The Importance of Forecasting in Business
Forecasting is the art and science of predicting future events. Forecasting may involve taking historical data (such as past sales) and projecting them into the future with a mathematical model. It may be a subjective or an intuitive prediction (e.g., “this is a great new product and will sell 20% more than the old one”).
Every day, managers makes decisions without knowing what will happen in the future. They order inventory without knowing what sales will be, purchase new equipment despite uncertainty about demand for products, and make investments without knowing what profits will be.
Managers are always trying to make better estimates of what will happen in the future in the face of uncertainty. Making good estimates is the main purpose of forecasting.
Our purpose is to show that there are many ways for managers to forecast. We also provide an overview of business sales forecasting and describe how to prepare, monitor, and judge the accuracy of a forecast. Good forecasts are an essential part of efficient service and manufacturing operations.
It may be based on demand-driven data, such as customer plans to purchase, and projecting them into the future. Or the forecast may involve a combination of these, that is, a mathematical model adjusted by a manager’s good judgment.
Forecasts may be influenced by a product’s position in its life cycle whether sales are in an introduction, growth, maturity, or decline stage. Other products can be influenced by the demand for a related product for example, navigation systems may track with new car sales.
Because there are limits to what can be expected from forecasts, we develop error measures. Preparing and monitoring forecasts can also be costly and time consuming.
Few businesses, however, can afford to avoid the process of forecasting by just waiting to see what happens and then taking their chances. Effective planning in both the short run and long run depends on a forecast of demand for the company’s products.
Forecasting Time Horizons
A forecast is usually classified by the future time horizon that it covers. Time horizons fall into three categories:
Short-range forecast: This forecast has a time span of up to 1 year but is generally less than 3 months. It is used for planning purchasing, job scheduling, workforce levels, job assignments, and production levels.
Medium-range forecast: A medium-range, or intermediate, forecast generally spans from 3 months to 3 years. It is useful in sales planning, production planning and budgeting, cash budgeting, and analysis of various operating plans.
Long-range forecast: Generally 3 years or more in time span, long-range forecasts are used in planning for new products, capital expenditures, facility location or expansion, and research and development.
Types of Forecasts
Organizations use three major types of forecasts in planning future operations:
Economic forecasts address the business cycle by predicting inflation rates, money supplies, housing starts, and other planning indicators.
Technological forecasts are concerned with rates of technological progress, which can result in the birth of exciting new products, requiring new plants and equipment.
Demand forecasts are projections of demand for a company’s products or services.
Forecasts drive decisions, so managers need immediate and accurate information about real demand. They need demand-driven forecasts , where the focus is on rapidly identifying and tracking customer desires.
These forecasts may use recent point-of-sale (POS) data, retailer-generated reports of customer preferences, and any other information that will help to forecast with the most current data possible.
Demand-driven forecasts drive a company’s production, capacity, and scheduling systems and serve as inputs to financial, marketing, and personnel planning.
In addition, the payoff in reduced inventory and obsolescence can be huge.
Economic and technological forecasting are specialized techniques that may fall outside the role of the operations manager.