Forecasting indicates the process of making predictions for the future. These predictions are based on historical data from the past as well as the present. Forecasting is mostly conducted by analyzing trends in businesses.
Both risk and uncertainty are the central elements for forecasting.
What is Forecasting?
Forecasting alludes to predicting what can happen in the future by considering various events and incidents of the past and the present. Forecasting is a decision-making tool that helps businesses cope with the uncertainty surrounding a business by carefully examining the historical data and trends.
It is can also be labeled as a planning tool that allows businesses to plot their upcoming moves and make budgets accordingly. Companies use the forecasting tool with the hope that it will cover all the uncertainties that might occur.
It is generally considered as a good practice of indicating the degree of uncertainty attached to forecasts. One thing should always be kept in mind; the data must be up to date to forecast accurately.
Let’s look at some of the definitions provided by Mc Farland, L.A. Allen, Webster’s New Collegiate Dictionary, and Neter and Wasserman-
Forecasting is a systematic tool to predict the future with help from known facts. – L. A. Allen
Forecasts are predictions of any change in economic conditions that might affect business plans. -Mc Farland
Forecasting indicates the statistical analysis of the past and present activities to obtain a notion about the future pattern of activities. -Neter and Wasserman
Forecasting is a prediction and its aim is to calculate future events or movements. -Webster’s New Collegiate Dictionary.
Time Series Forecasting Definition
This is one of the most popular forms of forecasting that is based upon the sequence of observations and data taken sequentially in time.
Being an important area of machine learning, time series forecasting predicts future values based on previously observed values. Such forms of forecasting are widely used for non-stationary data such as like economic, stock price, weather, and retail sales.
After going through all these definitions of forecasting, let us now understand how the channelization of forecasting methods occurs-
How Forecasting Works?
Investors use forecasting as a method to decide if events affecting a business, events like sales expectations, might inflate or deflate the price of shares in that particular business.
Forecasting methods also act as an important benchmark for businesses that require a long-term perspective of operations via key historical data as well as non-stationary data.
Stock analysts use the tool of forecasting to extrapolate how trends, for instance, GDP or unemployment, might get altered in the coming financial quarter or year. Forecasting for a longer period decreases the chances of accurate forecasting as many uncertain events can occur.
At long last, Statisticians can use forecasting to analyze the likely impact of a change in business operations. For example, historical data may be collected for the impact of customer satisfaction by altering the business hours or changes in certain work conditions might alter the company’s overall productivity.
Forecasting methods address an issue or a set of data. Financial analysts make certain assumptions for the circumstances being analyzed that must be established before the forecasting factors are determined. Because of the items decided, a suitable historical data set is chosen and used in the delusion of information.
The historical data in these forecasting techniques are broken down, and the forecast is determined accordingly. In the end, a verification period takes place where the forecast is contrasted with the actual results to set up a more precise model for forecasting in the future.
Now the time has come to delve into different forecasting methods that help in making short term as well as l0ng term predictions of the future-
Different Forecasting Methods
Stock analysts utilize different forecasting methods to determine how a stock price will change in the upcoming time.
They take a look at income and compare that to the various economic indicators. Any changes to the financial or statistical data are minutely observed to decide the relationship between different variables. These relationships might be based on the passage of time or based on the development of certain events.
For example, a sales forecast might be based on the passage of time (the period of the upcoming 12 months) or the development of certain events (the purchase of a competitor’s business).
Businesses rely on two basic methods of forecasting. These two methods try to predict what is about to happen in the future; these two methods are Qualitative and Quantitative methods of forecasting.
1. Qualitative method of forecasting
It is also known as the judgmental method. This method, for the most part, delivers subjective results. It is because qualitative forecasts are generally borne out of personal judgments by experts or forecasters.
The qualitative forecast is more often than not biased as they are comprised of an expert’s knowledge, intuition, and experience. They are rarely based on data, which makes the process non-mathematical.
One example of such a way of forecasting that springs up to mind is when a person forecasts the Cricket World Cup finals’ outcome. It is, of course, based on personal motivation and interest. This method’s biggest weakness is its inaccuracy and the high rate of failure.
The rate of failure is high because the forecast is not based on previous data and facts. Rather they are based on personal emotions and motivations.
2. Quantitative method of forecasting
This one is quite the opposite when compared to its other counterpart. It is a mathematical process that makes it more consistent and objective. The quantitative method does not believe in basing the results on the opinions and intuition of an individual.
It instead uses a huge number of data and facts available in the past, and after analyzing these, it concludes. Hence, in this way, Quantitative forecasting is done.
For instance, forecasting models based on time series, discounting, analysis of indicators that might be leading or lagging, and economic modeling are all classic examples of the Quantitative method of forecasting.
How to choose the right Forecasting Technique
To choose the right forecasting technique, the individual need to keep the following points in mind:
1. Desired forecast form
The forecast form can be different depending upon the person. You can obtain a point estimate or a prediction interval. The form of the forecast influences the forecasting method that will be used.
2. Time Pattern
The time frame is the total period for which the forecast is required. As the forecast time frame increases, the accuracy decreases along with it. We can say that the forecast’s time frame and the accuracy of the forecast are inversely related to each other.
3. Cost of forecasting
The cost of forecasting will entirely depend upon the cost involved in the collection and storage of data. The forecast cost should be contrasted with the value of having an accurate forecast for the business. Forecasters always aim to keep the deviation as low as possible. The business benefits from this accurate forecasting.
4. Availability of data
The decision of going through with quantitative or qualitative method will completely depend upon how much previous data is available. If you have more data, then go for a quantitative method and then go for the qualitative method.
5. Case of operation and understanding
The analyst should understand the forecast methodology. There is a lurking danger that the analyst might not foresee the model’s parameter that needs to be changed because of underlying changes in the data.
Process of Forecasting
All the individuals who want to forecast need to follow the process listed below carefully. By strictly adhering to this process, individuals can get accurate results. Some of the steps are as follows:
1. Develop the basis of forecasting
To start forecasting, the first step is to develop the basis of the investigation of the business’s condition. The aim is also to identify the company’s current position in the market.
2. Estimate the business’s future operations
After you have investigated as asked in the first step of the forecasting process. The second part of forecasting needs you to estimate the industry’s future conditions that your business is set in. After you are done with the estimations, you need to project and analyze how your business will fare in the upcoming future for a certain period.
3. Regulate the forecast
In the third step of the forecasting process, you need to look at different forecasts that were made in the past. After that, you need to compare those forecasts with the actual results that took place in the business. The differences in previous results of the forecasting and the actual result are analyzed. Then, the reasons for those deviations are considered in today’s grand scheme of things. It is done to ensure that the current forecasting can be done with as little deviation as possible.
4. Review the process
All of the forecasting steps mentioned above are thoroughly checked repeatedly to ensure there are no minute details that have been missed in the process. If there are indeed some details missed, then the refinements and modifications are made accordingly to optimize forecasting.
Features of Forecasting
The following forecasting features can be identified in successful decision making via key historical data-
1. Concerned with future events
Forecasting is concerned with future events. It is a systematic effort put into predicting the future. It can also be essentially called a technique of anticipation.
2. Based on past and present data
Forecasting when following the Qualitative method is based on opinions, intuition, guesses. The Quantitative methods are based on facts, figures, time series, and other relevant data. All of the forecasting factors mentioned above contribute to making a forecast. To some extent, all of these factors reflect what happened with the company in the past and what is considered likely to happen in the future.
3. Consideration of relevant facts
The forecasting technique considers all the different factors that affect the business daily. This is a technique to catch hold of all the economic, social, and financial factors affecting the short term as well as long term business goals revolving around different time series. Facts are crucial for qualitative as well as quantitative forecasting.
4. Inference from known facts
Forecasting is a systematic process to know the future by taking inference from the known facts. These facts are the data and information regarding the business activities that have taken place in the past. Hence, it is the analysis of past and present movements to predict future results.
5. Use of forecasting techniques
Most businesses worldwide use the quantitative forecasting method. As the method uses scientific, mathematical, and statistical techniques, the chances of deviation are minimal. Businesses use quantitative forecasting methods for budgeting and planning.
6. Element of guesswork
Personal observations certainly help individuals guess future events to a large extent. All the estimates of the futures are based on guesswork somewhat. People must already know that, along with guesswork, you need to analyze past and present circumstances.
Business forecasting revolves around the process of predicting short-term as well as long-term future developments in business based on analysis of historical data and trends based on past and present.
You can also understand forecasting as the estimation of the value of a variable (or set of variables).
It can be your business and sales decision-making tool to optimize your budgeting, estimating, and planning future growth. How important do you consider forecasting for your business?