what are the two main things to consider when selecting a forecast method? why?
What is Forecasting?
Forecasting refers to the practice of predicting what will happen in the future by taking into consideration events in the past and nowadays. Basically, it is a determination-making tool that helps businesses cope with the bear on of the future's uncertainty by examining historical data and trends. It is a planning tool that enables businesses to chart their adjacent moves and create budgets that will hopefully cover whatever uncertainties may occur.
Budgeting vs. Forecasting
One thing that is definitely true is that budgeting and forecasting are both tools that help businesses plan for their futurity. Notwithstanding, the two are distinctly unlike in many ways. Let's consider the post-obit points:
- Budgeting involves creating a statement that consists of numerous financial activities of a company for a specific period, such as projected acquirement , expenses, cash menses, and investments. It is usually non conducted solely by ane department, say, the finance section, because it requires input from other departments in social club to come up with a holistic and detailed study. Therefore, the budgeting procedure takes time to complete. The company uses the upkeep to guide it in its financial activities.
- While budgets are usually fabricated for an entire year, forecasts are usually updated monthly or quarterly. Through forecasting, a company is able to accommodate its upkeep and allocate more funds to a department, as needed, depending on what is foreseen. In summary, budgets depend on the forecast.
Forecasting Methods
Businesses choose between ii basic methods when they want to predict what can possibly happen in the time to come, namely, qualitative and quantitative methods.
1. Qualitative method
Otherwise known as the judgmental method, qualitative forecasting offers subjective results, as information technology is comprised of personal judgments by experts or forecasters. Forecasts are often biased because they are based on the proficient's knowledge, intuition, and experience, and rarely on information, making the process non-mathematical.
1 case is when a person forecasts the outcome of a finals game in the NBA, which, of course, is based more on personal motivation and interest. The weakness of such a method is that it can be inaccurate.
2. Quantitative method
The quantitative method of forecasting is a mathematical process, making it consequent and objective. It steers away from basing the results on stance and intuition, instead utilizing large amounts of data and figures that are interpreted.
Features of Forecasting
Hither are some of the features of making a forecast:
1. Involves future events
Forecasts are created to predict the future, making them important for planning.
2. Based on by and present events
Forecasts are based on opinions, intuition, guesses, as well as on facts, figures, and other relevant data. All of the factors that get into creating a forecast reverberate to some extent what happened with the business organization in the past and what is considered likely to occur in the future.
three. Uses forecasting techniques
Most businesses use the quantitative method, particularly in planning and budgeting .
The Process of Forecasting
Forecasters need to follow a careful procedure in order to yield accurate results. Here are some steps in the process:
1. Develop the basis of forecasting
The first step in the process is developing the basis of the investigation of the company's condition and identifying where the concern is currently positioned in the market.
two. Approximate the futurity operations of the business
Based on the investigation conducted during the starting time stride, the second office of forecasting involves estimating the future conditions of the industry where the business operates and projecting and analyzing how the company will fare.
3. Regulate the forecast
This involves looking at different forecasts in the past and comparing them with the actual things that happened with the business. The differences in previous results and current forecasts are analyzed, and the reasons for the deviations are considered.
4. Review the process
Every step is checked, and refinements and modifications are made.
Sources of Information for Forecasting
1. Primary sources
Information from principal sources takes time to gather because it is first-mitt data, also considered the most reliable and trustworthy sort of information. The forecaster himself does the collection, and may do so through things such as interviews , questionnaires, and focus groups.
2. Secondary sources
Secondary sources supply information that has been collected and published by other entities. An example of this type of information might be industry reports. As this data has already been compiled and analyzed, information technology makes the process quicker.
Additional Resources
Give thanks you for reading CFI'due south guide to Forecasting. To keep learning and advancing your career, the post-obit CFI resources will be helpful:
- DCF Modeling Guide
- Projecting Residual Sheet Line Items
- Projecting Income Statement Line Items
- Regression Analysis
Source: https://corporatefinanceinstitute.com/resources/knowledge/finance/forecasting/