Business Forecasting - Definition, Why it is Important

Tally Solutions |Updated on: July 4, 2022

What is Business Forecasting?

Every business’ prime motive is to make profits. Revenue generation is the only way a business can retain its position in the market, and it can be achieved through careful planning, analysis and quick decision-making techniques. Business forecasting is a method to predict the future, where it is narrowly defined by economic conditions. It combines information gathered from past circumstances with an accurate picture of the present economy to predict future conditions for a business. To operate efficiently, businesses need a concrete plan on achieving both their long-term and short-term goals.

What is the need for Business Forecasting?

Business forecasting can help multiple functions for crucial decision making. Eg: Forecasts also help to understand customer engagement and therefore shape marketing efforts.

Since forecasts estimate an expected sales volume over a specified period of time, salespeople can use them to set their activity goals, and subsequent adjustments can be made to reach sales goals
Marketers can use forecasts to gauge the effectiveness of their campaigns, decide which markets to enter and exit, and determine the life cycle of their products
Senior managers and finance teams use forecasts to prepare and evaluate financial plans, capitalize on production, and assess needs and logistics. A forecast can help inform critical decisions on how to allocate resources and set overhead levels within a business: personnel, rent, utilities, and other overhead

Questions That Businesses Must Ask for Accurate Forecasting

Since forecasting is something that can be predicted based on the analysis and data fetched from past and current scenarios, assumptions become an obvious part of the process. However, to mitigate incorrect assumptions and be more accurate in your judgement about the future, you need to ask some relevant questions:

Changes to the market: How much will the market grow? What other competitors exist that might affect market share?
Customer behaviour: Get an idea of how many customers are gained and lost each year, whether there are certain periods of greater sales fluctuation (e.g., seasonality), and the average customer sales, along with their variance
Resources: Businesses also need to be aware of how much they may be required to grow and the limitations, as well as how much to spend in advertising and what is driving or hurting sales

Once you have found answers to these questions, it’s time to set up an accurate forecasting method, which is suitable for your business. There are primarily three general methods: Qualitative, Quantitative and Causal models.

Qualitative Approach

This method is generally used when a business/product/service is new. This technique gains its insights using expert opinions and well-informed judgements that are logical, systematic, and unbiased in their estimations, which are then quantified. As the name implies, they are not as rigorous generally as quantitative methods.

Quantitative Approach

This approach relies on historical or “time-series” data, so it is more often used when the product or service has been existing in the market since sometime. New businesses or businesses with new products might not be able to use this method. The forecast is analysed by recognising patterns, trends, and changes in the data using this mathematical technique.

Casual Modelling

Causal modelling, is considered as the most sophisticated of the three forecasting tools, identifies the relevant causal relationships. This process considers everything that influences sales, even employing some time series analysis, and restricts the number of assumptions. In case assumptions are made, they are monitored throughout the modelling to ensure their validity, and the model is constantly filtered as and when more information is available.

Post choosing the relevant forecasting method, the final step you should perform is checking the results of the approach you’ve taken to predict the state of your business. Verifying the model performance will help you draw conclusion of how well the methodology that you’ve applied to assess the future of your company is working out for you. Thus, you can then take actionable steps accordingly and plan to climb up the business ladder successfully.

Business forecasting techniques

Business forecasting is the method of using the existing trends and patterns in the industry and the company to make projections of expected future trends and developments. This enables the management of a company to be better prepared by allocating resources and planning projects and related costs according to the projections. Existing data about the industry and the company’s business are a gold mine of information that needs proper analysis to yield the best insights into the possible future trends. A company that gets its business forecasting right will have a headstart on the rest of the competition. Fact-based decision-making is less risky than making decisions based on feelings and emotions.

Quantitative techniques in business forecasting

A quantitative analysis is based on actual numbers and data. It is easy to do this analysis when you have reliable data for your industry and your company. Good software tools help you analyze this data and extract insights that help you make better forecasts and forecast-based decisions. The past sales data of your company is a valuable resource that you can use for business forecasting. Some of the forecasting models used are:

● Indicator: Certain indicators such as the country’s GDP and employment rates make a huge impact on the spending capacity of the average citizen. These indicators are one of the important base factors for qualitative analysis.

● Average: When the company presumes that the future will be a reflection of the past they can use the past data to create inferences and forecasts for the future directly.

● Econometric modeling: This is a strictly mathematical modeling method for forecasting that assumes that the relationships between the indicators stay the same. This method instead tests the strength and consistency of the relationship between the datasets.

● Time-series methods: This is a method that closely tracks the happenings of the past and uses them to predict the future as accurately as possible.

Qualitative techniques in business forecasting

Not all the factors that go into forecasting are measurable quantities. When there is insufficient data to make an accurate quantitative forecast, we can use the qualitative methods. These methods use the opinion of experts in the industry, judgment, customer opinions and other such inputs to make a forecast of the future. These methods work better in the short term rather than the long term. Since they are not data-based, they are less reliable than the qualitative methods. Some examples of these methods are:

Market research: This is the method that collects the opinions of a varied target sample size and forms an analysis based on their choices, opinions and feedback.

Delphi method: This is the method that questions experts in the industry or field for their detailed opinion in order to make forecasts.

How do you choose the right business forecasting technique?

There are many different factors that influence the choice of business forecasting method: Some of them are:

● Data availability: you can choose to do a quantitative analysis only if you have enough high-quality data

● Context: Certain aspects of forecasting are quantitative, while others are qualitative

● Time frame: A quantitative analysis with software tools is very quick when time is short

● Required accuracy: Quantitative analysis is more accurate than qualitative

● Costing: The company would have to choose the option that is the most cost-effective for them

● Analysis period: Qualitative analysis works well in the short term

● Business size: The quantity of data to be analyzed depends on the size of the business. Software tools like TallyPrime make it easy to perform quantitative analysis for both small and large companies

Why is business forecasting important?

The market that a business operates in is not always constant. The business that is best prepared for situations will perform better than the competition. Business forecasting gives a business the advantage of being able to predict the coming trends so that they can change and adapt their business strategies to match. A combination of quantitative analysis, qualitative analysis, statistics, objectivity and econometric models helps the business to get reliable projections and estimates.

Managers can strategize with more confidence when they use data-backed business forecasting tools that give them more reliable and accurate results. Forecasting works best when it incorporates the company’s data as well as the other industry factors. Business forecasting brings logic and data into business strategy and decision-making.

What are the integral elements of business forecasting?

There are different approaches and methods that are used for business forecasting. The most common ones are:

● Set the stage: First, assess and analyze your business now

● Specify the required answer: Frame the question that you need an answer to very specifically. A well-formed question makes the rest of the analysis easier

● Choose indicators and data sets: Identify the data that is relevant to your question or collect the required data

● Make initial assumptions: Sometimes, making assumptions that you then validate against the data makes the process easier

● Select forecasting technique: Select the appropriate business forecasting technique that you will use

● Analyze data: Analyze the selected data set with the selected forecasting technique

● Estimate forecasts: Generate data-backed estimates or conclusions

● Verify forecasts: Compare the result to the assumptions that you made. Any difference will help you identify where you are making mistakes

● Review forecasting process: After the actual event has happened, go back to the analysis and review if it was correct. Try to improve on the techniques used to make better predictions the next time

FAQ:

What do you mean by business forecasting?

Business forecasting is the usage of business tools to create projections and forecasts that help a business strategize and make business plans.

What are the business forecasting methods?

The two main business forecasting methods are quantitative and qualitative analysis.

What are the three types of forecasting?

The three types of business forecasting are: