A business that wants to thrive must engage in business forecasting. It’s a multifaceted approach to accounting that’s used in predicting revenue and economic fluctuations. Essentially, forecasting helps determine business needs, potential growth, and many other factors. The risks and misconceptions coupled with a steep learning curve, however, are overwhelming, especially to new entrepreneurs.
We’re here to add simplicity to these complex processes. In this guide, you’ll learn:
- What business forecasting is and how it’s used
- Forecasting methods and process
- The best approach for effective forecasting
- Potential problems with forecasting
- How to avoid forecasting errors
- Why you should consider forecasting software
What is Business Forecasting?
Business forecasting can be defined as the calculation of future developments that will affect the budgeting process of a business. These developments are sales, profits, and expenditures, among other factors. Business forecasts got a big push after the Great Depression in the 1930s in an effort to avoid another economic catastrophe.
Given that the economy shifts drastically, business forecasting is a necessary part of accounting. You may think it only affects large corporations, but small businesses will benefit, too. Through forecasting, a business can estimate the forces that have a bearing on future production, demand planning, financial operations, and marketing operations.
Executives leverage these estimations to create short and long-term plans. For example, a forecast can show a dramatic increase in sales from one year to another. In these cases, a business owner will need to prepare themselves and their employees.
The changes can include:
- Increasing the store’s inventory
- Hiring more people to handle the new workload
- Updating the production quotas among their staff
These steps allow business owners to keep up with higher demands and watch their bottom lines grow. Alternately, if there’s an economic downturn in sight, they can adjust to cut the impact and loss. While business forecasts aren’t always accurate, they are incredibly useful resources.
How Does a Business Forecast Differ From a Budget?
With budgeting, you also use past data as well as information about your current finances to plan for the future. You generally set budgets annually and have some check-in points throughout the year to make sure that you are on track.
Forecasting, on the other hand, is all about looking at the present. It is a sort of real-time update to your budget progress. It helps you ensure that you stay on track of your budget and respond more quickly to your business’ changing needs. For example, you may be picking up more work and generating more revenue than you anticipated in your budget. With forecasting, you could see this and decide if you need to take on more staff to fulfill this demand and keep growing.
Additionally, a good forecast takes other factors into account that aren’t normally included in a budget. Changes in the economy or stock market can affect your forecast. So can major events, news articles or trending subjects. If you had a toy store, for example, and you noticed the fidget spinner craze just beginning to take hold, your forecast would help you decide how to act. You might be able to assume that since sales will increase, you can spend a bit more to increase your stock beforehand.
Basically, a forecast is different from a budget because it gives you current information, helps you make decisions in the present and takes trends and current events into account.
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Forecasting Methods and Process
Methods for Business Forecasting
Forecasting can be qualitative-based or quantitative-based:
The Qualitative method is most productive when it is used for short-term predictions. They depend on market mavens (well-informed investors) instead of stats. Because of this, qualitative models have their limitations. Examples include polls for market research and opinions from field experts.
The downside of qualitative forecasting is that when there is no historical data to analyze, making a prediction can be a challenge. The approach relies a lot on identifying repetitive patterns in the business data. With limited data, it may take a while to establish a trend over time.
The quantitative method removes people from the equation and focuses solely on the numbers. The variables this method uses can be sales, housing prices, and gross domestic product.
You can get the best forecasting results by combining qualitative and quantitative forecasting.
Business Forecasting Process
The specific steps of forecasting, also known as the elements, are the systematic approach to creating a business forecast.
Step 1: Develop the Basis of the Systematic Investigation
At this step, you need to analyze the economic situation, the position of your products, and the industry. The predictions you make about the general operations and sales should depend on the outcome of the investigations. Forming the basis of the forecast marks the first step of business forecasting.
Step 2: Make an Estimate of Future Business Operations
The second step calls for the estimation of the course of future events and conditions within the industry. Based on the information you collect through investigation. You are in a good position to estimate future business operations.
The estimates should be quantitative and made on certain assumptions for future scale operations.
Step 3: Regulate the Forecasts
Check to see if there are any deviations. You can do this by measuring the forecasts against the actual results. If any variations exist, determine the reasons behind them and take corrective actions in the future.
Step 4: Review the Process of Forecasting
Once you establish the differences between forecast and performance, you can make improvements in the forecasting process. Refining the process of predicting will make your future predictions more accurate.
The Best Approach for Effective Forecasting
Forecasting can be the difference between exceeding goals and missing them entirely. We did some research and found a few simplified business forecasting tips, which can easily merge into your business planning strategies today.
Look at Your Expenses Not Revenue
This analysis is especially true with new businesses and startups. Estimating the costs of recurring monthly bills establishes a foundation for a starting price point. Since new companies don’t have a point of reference or history for their revenue, this is a powerful tool.
These expenses include:
- Rent for office or store space
- Utility bills
- Phone and internet bills
- Legal fees and insurance
- Equipment like computers or copy machines
- Employee salaries and benefits
It’s safe to overestimate costs for advertising, legal fees, and insurance. These expenses tend to surpass the predicted amounts.
Know the Market
Forecasting is more than looking at the way your business performs. Yes, your stats are important factors, but there’s a bigger picture. Forecasting is about the way the market performs as a whole.
Forecasters should be asking themselves who the customers and competition are respectively.
Understanding consumers’ needs for a business and how competing companies are meeting them is priceless.
Know the Reasons for Forecasting
A forecasting strategy shouldn’t change based on the reason for the forecast. But the way the data is organized should differ depending on the intended audience.
A business forecast can be created for an outside investor or bank. If your purpose is to ask for more funds, investors might want to see specific types of data. For example, when a new product line is launching, they can ask how it’ll pay for itself. The data the forecast should highlight is how the new line will impact revenue.
Another section can display what types of resources will be required. Sometimes categories will need to be broken down more based on who will be looking at the forecast.
Do Forecasts for Conservative and Aggressive Cases
New business owners tend to go back and forth in their thoughts about income. In conservative cases, the train of thought is based on facts and rationalizations.
Aggressive cases are those that involve more dreaming than strategizing. A conservative forecast may not involve hiring employees to do sales because there isn’t a strong need for it at the time. An aggressive forecast wouldn’t just include making those hires. It can involve awarding bonuses or commissions based off of the hope that business picks up.
Don’t force the aggressive thoughts into silence. Allowing yourself to think both ways can help you find a safe and sensible middle ground.
How Does Your Client Base Compare to Your Employees?
Many entrepreneurs start out playing the roles of owner, sales, customer service, manager and bookkeeper all in one. However, as a business grows, new employees are often considered to decrease the owner’s workload.
Look at the number of active clients that are coming in compared to the number of employees. Divide the number (use 1 if it’s just the owner) of employees by the total amount of clients you have. The workload might be alright for a single person right now. But if after your business has grown in a few years, will you still be able to deliver quality on your own? Do you see yourself needing to turn down work? Or perhaps, you’ll discover a new revenue stream you’ll need help producing.
Forecasts are designed to go through multiple edits. If you think you’ll need help soon, update the employee salary section of your forecast. When this is done, you’ll determine if the revenue will support new hires.
Regulate the Forecasts
This is where past forecasts are compared to what really happened. Any inconsistencies should be identified and then refined for future predictions.
Set a Plan for Sales and Discounts
The most popular discounts retailers offer are promotional discounts, clearance markdowns, and holiday sales. All three of these discount opportunities should be implemented in a business forecast. Discounts attract customers and increase sales. Meaning, there will be a greater need for sales associates, supplies, and inventory.
Consider using a calendar to help with this part of forecasting. Plan sales for well-known holidays like Christmas, Thanksgiving, and Mother’s Day. But take advantage of some of the silly, made up holidays out there. These can be fun, especially if a company’s products relate. For example, the Cheesecake Factory celebrates National Cheesecake day every year by selling half-off slices. They sometimes debut a new flavor that day, too.
Promotional discounts are to be planned during the season there’s a high demand for the product. Clearance markdowns should occur toward the end of that season.
If these sales have a place in the forecasting process, it will be much easier to manage inventory. You don’t want to have too much or too little product at a given time.
Work Smarter, Not Harder
Financial forecasting is one of the most stressful tasks entrepreneurs have to complete. An incorrect forecast can cause wasted inventory, negative account balances and an upset customer base.
There are online forecasting tools for those business owners who are terrified of making an expensive mistake.
There’s no shame in taking a little extra help.
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Potential Problems with Forecasting
Business forecasts are essential for businesses. Proper predictions allow a company to plan for financing and production. However, projections are not without their share of challenges.
- Despite all the mental gymnastics involved in coming up with a business forecast, it is never guaranteed that errors will not occur. Some schools of thought argue that the future outlook of the forecaster influences a business forecast. If they are pessimistic, that is what they will project in their analysis and vice versa.
- It is not possible to encompass unexpected events in the prediction. Making assumptions is dangerous. Black swan events have been on the increase due to dependence on forecasts.
- Integrating the impact of a forecast is hard. Whether a forecast is accurate or not, factors that weren’t taken into consideration can influence results.
- So much effort goes into manipulating the forecast than in focusing on the current operations of the business.
- It is almost impossible to make pin-point accurate forecasts. Errors are bound to creep up, and you can’t eliminate guesswork entirely from the forecasts. Businesses and governments use millions of dollars in making projections, yet they are not always on target.
- In turbulent economic times, it is difficult to determine what to pay attention to, as was the case in 1982. Forecasters got caught in the supply-side economic programs by President Reagan. They stopped paying attention to real economic events and made the worst predictions.
How To Avoid Forecasting Errors
Even though a lot of companies use analytical software, up to 93% of them will adjust any forecasts generated by it. This statistic shows how unreliable people think this software is. However, you can still use it to predict the future of the market.
The problem is that forecasting errors can cloud a prediction’s accuracy, causing short term issues to snowball into bad news for any business. The key to tackling this issue is to understand forecast bias, recognize what causes forecast errors, and know the best ways to avoid them.
What is Forecast Bias?
Forecast bias results from a forecast error. It’s essentially a continuous miscalculation of the future. Whenever a predicted forecast outcome happens, the forecast is evaluated. It’s either considered perfect, relatively accurate, or incorrect. If it’s incorrect, then the business may label it as a forecast error. On the other hand, when you have multiple incorrect predictions, it may be a sign of forecast bias.
Forecast bias can decrease the efficiency of any business. To prevent it, you have to find the cause of the error.
What Causes Forecasting Errors?
1. No Systematic Process
Some people don’t believe in the need for a systematic forecasting process. They couldn’t be more wrong. In fact, according to AMR research, even a 3% increase in the accuracy of a sales forecasting will increase profit margins for a company by 2%. Therefore, forecasting is not only critical to the profit margins, but also a highly systematic process.
2. Planning Around Goals, Not Reality
Ignoring reality during the planning process makes forecasting more difficult. For example, the business may base staffing on a handling time of four minutes when it’s actually closer to nine minutes. This is completely unreasonable.
There are ways to go about the planning process to make it more accurate, but it’s vital to plan around actual, achievable goals.
3. Assuming That Forecasting Software is Entirely Accurate
Forecasting software is a useful tool. It can collect and analyze data, run different scenarios, and predict potential outcomes. However, it has its limitations. This software is unaware of what any department is doing, nor does it know any initiatives that have been put in place that may reshape answers.
According to statistics, there is a growing demand for forecasting software to have more and more accurate predictions. Thus, there’s a limited amount of work a computer program can do, so it should not always be completely relied upon.
4. Taking the Forecast Lightly
So, there has been a forecast error or perhaps there have been several wildly inaccurate ones. If the business takes these errors lightly, there is a big chance that they will continue to occur.
Instead, taking these errors seriously can shape the profitability of the business significantly.
5. No Ongoing Communication with Other Departments
Without strong ties between departments (in any business), you can expect many forecast errors and biases. This is because of the lack of communication impedes the departments from keeping track of interdepartmental changes which may affect the business, and are essential to the forecasting.
6. No One is Being Held Accountable
There needs to be someone responsible for bringing various types of inputs together. They also need to ensure their integrations are included in the forecast, as well as discover what assumptions were off if there is a forecast error. This effectively reduces the number of forecast errors.
7. Not Making Connections with Staffing
In the end, any forecast made means nothing unless it has a tie to the system resources and staff. This ensures that the results obtained are factual and closely tied to the business.
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How Can Forecasting Errors Be Avoided?
1. Using Quality Forecasting Software
Time and time again businesses fail to utilize the best forecasting software when it comes to making accurate predictions. This, therefore, leads to catastrophic forecasting errors.
A quality forecasting software will provide you with unlimited forecasting scenarios that you can use to predict future outcomes. It should also be easy to use with simple input requirements, as well as show exactly what needs to be done to allow the business to improve.
2. Cleaning Up Bad Data
Often, a forecasting engine will use historical data in order to produce a forecast. Sometimes, this data can be terrible and wildly inaccurate. In fact, bad data is often considered to be one of the top causes of forecasting errors. To avoid this, there needs to be a quality supply of clean data going into the forecasting software. That way, decent results will emerge.
The best way to get clean data is by correcting errors in historical data. The business can rectify these errors by using a second set of data to compare against it. This will allow you to get rid of the inaccurate data entries and replace them with correct values.
During this cleaning process, you shouldn’t make up data to fill in a missing cell, nor should you delete bad values. However, if the right value is known, you should correct it. If it isn’t known, the data should remain as is.
3. Use Special Days
Although data cleaning corrects errors, it doesn’t really do much for data anomalies.
Which raises the question, “What can be done to deal with this big issue?”
Well, they can’t be cleaned but they can be marked using a feature called special days or special events. This feature allows the user to mark specified calendar days as special. By marking a day or multiple days as special, it can prompt one of two different responses from any forecasting software. In some cases, it can cause the forecasting engine to ignore the special day. In other cases, it can cause it to use other related special days to properly forecast the event.
Special days are fantastic tools that can often be misused, so it is vital that it is used correctly to get its full potential.
4. Change the Timing of the Forecast
The timing of when a forecast is done can actually have quite a big impact on the accuracy of the forecast. For example, creating a forecast one week from now will logically be much more accurate than one that is created a month from now.
Thus, it is important that forecasts are created as close to the date of the outcome as possible. In fact, it would be ideal to create them on the day of the outcome, but this is not practical.
Forecast timings need to coincide with the start of schedules and the time required for reviewing the forecast and editing the schedule. The shortest time between the finalization of a forecast and the dates it represents needs to be between 6 and 13 days.
So, the best way to avoid a forecast error is to consider generating forecasts as soon as possible.
5. Change the Granularity of the Forecast
It’s no surprise that statistics with bigger numbers will produce more accurate results than those with smaller numbers. Applying this to forecasting means that using larger numbers will allow any business to produce more accurate results.
Larger numbers can be created by changing the granularity of what is being forecasted. For example, forecast by product category rather than by product line and by the hour rather than the quarter hour. Thus, every business should consider creating larger numbers to use in forecasting software.
6. Consider Making a Change to the Forecast Method
The last (but certainly not least!) important way to avoid a forecast error is to go beyond problems with the data and instead look at the method of forecasting that is being used.
This may feel like a step backward for some people due to the assumption that the forecasting method is the first aspect that should be considered. However, until you’re using clean data, there is no way to actually have accurate forecasts in the first place.
It’s important to note that this is not a request to completely change the forecasting method. This is just a suggestion. At this point, most businesses have a certain type of forecasting method they use.
If that is the case, consider validating any initial analysis of the various forecasting methods that were available to use to see if it is still correct.
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Cash flow is king.
Why You Should Consider Forecasting Software
Understanding the Methodology Helps You Make Decisions
Quality forecasting software won’t just give you projections. It will help you understand those projections, and how to make strategic decisions from them.
There are different models and methodologies used to generate forecasts. One software might use a different method than another, and come to different results. When you understand how the software is generating the report and what sorts of things it is taking into account, you can be more confident in making decisions.
One of the best parts of leveraging forecasting software is how easy it is to generate the reports. Accurate and useful projections are available with just a few clicks. This means you can take advantage of projections as often as you would like. You don’t have to worry about wasting your precious time fiddling with numbers and complex risk assessments.
Smart forecasting software takes care of the gritty details, leaving you with actionable projections.
Get Alerts To Stay On Track
Like we said before, forecasting gives you up-to-date information. The reports can be run automatically, and you can get insight anytime you want. Constant automated updates give you another level of security to make sure you stay on track.
You can get smart alerts that give you a warning whenever things look like they aren’t going according to plan. This means that you can respond to the unexpected instantly, and you can get ahead of potential issues before they become a real problem. It also means that you can take advantage of any potential opportunities. You can respond instantly to changes that give your company a boost, helping grow your business even more.
Analyze Your Business
When you use quality forecasting software, you can get a breakdown of your business’s performance. This can help you plan, streamline, and improve your business. You can see what areas are doing well, and which areas might need some extra work or investment. Since all businesses have limited resources, forecasting software, allows you to allocate these resources most effectively. Reliable forecasting helps you see these possibilities, and take advantage of them.
Smart Inventory Management
How do you know the best times to re-order inventory? With forecasting software, you can compare the probable demand with the cost of storing unused inventory. This way, you can make more accurate decisions about the inventory you will need. It will help ensure you won’t have too much on hand, but you won’t run out either.
Smart inventory management saves on costs. It also helps avoid shortages, which can be catastrophic for your business. If you don’t have the product your customers need, they will go to your competitors. Great forecasting can help you make sure this doesn’t happen.
Strengthen Your Budgeting
Great forecasting can help you with your budgeting, and vice versa. At its most basic, a budget is all about making sure you have the money you need for everything important to your business.
No matter how great your forecast is, it shouldn’t be a replacement for budgeting. Instead, you can use the information you’ve gained from a year full of forecasting to inform your budget. Then, as you go throughout your year, your forecasts will be informed by your budget. This will help make sure that while you try to take advantage of opportunities and challenges as they arise, you will never make an error you can’t afford.
When you use your forecasts and budget to support each other, you can feel confident in taking calculated risks.
Get Access to Other Business Tools
With ScaleFactor, the software comes loaded with a ton of other essential tools besides forecasting. You will be able to handle the bulk of your accounting and finance management with this software alone.
The software has tools for bookkeeping, invoices, bill pay, and compliance. The great thing about having all these tools connected in one software is that everything is integrated and compatible. All of your accounting data is connected to the forecasting software. This means you only have to input information or make changes once for it to show up in all your reports. With everything tied together, there is less room for errors.
Interested in seeing how all these products work together? Request a demo to see how you can use forecasting and all these other tools to manage your business.