Business Forecasting
Business
forecasting refers to the analysis of past and present economic conditions with
the object of drawing inferences about probable future business conditions. The
process of making definite estimates of future course of events is referred to
as forecasting and the figure or statements obtained from the process is known
as ‘forecast’ future course of events is rarely known. In order to be assured
of coming course of events, help is taken of an organised system of
forecasting. The following are two aspects of scientific business forecasting.
a)
Analysis of past economic conditions: For this purpose, the components of
active series are to be studied. The secular trend will show how the series has
been moving in the past and what its future course is likely to be over a long
period. The cyclic fluctuations would reveal whether the business activity is
subjected to boom or depression. The seasonal fluctuations would indicate the
seasonal changes in the business activity.
b)
Analysis of present economic conditions: The object of analysing present
economic conditions is to study those factors which affect the sequential
changes expected on the basis of the past conditions. Such factors are new
inventions, changes in fashion, changes in economic and political spheres,
economic and monetary policies of the Government, war. These factors may affect
and alter the duration of trade cycle. Therefore it is essential to keep in
mind the present economic conditions since they have an important bearing on
the probable future tendency.
Objectives of
forecasting in business: Forecasting is a part of human
conduct. Businessmen also need to look to the future. Success in business
depends on correct predictions. In fact when a man enters business, he
automatically takes with it the responsibility for attempting to forecast the
future.
To a very large extent, his success or
failure would depend upon the ability to successfully forecast the future
course of events. Without some element of continuity between past, present and
future, there would be little possibility of successful prediction. But history
is not likely to repeat itself and we would hardly expect economic conditions
next year or over the next ten years to follow a clear cut prediction. Yet,
frequently past patterns prevail sufficiently to justify using the past as a
basis for predicting the future.
A businessman cannot afford to base
his decisions on guesses. Forecasting helps a businessman in reducing the areas
of uncertainty that surround management decision making with respect to costs,
sales, production, profits, capital investment, pricing, expansion of
production, extension of credit, development of markets, increase of
inventories and curtailment of loans. These decisions cannot be made off-hand.
They are to be based on present indications of future conditions.
However, we should know that it is
impossible to forecast the future precisely. There is a possibility of
occurrence of some range of error in the forecast. Statistical forecasts are
the methods in which we can use the mathematical theory of probability to
measure the risks of errors in predictions.
Characteristics of
business forecasting
a)
Based
on past and present conditions: Business forecasting is based on past and present economic condition
of the business. To forecast the future, various data, information and facts
concerning to economic condition of business for past and present are analysed.
b)
Based
on mathematical and statistical methods: The process of forecasting includes the use of statistical and
mathematical methods. By using these methods, the actual trend which may take
place in future can be forecasted.
c)
Period:
The forecasting
can be made for long term, short term, medium term or any specific period.
d)
Estimation
of future: The
business forecasting is to forecast the future regarding probable economic
conditions.
e)
Scope:
The forecasting
can be physical as well as financial.
Steps in forecasting
The forecasting of business
fluctuations consists of the following steps:
a)
Understanding
why changes in the past have occurred: One of the basic principles of statistical forecasting is that the
forecaster should use the data on past performance. The current rate and
changes in the rate constitute the basis of forecasting. Once they are known,
various mathematical techniques can develop projections from them. If an
attempt is made to forecast business fluctuations without understanding why
past changes have taken place, the forecast will be purely mechanical.
b)
Determining
which phases of business activity must be measured: After understanding the reasons of
occurrence of business fluctuations, it is necessary to measure certain phases
of business activity in order to predict what changes will probably follow the
present level of activity.
c)
Selecting
and compiling data to be used as measuring devices: There is an independent relationship
between the selection of statistical data and determination of why business
fluctuations occur. Statistical data cannot be collected and analysed in an
intelligent manner unless there is a sufficient understanding of business
fluctuations. It is important that reasons for business fluctuations be stated
in such a manner that is possible to secure data that are related to the
reasons.
d)
Analysing
the data: Lastly, the data
are analysed in the light of understanding of the reason why change occurs. For
example, if it is reasoned that a certain combination of forces will result in
a given change, the statistical part of the problem is to measure these forces,
from the data available, to draw conclusions on the future course of action.
The methods of drawing conclusions may be called forecasting techniques.
Methods of Business
Forecasting: The following are the main methods of
business forecasting.
a)
Business
barometers
b)
Time
series analysis
c)
Extrapolation
d)
Regression
analysis
e)
Modern
econometric methods
f)
Exponential
smoothing method
Business barometers: Business indices are constructed to study and analyse the business
activities on the basis of which future conditions are predetermined. As
business indices are the indicators of future conditions, so they are also
known as “business barometers” or ‘economic barometers’. With the help of these
business barometers the trend of fluctuations in business conditions are made
known and by forecasting a decision can be taken relating to the problem.
The
construction of business barometer consists of gross national product,
wholesale prices, consumer prices, industrial production, stock prices, bank
deposits. These quantities may be converted into relatives on a certain base.
The relatives so obtained may be weighted and their average is computed. The
index thus arrived at in the business barometer.
Merits and demerits of business
barometers method
Merits
|
Demerits
|
The business barometer method is
scientific and reliable and used by management for the purpose of various
business decisions at different levels.
|
It is very difficult to construct
indices of business activities.
|
Business barometer method helps in
proper forecasting of future trends of a business.
|
In most of the cases, the business
barometers provide inaccurate, incomplete and inconclusive forecasting due to
index numbers prepared on the basis of incorrect and inadequate data.
|
The business barometers are the
indicators of future business trends and help to forecast the speed of
fluctuations.
|
The business barometers are the
indicators of past conditions and the forecasting based on these conditions
may be erroneous.
|
This method helps to find solutions
of various business problems such as development of market, capital
investment, exploration of new consumer market and so on.
|
Separate indices are calculated for
individual industry and firm which are entirely different from general
indices.
|
Time series analysis: Time series analysis is also used for
the purpose of making business forecasting. The forecasting through time series
analysis is possible only when the business data of various years are available
which reflects a definite trend and seasonal variation. By time series analysis
the long term trend, secular trend, seasonal and cyclical variations are
ascertained, analysed and separated from the data of various years.
Merits and demerits of time series
analysis
Merits
|
Demerits
|
It is an easy method of forecasting.
|
This method is expensive, difficult
and time taking.
|
By this method a comparative study
of variations can be made.
|
This method deals with past data
only.
|
Reliable results of forecasting are
obtained as this method is based on mathematical model.
|
This method can only be used when
the data for several years are available.
|
Extrapolation: Extrapolation is the simplest method
of business forecasting. By extrapolation, a businessman finds out the possible
trend of demand of his goods and also about the future price trends. The
accuracy of extrapolation depends on two factors:
i) Knowledge about the fluctuations of
the figures
ii) Knowledge about the course of
events relating to the problem under consideration
Thus, there are two assumptions on
which extrapolations are based:
i) There is no sudden jumps in figures
from one period to another
ii) There is regularity in
fluctuations and the rise and fall is uniform
In extrapolation, we assume that the
variable will follow the established pattern of growth. For the purpose of
business forecasting, it is to determine accurately the appropriate trend curve
and the values of its parameters.
Merits and demerits of extrapolation
method
Merits
|
Demerits
|
This method is very useful to
forecast the future demand and production.
|
This method can be used under its
own assumptions only.
|
This method is widely used for the
forecasting of business events because it is a simple method.
|
This method is not simple but
technical, because of its mathematical formulation.
|
We get pure and reliable results by
this method, because it is a mathematical method.
|
The selection of trend curve is very
difficult.
|
Regression analysis: Refer to
Regression analysis chapter
Modern econometric methods: Econometric techniques, which
originated in the eighteenth century, have recently gained in popularity for
forecasting. The term ‘econometrics’ refers to the application of mathematical
economic theories and statistical procedures to economic data in order to
verify economic theorems. Models take the form of a set of simultaneous
equations. The values of the constants in such equations are supplied by a
study of statistical time series, and a large number of equations may be
necessary to produce an adequate model.
At the present time, most short-term
forecasting uses only statistical methods with little qualitative information.
However, in the years to come when most large companies develop and refine
econometric models of their major business, this tool of forecasting will
become more popular.
Merits and demerits of modern
econometric methods
Merits
|
Demerits
|
Accurate and reliable results are
obtained under this method.
|
This method is difficult and
complicated.
|
It is a scientific method where
computer technology is used.
|
This method can be used only when
adequate series of data is available.
|
This method explains in detail and
in quantitative terms the way in which various aspects of the economy are
interrelated.
|
It is very difficult to construct
growth model for every business activity.
|
Theories of Business
Forecasting
There are a few theories that are
followed while making business forecasts. Some of them are:
a. Sequence or time-lag theory
b. Action and reaction theory
c. Economic rhythm theory
d. Specific historical analogy
e. Cross-cut analysis theory
Sequence or time-lag theory: This is the most important theory of business forecasting. It is
based on the assumption that most of the business data have the lag and lead
relationships, that is, changes in business are successive and not
simultaneous. There is time-lag between different movements. The table 13.5
lists the merits and demerits of sequence or time-lag theory.
Merits and demerits of sequence or
time-lag theory
Merits
|
Demerits
|
This method is largely used for
business forecasting because of the accuracy.
|
This method studies only the action
not the reaction.
|
Though this theory is based on
statistical techniques, yet it is easy to understand.
|
This method cannot be regarded as
accurate because by using statistical techniques the results can be up to the
truth but not an accurate one.
|
Time-interval between two events can
be ascertained.
|
|
Government can use this technique
for the purpose of economic stability of the economy by exercising control
over possible losses.
|
|
Action and reaction theory: This theory is based on the following
two assumptions.
Every action has a reaction
Magnitude of the original action
influences the reaction
Thus, if the price of rice has gone up
above a certain level in a certain period, there is a likelihood that after
some time it will go down below the normal level. Thus, according to this
theory a certain level of business activity is normal or abnormal; conditions
cannot remain so for ever. Thus, we find four phases of a business cycle. They
are:
i. Prosperity
ii. Decline
iii. Depression
iv. Improvement
Merits and demerits of action and
reaction theory
Merits
|
Demerits
|
This is better than other theories.
|
The determination of normal level is
very difficult.
|
By this theory more reliable results
can be obtained because this theory gives attention to action and reaction of
an event.
|
It is not necessary that reaction is
equal to the action.
|
Economic rhythm theory: The basic assumption of this theory is
that history repeats itself and hence assumes that all economic and business events
behave in a rhythmic order.
According
to this theory, the speed and time of all business cycles are more or less the
same and by using statistical and mathematical methods, a trend is obtained
which will represent a long term tendency of growth or decline. It is done on
the basis of the assumption that the trend line denotes the normal growth or
decline of business events.
Merits and demerits of economic rhythm
theory
Merits
|
Demerits
|
Forecasting is made on the basis of
past conditions, hence they are more reliable.
|
The business events are not strictly
periodic and prediction of business cycle on the basis of statistical method
is not satisfactory.
|
This method is helpful in long-term
forecasting.
|
Past conditions are given more
weightage than the present conditions.
|
Specific historical analogy: History repeats itself is the main
foundation of this theory. If conditions are the same, whatever happened in the
past under a set of circumstances is likely to happen in future also. A time
series relating to the data in question is thoroughly scrutinised and from it
such period is selected in which conditions were similar to those prevailing at
the time of making the forecast but it is largely dependent on past data. The
table 13.8 lists the merits and demerits of specific historical analogy.
Merits and demerits of specific
historical analogy
Merits
|
Demerits
|
It is an easy method.
|
In this theory, the forecasting is
based on guess work, not on a scientific method because the past and present
conditions are rarely found to be similar.
|
As the future is forecasted on the
basis of past business conditions, the forecasting is more reliable.
|
It is very difficult to select the
past period with the same business conditions like present.
|
Advantages of business forecasting
a)
Helpful
in increasing profit and reducing losses: Every business is carried out with the
purpose of earning maximum profits, so by forecasting the future price of the
product and its demand the businessman can predetermine the production cost,
production and the level of stock to be determined. Thus, business forecasting
is regarded as the key of success of business.
b)
Helpful
in taking management decisions: Business forecasting provides the basis for management decisions,
because in present times the management has to take the decision in the
atmosphere of uncertainties. Also, the business forecasting explains the future
conditions and enables the management to select the best alternative.
c)
Useful
to administration: On
the basis of forecasting, the government can control the circulation of money.
It can also modify the economic, fiscal and monetary policies to avoid the
adverse effects of trade cycles. So, with the help of forecasting, the
government can control the expected fluctuations in future.
d)
Basis
for capital market: The
business forecasting helps in estimating the requirement of capital, position
of stock exchange and the nature of investors.
e)
Useful
in controlling the business cycles: The trade cycles cause various depressions in business such as sudden
change in price level, increase in the risk of business, increase in
unemployment and so on. By adopting a systematic business forecasting, the
businessman and government can handle and control the depression of trade
cycles.
f)
Helpful
in achieving the goals: The
business forecasting helps to achieve the objective of business goals through
proper planning of business improvement activities.
g)
Facilitates
control: By business
forecasting, the tendency of black marketing, speculation, uneconomic
activities and corruption can be controlled.
Limitations of business forecasting: The business forecasting cannot be
accurate due to various limitations which are mentioned below.
a.
The
forecasting cannot be accurate, because it is largely based on future events and
there is no guarantee that they will happen.
b.
The
business forecasting is generally made by using statistical and mathematical
methods. But the use of these methods cannot claim to be able to make uncertain
future certain.
c.
The
underlying assumptions of business forecasting cannot be satisfied
simultaneously. In such a case, the results of forecasting will be misleading.
d.
The
forecasting cannot guarantee the elimination of errors and mistakes. The
managerial decision will be wrong if the forecasting is done in a wrong way.
e.
Factors
responsible for economic changes are often difficult to discover and to
measure. Hence, business forecasting becomes an unnecessary exercise.
f.
The
business forecasting does not evaluate risks.
g.
The
forecasting is made on the basis of past information and data and relies on the
assumption that economic events are repeated under the same conditions. But
there may be circumstances where these conditions are not repeated.
h.
Forecasting
is not a continuous process. In order to be effective, it requires continuous
attention.