What is business forecasting?
Business forecasting refers to the set of methods and techniques used to determine and predict the future evolution of business. These include sales figures, expenses, and profit margins. Business forecasting is a crucial practice that represents an integral part of any well-functioning organization, regardless of its nature or size.
The practice of business forecasting is based on what is essentially research. Your company will inevitably face some problems, and the forecast examines these problems and tries to determine their root causes. The goal is to end up modifying certain business operations according to a better performance prediction.
The name of the game is data analysis. Whether quantitative or qualitative, the data that is acquired and collected throughout the activities of the company, ideally, means something. Data analysis is the process of extracting meaning from raw data in a way that helps you improve your future operations.
Business forecasting techniques can be divided into two general categories: quantitative and qualitative. Both are valuable and critical to the overall operation and management of a business.
7 quantitative business forecasting methods
Trend analysis refers to observing recent and current trend data and subsequently predicting future trend movements based on this data. This method is based on the assumption that past trends can indicate what might happen in the future.
One of the most popular and widely used types of trend analysis is the so-called failure analysis, whereby early indicators of potential problems are detected and subsequently avoided.
Using trend analysis, you can also forecast or anticipate future sales growth, market trends, interest rates, and inventory levels based on existing data. This is incredibly useful because it is the foundation of all your business decisions and can determine whether to grow, stagnate, or fail. In general, trend analyzes can be performed over three different time horizons: short, medium and long term.
As a general definition, regression analysis measures the correlation between an independent variable and a dependent variable. In other words, your goal is to predict the direction of a relationship between an intervention and an existing “background” state, for example, the effect of a two-week targeted advertising campaign on company sales.
This allows you to run a real experiment to see how your audience responds to a new marketing, advertising, or branding strategy. This is especially useful if you are just starting out or if your company is undergoing major changes in terms of its visual identity, its inventory, its commitments… The list goes on.
Extrapolation is a general term that refers to the use of past trends to predict future events based on the assumption of the trend constancy. This means that when extrapolated, it is assumed that a trend that has been ongoing, probably for a long period, will continue to go in the same direction.
Extrapolation is therefore a kind of fundamental budget that companies must make at certain times. Once you establish a marketing strategy that works or a market trend that does not appear to be affected by acute events, for example, it’s usually best to assume that you’ll take the same direction for the foreseeable future. Therefore, extrapolation is usually a long-term strategy.
This method consists of observing economic indicators and using them to determine the possible direction of trends. The concept was created from the way that meteorologists forecast weather conditions based on the movement of mercury in a barometer.
Normally, economic indicators are classified into several time series so that analysts can study them and predict future trends. These time series are as follows:
It is a series whose indicators move in any direction ahead of other series. In other words, leading indicators predict a change in other series. Examples of leading indicators are after-tax corporate earnings, the change in the value of inventories, and the net business investment ratio.
The lagged series is considered the inverse of the main series. Lagging indicators follow a certain change in trend after a period of time. This means that after the change of a related variable, the lagging indicators change in turn. Examples of lagging indicators are labor cost per unit of production and interest rates on loans.
The matching series is a series whose indicators move according to the movement of general economic activities. Matching indicators include items such as the unemployment rate in a given country, gross domestic product, and the number of employees in a given sector.
A forecast econometric model refers to a model whose set of equations is capable of correctly predicting changes in the values of its variables. The econometrics process is usually as follows:
- Statement of the hypothesis
- Determination of the mathematical model
- Determination of the model frame
- Data collection and evidence
- Estimation of the model parameters
- Hypothesis testing
- Making predictions
The input-output model of the economy aims to represent a picture of the current state of the market. This means that it includes factors such as transactions and the general flow between institutions and industries in a country or region, and uses these factors to create an accurate picture of the economy of that region.
The purpose is to be able to eventually predict certain changes in different sectors of the economy, including the different behaviors of consumers, government entities and foreign suppliers.
Input-Output (IO) analysis refers to statistical macroeconomic analysis that takes place as part of a forecasting process based on the input-output model. It is carried out based on the interdependencies that exist between the different industries of the economy.
IO analysis is often used to predict the short-term or long-term impact of events of economic shocks, such as a significant increase in unemployment rates, on the overall state of the economy. The shock event can also be beneficial, such as a sharp decline in the number of people living below the poverty line.
The objective of IO analysis is to predict the influence of such changes on the interdependencies between sectors, industries and institutions in a given country or region.
6 Qualitative business forecasting methods
As its name suggests, brainstorming is the effort made by a group of people to come up with a set of ideas. The goal of brainstorming forecasting is to predict changes in the market or anticipate fluctuations in a company’s transactions as a result of past and current trends.
This is based on the assumption that a group of experts in the field will come up with more informed ideas, usually better, compared to any individual working alone. From these ideas, you can forecast demand rates, sales figures, or profit margins.
Direct Vs. Indirect Forecast
When it comes to cash flow forecasting, there are two different methods that can be used. The goal of direct cash flow forecasting is to predict the exact dates when money will enter and leave the business. In contrast, indirect cash forecasting uses accounting information to predict long-term business growth.
In general, the indirect method is easier to adopt and, therefore, more widely used, especially in large companies that carry out a large volume of transactions on a regular basis. This is because it is less time consuming and more useful for long-term forecasting. However, it is good to note that this method can give somewhat inaccurate results in the short term.
Smaller companies can benefit more from the direct method, as they can focus on short-term forecasts and have time to make accurate predictions. The direct method can generate accurate forecasts; however, the accuracy of the predictions tends to decrease longer the predictions. It is more difficult for a business to record all transactions over time, especially when experiencing rapid or exponential growth.
A qualitative forecasting method is to analyze data that emerge from market research. By definition, forecasting is the use of collected data to anticipate future trend movements. When you use market research to determine the direction of these trends, you focus on changes in your specific market or sector.
This is a very valuable tool, especially for your company’s marketing team. It goes without saying that in order to properly advertise your product and successfully communicate with your target audience, you must constantly be aware of the current market state.
Depending on your industry, different sectors of the economy tend to have different trends. This fluctuation also depends on other factors, such as social events, the economic outlook of your country or region, the global outlook…
Market research consists of surveying a group of people, usually your target audience, about how they would react if a product or service were launched. This includes information on whether they would respond positively to it, whether they would buy it, how useful it would be to them, and so on.
Market research is a great way to get a complete and comprehensive view of how your industry is performing and has performed. Analysis of the data obtained from market research allows you to predict future changes and adjust marketing and advertising strategies accordingly.
Internal forecasting simply means using an accumulation of past forecasts within a company’s own sales channels to predict the company’s future sales trends and rates.
As part of a more comprehensive and global forecasting process, internal forecasting is useful because it allows you to establish patterns within the company and determine what needs to be improved and implemented to increase sales.
Sales Force Composite Method
Sales Force composite forecasting is a method used by companies selling in multiple territories or countries. Each sales agent performs a regional sales forecast, and regional factors are added to create a global sales forecast for the entire company.
For companies with sales activity in multiple regions and in multiple countries, composite forecasting is effective and can provide a detailed view of the business success at each of its bases.
It is also an effective tool for sales and accounting teams to visualize what may be missing from their overall strategy and adjust their operations based on other factors, such as the differential market states in each country.
This method is self-explanatory: you look at the past performance of the company to predict future trends in its sales, expenses, and other items.
As qualitative forecasting methods often overlap, it can be part of a brainstorming process between experts from different specialties. It is also a necessary part of a direct or indirect forecasting method. In general, forecasting involves evaluating the company’s own sales performance in the past and making predictions from that data.
Business forecasting is an incredibly powerful tool for any business, large or small, regardless of its transaction volume. As we have seen, there are many different forecasting methods, and the choice depends entirely on the nature of your business, your overall goals, your market, and your preferences.
It is advisable to use both quantitative and qualitative forecasting methods, as they offer different results and both are equally valuable to the success of your business.
While quantitative methods are meant to provide detailed, reliable, and accurate predictions, don’t underestimate the power of a simple brainstorming session in the presence of people who are experts in their respective fields. Ideally, forecasting should take a holistic approach that combines both strict statistical analysis and creative brainstorming.