Best Practice of the week: 6.3.3 Forecasting

Every management decision, plan, and process is based on a forecast, often someone’s faulty hunch.  Forecasting accuracy reduces risk, so educated guesses about the future are better than pure intuition. In volatile times, risk reduction can be the top concern. Fortunately, there are established techniques that reduce costly and embarrassing forecast errors.

Definition of forecasting: “Anticipating the cash and capital needed to prepare for risks and opportunities in sales, operations and investments.”

Practice Summary

Management applications

  • Strategic planning and decision-making
  • Finance:  accounting, budgeting and cost control
  • Marketing: consumer behavior, life cycle management, pricing
  • Operations and supply chain:  resource planning, production, logistics, inventory

Input data forecasting methods

  • Quantitative: time series (trends), use of indicators, econometric modeling
  • Qualitative:  expert opinions solicited by marketing research, polls, Delphi method surveys

Financial projection statements, up to 5 years

  • Pro forma (estimated) income statement
  • Estimated balance sheet:  project assets needed for growth and liabilities to pay for them
  • Projected cash flow:  seasonal cycles, capital and operating financing, debt repayment
  • Projected cash reserves, based on risk-level

Key forecasted inputs

  • Sales (also see “Basic Sales Forecasting” at term 1 Market Research)
  • Direct and indirect costs
  • Interest rates
  • Major initiatives and asset purchases
  • Employment levels

3 Good Questions (discuss in a management meeting)

  1. What types of trends should we track?
  2. How volatile will our future be?
  3. We will be prepared to fulfill our aspirations?

Because everybody’s long-term economic outlook is now in doubt, quantitative techniques using historical data are less reliable. However, qualitative techniques that poll your organization’s accumulated knowledge usually produce better short-term projections than fancy econometric models.