendencies disclosed by the trend and seasonal factors are fairly clear and stable.

ii. Economic Models:

Utilize a system of interdependent regression equations that relate certain economic indicators of the firm’s sales, profits etc. Data center or external economic factors and internal business factors interpreted with statistical methods. Often companies use the results of national or regional econometric models as a major portion of a corporate econometric model.

While such models are useful in forecasting, their major use tends to be in answering “what if”? Questions. These models allow management to investigate and in major segments of the company’s business on the performance and sales of the company.

iii. Regression Analysis:

Regression Analysis are statistical equations designed to estimate some variables such as sales volume, on the basis of one or more ‘independent’ variables believed to have some association with it.

Advantages of Forecasting:

Forecasting plays a vital role in the process of modern management. It is an important and necessary aid to planning and planning is backbone of effective operations.

Thus the importance or advantages of forecasting are stated below:

1. It enables a company to commit its resources with greatest assurance to profit over the long term.

2. It facilitates development of new products, by helping to identify future demand patterns.

3. Forecasting by promoting participation of the entire organisation in this process provides opportunities for teamwork and brings about unity and co-ordination.

4. The making of forecasts and their review by managers, compel thinking ahead, looking to the future and providing for it.

5. Forecasting is an essential ingredient of planning and supplies vital facts and crucial information.

6. Forecasting provides the way for effective coordination and control. Forecasting requires information about various external and internal factors. The information is collected from various internal sources. Thus, almost all units of the organisation are involved in this process, which provides interactive opportunities for better unity and coordination in the planning process.

Similarly, forecasting can provide relevant information for exercising control. The managers can know their weakness in forecasting process and they can take suitable action to overcome these.

7. A systematic attempt to probe the future by inference from known facts helps integrate all management planning so that unified overall plans can be developed into which divisional and departmental plans can be meshed.

8. The uncertainty of future events can be identified and overcomes by an effective forecasting. Therefore, it will lead to success in organisation.

Limitations of Forecasting:

The following limitations of forecasting are listed below:

1. Basis of Forecasting:

The most serious limitations of forecasting arises out of the basis used for making forecasts. Top executives should always bear in mind that the bases of forecasting are assumptions, approximations, and average conditions. Management may become so concerned with the mechanism of the forecasting system that it fails to question its logic.

This critical examination is not to discourage attempts at forecasting, but to sound caution about the practice of forecasting and its inherent limitations.

2. Reliability of Past Data:

The forecasting is made on the basis of past data and the current events. Although past events/data are analysed as a guide to the future, a question is raised as to the accuracy as well as the usefulness of these recorded events.

3. Time and Cost Factor:

Time and cost factor is also an important aspect of forecasting. They suggest the degree to which an organisation will go for formal forecasting. The information and data required for forecast may be in highly disorganized form; some may be in qualitative form.

The collection of information and conversion of qualitative data into quantitative ones involves lot of time and money. Therefore, managers have to tradeoff between the cost involved in forecasting and resultant benefits. So forecasting should be made by eliminating above limitations.