What are Forecasting Methods?
Forecasting is estimating the magnitude of uncertain future events and provide different results with different assumptions. Top forecasting methods includes Qualitative Forecasting (Delphi Method, Market Survey, Executive Opinion, Sales Force Composite) and Quantitative Forecasting (Time Series and Associative Models). Not all methods would necessarily serve the purpose of forecasting, the decision-makers should understand what type is best suited for the business.
Top 6 Methods of Forecasting
Forecasting methods can be broadly classified into:
- Qualitative Methods – These methods are based on emotions, intuitions, judgments, personal experiences, and opinions. This means that there is no math involved in qualitative forecasting methods. Delphi MethodDelphi MethodThe Delphi method is a forecasting framework wherein the main objective is to arrive at a group consensus and fill up questionnaires by chosen experts. Next, the expert group opines their views on an initiator or facilitator, summarizing the gathered information into an understandable report., Market Survey, Executive Opinion, SalesForce Composite are part of this type of forecasting.
- Quantitative Methods – These methods depend wholly on mathematical or quantitative models. The outcome of this method relies entirely on mathematical calculations. Time Series and Associative Models are a part of this type of forecasting.
#1 – Delphi Method
The agreement of a group of experts in consensus is required to conclude in the Delphi method. This method involves a discussion between experts on a given problem or situation. An argument or brainstorming is done to complete that everyone involved in the debate agrees to.
#2 – Market Survey
In a market survey, interviews and surveys of customers are made to understand the ask of the customer and tap the trend well in advance to deliver the right product or service according to the changing needs of the customer.
#3 – Executive Opinion
As the name suggests, the executives or managers are involved in such forecasting. This method is very similar to the Delphi method; however, the only difference here is that the executives may or may not be experts of the matter in question, albeit they have the experience to understand the problem or situation and formulate a forecasting method that would bring out the best possible result.
#4 – Sales Force Composite
The information and intuition of the salesperson determine the needs of the customer and estimate the sales in the particular region or area assigned to the salesperson. This information is vital in forecasting the needs of the customer, which can be used to make necessary changes in the business to meet the needs of the customer and identify the sales volumes beforehand.
#5 – Time Series Models
Time series models look at historical data and identify patterns in the past data to arrive at a point in the future based on these historical values. Since the historical data has a pattern, it becomes evident that the data in the future should also have a pattern, and this method looks at cracking the pattern in the future so that there is very little deviance from the actual calculations and the outcomes in the real world. Below is the example of a time series model
Example – Straight Line Method
One of the simplest methods in forecasting is the Straight Line Method; This uses historical data and trends to predict future revenue.
ABC Ltd. looks to achieve a YoY growth of 6% for the next three years. In a straight-line method, the first step is to find the growth rateFind The Growth RateThe Growth rate formula is used to calculate the annual growth of the company for a particular period. It is computed by subtracting the prior value from the current value and dividing the result by the prior value. of sales used in our calculation. For 2019, the growth rate is 6%, as per historical data.
Example – Moving Averages Method
Moving averagesMoving AveragesMoving Average (MA), commonly used in capital markets, can be defined as a succession of mean that is derived from a successive period of numbers or values and the same would be calculated continually as the new data is available. This can be lagging or trend-following indicator as this would be based on previous numbers. are averages that move with the underlying data, thereby providing accurate information relevant to the current scenario. In the below example, the Sales generated for the year 2019 for ABC Ltd are represented. The moving averages for Bi-Monthly, Quarterly, and Half-yearly are calculated below. The excel shows the formulae used to arrive at the moving averages.
#6 – Associative Models
Associative models look at the variable that is being forecasted as being related to other variables in the system, which means each variable is associated with the other variable in the system. The forecast projections are made based on these associations.
Forecasting enables a business to take the necessary steps to achieve a particular goal by providing vital information regarding future events and its occurrence and magnitude. Forecasting can be either Qualitative or Quantitative, depending on the information gathered and its nature, usually subjective or objective, and as a result, is based on mathematical calculations or no mathematical calculations at all. The management decides on the best forecasting method to be used according to the business. It is based on internal and external factors and whether the external factors are controllable or uncontrollable. Uncontrollable factors can be government policies, competitors’ strategies, natural calamities, and so on. Quantitative forecasting uses mathematical models to arrive at the forecasting results, and it also relies on historical data to back the findings. Qualitative forecasting uses emotions, intuition, past experiences, and values. It is an essential procedure in business that enhances business operations and ensures the functions can be performed smoothly in the ever-changing business environment.
This has been a guide to what are Forecasting Methods. Here we discuss the top six types of forecasting methods along with examples and explanations. You can learn more about financial modeling and forecasting from the following articles –