What is forecasting?

Forecasting is the process of predicting the future based on the past and the present data and circumstances. In other words, forecasting is the act of making a detailed analysis of future events based on the decisions made in the past as well as the present. Forecasting plays a very important role in operational management as it helps in planning and decision-making. It is not only important for the success of a business but also contributes to individual growth and success. Many business organizations or companies have failed due to the shortcomings of their forecasting.

The process of forecasting includes activities such as the collection, pre-processing, and preliminary analysis of data. It also includes a selection of the model of forecasting, model fitting, and diagnostic checking. Moreover, forecasting helps functional level managers in revealing the system dynamics, determining problems, monitoring, and their preventions.

Forecasting in different areas

Forecasting can simply be described as a process that produces the data and information required by companies in a systematic approach and process for managerial decisions. It is used in different areas such as forecasting costs, market shares, sales, inventory, cash flows, dividends, stock prices, interest rates, inflation rates, and growth rates of the economy.

Managers and other decision-makers make decisions based on true cases, assumptions, data, and information. This is why the decision-makers of business organizations must have true, reliable, and up-to-date data and information.

Forecasting is an integral part of the processes of planning and decision-making. Hence, the production managers must be clear about the horizon of forecasts. There are three ranges of forecasts based on the time horizon. They are:

• Short-range forecast
• Medium-range forecast
• Long-range forecast

Short-range forecast

These forecasts exist for a very short time - usually, less than three months. However, the duration might extend up to one year. They are used in the planning and the purchasing of job schedules, job assignments, workforce levels, and product levels. The importance of short-range forecasts is given below:

• It helps ascertain the level of inventory for a particular product that should be carried out next month.
• It gives information on how much of each product should be scheduled for production in the coming week.
• It determines the number of raw materials that should be ordered.
• It helps in the preparation of the schedule of the workers - if they should be scheduled to work overtime or not.
• It helps to determine the number of maintenance workers that should be scheduled to work next week.

Medium-range forecast

Medium-range forecasts have a period between one to three years. They are mainly used for planning sales, production, and different types of budgets such as cash budgets.

The importance of medium-range forecasts is as given below:

• It helps determine the budget of a marketing/ promotional campaign.
• It helps to plan the expenditure for the manufacturing of a product.
• It gives the estimate of revenue before the preparation of financial statements

Long-range forecast

This forecast is made for a very long period and has a period of more than three years. It is used for installing and designing new plants and facilities, analyzing location feasibilities, total capital expenditures, and research and development costs.

The importance of long-range forecasts are:

• It helps to select a product design. The final design is dependent on the expected sales volume. If the demand is high, the design should be such that the product can be mass-produced in a short period. This ensures low costs of production and manufacturing.
• It helps to select the schemes for production processing.
• It determines the supply chain for scarce materials.
• It helps select a long-range production capacity plan.

Medium and Long-range forecasts deal with more comprehensive and long-term issues. They support management decisions regarding the design and development of new products, plants, and processes.

Methods of forecasting

Qualitative method

Qualitative methods do not use any mathematical model or tools in forecasting. They are used when historical evidence is unavailable. These methods are subjective, and mainly include consumer and expert opinions regarding a product. They are mainly used to make medium and long-term range forecasting decisions.

Qualitative methods are of the following:

• Delphi Method
• Market Survey
• Executive opinion
• Salesforce composite

Quantitative method

Quantitative methods are used to forecast with the help of leveraging past numerical data. In this method, the information is quantified. It is mainly used for a short-range forecast which involves mathematical models and tools.

Quantitative methods are of the following:

• Time series models
• Associative models

Average method

In this method, all the future values are predicted to be equal to the arithmetic mean of the previous data.

Naïve method

In this method, data related to the previous month is used for the current period forecast. No changes are made to this data. This method is usually used for time series analysis.

Context and Applications

This concept is important in various professional exams at graduate and post-graduate levels. It is an important part of certain management courses and training programs. In corporate industries, forecasting is done regularly to set up and adhere to the plans.

• Masters in Data Science
• Masters in Machine Learning

Practice Problems

1. Which of the following is not a component of the quantitative method of forecasting?

1. Time series model
2. Associative models
3. Delphi model
4. Moving average

Answer: Option c

Explanation: Quantitative methods are used to forecast with the help of leveraging past numerical data. The Delphi model is a qualitative method that does not use any mathematical model or tools in forecasting.

2. Which of the following is not considered a forecasting technique?

1. Time series
2. Time horizon
3. Associative
4. Judgmental

Answer: Option b

Explanation: Time horizon is the range of forecasting which includes short-term, medium-term, and long-term ranges.

3. In which of the following methods data related to the previous month is used for the current period forecast?

1. Qualitative forecast
2. Quantitative forecast
3. Average method forecast
4. Naïve method forecast

Answer: Option d

Explanation: In the Naïve method, data related to the previous month is used for the current period forecast. No changes are made to this data. This method is usually used for time series analysis.

4. Which of the following statements is not true about forecasts?

1. Short-range forecasts are used in the planning and the purchasing of job schedules, job assignments, workforce levels, and product levels.
2. Short-range forecasts support management decisions regarding the design and development of new products, plants, and processes.
3. Medium-range forecasts are mainly used for planning sales, production, and different types of budgets such as cash budgets.
4. None of the above

Answer: Option b

Explanation: Medium and Long-range forecasts deal with more comprehensive and long-term issues. They support management decisions regarding the design and development of new products, plants, and processes.

5. Who are the users of forecasting?

1. Operational managers and production department
2. Research and development department
3. Human resources and finance department
4. All of the above

Answer: Option d

Explanation: All the above-mentioned people and departments use forecasting. It acts as a driving force and impacts their decisions. Forecasting helps functional level managers in revealing the system dynamics, determining problems, monitoring, and their prevention.

Related Concepts

• Data analysis
• Data science
• Regression analysis