What if you could know the twists and turns of the stock market before they happened? What if you could preempt the demands of the economy before they manifested? With business forecasting you use data and savvy analysis to create your own business crystal ball, enabling you to build long-term business strategies.
Today we’re giving you a quick introduction to the world of business forecasting, including types of business forecasting, issues you may face, and the forecasting methods you should use for your business.
What is business forecasting?
Business forecasting is predicting the economic future—along with how your business will respond.
Using past economic data and careful analysis of current economic conditions, business forecasting attempts to predict what will happen next for your business or industry. This type of analysis can allow businesses to prepare for shifts in the market or a change in demand. Business forecasting may change the investment and saving strategies of businesses and individuals, as well as affect the timing of new offerings.
The business forecasting process typically involves: collecting primary and secondary sources of data, analyzing the datasets, creating strategies for projections, and finally, comparing your forecasting model to the realized outcomes.
Why should you forecast for your business?
It may seem like forecasting is a lot of work for an unpredictable, possibly nonexistent payout. But there are several solid reasons that you should be regularly using forecasting to benefit your business.
Benefits of business forecasting:
- Better grasp on in-house data and business performance
- Competitive advantage
- Setting and enforcing effective budgets
- Faster response to cyclical or seasonal changes
- Ability to identify larger patterns and relationships
- To assist in long-term strategy and goal-setting
What are the common types of business forecasts?
There are a lot of ways to estimate data and scenarios for your company, so you’ll need to get specific about what you wish to know. The answers you seek will determine the type of business forecast you’ll create. Each forecast can be perfectly tailored to your needs, but here’s a quick run down of the most common types of business forecasts you’re likely to use.
General business forecast
A general business forecast is a prediction of the universal economic climate, including political factors, income, and community social factors. A general business forecast can give you a holistic view of the hypothetical future environment in which you’re doing business.
Financial forecasting is the general term for analyzing and predicting the finances of a business, including future revenue, operating costs, capital needs, and more.
Accounting forecasting is zeroing in on cost for your business, predicting future costs, when they’ll be incurred, and how to prepare for them now.
Demand is the need or desire for a good or service, and estimating future demand can help businesses prepare to meet that demand. Demand forecasting is focusing on what customers will need in the future, how much they’ll need, and what they’ll be willing to pay for it through demand planning and your supply chain.
A sales forecast goes hand-in-hand with a demand forecast, as it estimates sales for a future period based on demand. Using the data of your demand forecast, you can predict your future sales and prepare your resources.
Capital forecasting helps predict the amount of working capital your business might enjoy. A capital forecast is based on current and future assets and liabilities, as well as predictions for liquid capital and cash flow estimates.
What are different business forecasting methods?
Business forecasting methods fall into two main categories: qualitative and quantitative. These methods are the specific steps you take to construct the future data you wish to use.
For example, you may need a demand forecast for the coming year so you might use qualitative market research combined with the quantitative naive approach to estimate the future demand for your business. Let’s dive into some of the methods your business can use.
A qualitative forecasting method is based primarily on the best judgment and opinions of knowledgeable industry observers. While a qualitative forecast does involve some data, it relies on expert opinion rather than extensive data projections.
Qualitative forecasting is especially helpful in industries where there have been recent disruptions that make the future vary distinctly from past practices (i.e. new laws, major innovation). It can also be used when you have insufficient historical data to reproduce meaningful predictions.
Qualitative forecasting methods
The Delphi method is a forecasting technique in which a panel of experts is selected to give their opinions on the specific economic situation, then is asked for their predictions and analysis, independently of the other experts.
Market research or market survey forecasting has been used for generations, and involves speaking to potential customers to determine their likelihood to buy or participate in a particular economic target. For example, driving-age adults might be given a brief questionnaire to determine how likely they are to purchase a vehicle in the next five years.
Quantitative forecasting is a complex accumulation of data searching for significant connections and patterns that may predict future outcomes. The data used in the quantitative method of forecasting can include sales and growth data from your business, demographic information from a census or survey, or any other relevant data which is available.
When cause-effect relationships are discovered (or suspected) your business can leverage the variables for maximum benefit.
Quantitative forecasting methods
Time series analysis
In this quantitative business forecasting method, the past predicts the future through the use of averages, determining patterns, and extrapolating data.
Causal relationships are important in an economic climate, so forecasting how different factors might interact can help businesses better prepare. Causal forecasting can help you determine how elements like price, sales, availability, production costs, and locations might impact future sales.
This approach operates on the assumption that future values will equal the average of all past values. It’s frequently used when you need to predict an unknown value, such as sales of a particular product for a given month. A good starting point for your forecast would be to average the sales of that product over the past year and use that mean for the unknown value.
The naive approach uses the last available data to predict the next set of unknown variables. Rather than comparing your December 2020 to December 2019, you’d use November 2020 numbers to predict December 2020. This approach assumes that what’s happening now is more relevant than what has happened in the past.
What are common issues with business forecasting?
There’s really only one issue with business forecasting—it’s just an educated guess. It’s impossible to accurately predict the future. If 2020 has taught us anything, it’s that our very best guesses can be completely derailed by any variety of factors.
Beyond this obvious issue, there are a few others that can make your forecasting less accurate and helpful.
- Bad data: Your forecasting is only as good as the data you use. If you’re using overly simplistic, out-of-date, incorrect, or incomplete data then you are dealing with poor forecast accuracy.
- Lack of flexibility: A good business forecast must always allow for unexpected changes or events. This may include adding a cushion, or conducting multiple scenarios as you build out your forecasting process.
- Excessive optimism: It’s tempting to skew your data and predictions to project the best possible future for your business. Unfortunately it can spell disaster and disappointment for your future when your business is unable to hit your optimistic numbers.
- Forecast and forget: Once you’ve analyzed data and predicted outcomes, you have to continue to use those predictions in order to learn from them. Compare your forecast to the actual outcomes in order to see where you were correct, where you were incorrect, and how you can better tweak your forecasting methods.
No matter the quality of data you use or the sophistication of your forecasting software, you’re simply trying to get as close to the future outcome as you can while acknowledging that you’ll never know for sure. We recommend that you use a variety of business forecasting methods for your business, and use each one with a grain of salt. Never make dramatic or irreversible moves based on fallible business forecast predictions.
Divvy provides cutting edge technology to help you use the best possible data for all of your business forecasting, budgeting, and expense management needs. Start now with a Divvy demo.