A business that wants to thrive must engage in business forecasting. The process is vital to business people because they know that financial statements form a particular impression. The General Accepted Accounting Principles requires accountants to capture business forecasts in their records.
There are debates about what business forecasting should entail, and the best way to go about it. Measuring the accuracy of prediction is not cast on stone. Different situations call for different approaches to business forecasting.
Before getting into the details of what business forecasting is, have a look at some facts behind the prediction:
- A forecast will always contain errors
- Time horizons increase the accuracy of a projection
- Aggregation can improve forecast accuracy
These three facts apply in every forecasting situation. You can use them at any point in the supply chain management.
Keep on reading for more delicate details of business forecasting.
What is Business Forecasting?
The calculation of future events that will affect the budgeting process of a business is what comprises forecasting. It depends on the scrutiny of the latest scientifically tested, interpreted and modified info. Its application depends on an executive’s social knowledge and judgment of the business and industry.
Business forecasting involves a prediction of what might happen and the implication it will have on a business’ finances. The research procedure aims to establish the social, economic and financial influences that govern business activities.
Through forecasting, a business can estimate the forces that have a bearing on the future production, demand planning, financial operations and marketing operations.
In another definition, a business forecast is the estimate of future developments. These developments are sales, profits, expenditures and other factors. As part of corporate planning, forecasting has emerged as a crucial aspect because of the changes in economic activity. The variations can have drastic effects on profit margins.
Forecasting serves to cushion a business from the impact. At a minimum, a company should do an annual forecast. Quarter-to-quarter measures can play havoc in a market when the economic climate changes.
How to do Business Forecasting the Right Way
The process of forecasting is never as simple as it may sound, but it is downright essential. The shaky economy does not make the situation any better. With the right guidance, and if you know what to do, you will most probably get it right.
Here is how:
Project good happenings but plan for the worst as well. When preparing on how to break even in tough times, be ready for growth as well. Try as much as possible to remain profitable even if the worst happens.
If the contrary happens and the best case predictions occur, a business must ensure that it has enough staff and products in that event. Looking at the month-to-month growth rate in the last few years can help predict the profit margins for the months to come.
Do not rely on stale forecasts. As the economy changes, it might be necessary for you to make new predictions for your business. An annual forecast may not serve the right purpose in uncertain economic conditions.
When such a situation arises, it is advisable to create another one if you want to run your business on a forecast you can trust.
Update your customer terms. If you extend credit to most of your customers, you might need to reconsider this position. Occasionally, your customers might run into a slowdown. Statistically, some of them might even run into bankruptcy.
Your forecasts in such a situation should be more conservative. This will allow you to subsidize the risk on outstanding credit from your customers. Creating a prediction based on the premise of updating the customer terms works best if you know their paying habits.
Involve your sales team in creating the forecast. One factor that is essential for building a business forecast is predicting the sales for the whole year. The decisions of the senior management determine whether the sale team will buy, hold or sell. This influences expenses and hiring.
Steps of Forecasting
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.
Types of Business Forecasting
Forecasting can be judgment-based or quantitative-based. Judgment forecasting relies on insight and experience.
As a business person, your mind can analyze situations, make connections and interpret a situation that a computer cannot. Unfortunately, human minds are prone to making a biased analysis that makes interpretation of large amounts of data complicated.
- Judgment forecasting is best used where there is no availability of historical data like competitor actions, product launches or new growth plans.
- Quantitative forecasting refers to the use of analytics to evaluate large amounts of business data to establish the patterns and trends. This approach to forecasting is best applied where there are large amounts of data because it is less prone to bias.
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.
You can get the best forecasting results by combining judgment and quantitative forecasting.
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 not categorized as variables influence the business’ actions. In the worst case scenario, businesses become slaves to their historical data and trends.
- 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.
The Bottom Line
Business forecasting has both advantages and disadvantages. While it helps a business plan for adverse outcomes, it can also limit the much a business can achieve. A forecast can be dangerous because it may present an already determined short-to-long-term future that is already determined.
Forecasts are subject to random elements that can’t go into a model. These elements might be wrong from the start.
On the other hand, business forecasting is here to stay. If appropriately used, it puts a business in a position where it can plan ahead of its needs. Making a prediction raises the chances of a company remaining healthy through the economic changes.
One function of business forecasting that many investors appreciate is that it keeps them on their toes when planning. Having a good idea about future revenue and where it is likely to come from is the best way to make the most out of changes occurring in the economy.
Plus, it will allow you to manage your bookkeeping and payroll tasks. In fact, you can have these tasks on autopilot to create more time for other business needs.
If you want to manage your bookkeeping and payroll effectively, you can get started here.