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“Forecasting can be broadly defined as a method or technique for estimating future aspects (of which there are many) of a business or an operation. ”

Forecasting - An Ongiong Process

There are numerous techniques and methodologies that can be applied to accomplish the goal of forecasting. The techniques and methodologies applied are usually informed by the type of organisation as well as the area of forecasting required.

Planning for the future is a critical aspect of managing any organisation and the long-term success of any organisation is closely aligned to how well the management of the organisation is able to predict its future and develop appropriate strategies to deal with possible future developments. Poor forecasts or estimates have proven to lead to poor planning, which results in increased and/or additional costs to the organisation.

All forecasting methods can be divided into two broad categories which are qualitative or quantitative in nature. Visit www.accountancysa.org.za for more information.

Time series
Time series comprises of four main components: a trend component, a cyclical component, a seasonal component and irregular components.

A trend emerges in a time series due to one or more long-term factors changing such as changes in the population size, changes in the demographic characteristics of the population or changes in tastes or preferences of consumers. The cyclical component is the recurring sequence of points above and below the trend line that lasts more than a year, and the seasonal component is similar to the cyclical component in that they both refer to fluctuations in a time series. However, the seasonal component captures the pattern of variability within one year. The irregular component represents the residual left in an observation of the time series once the effects due to trend, cyclical and seasonal are removed.

Strategic forecasting
Strategic forecasting approaches must consider a wide range of variables, some of which include market segmentation, demand drivers and the product life cycle. A closer view of these three aspects is considered below.

Market segmentation

There has been an increasing recognition that consumer markets are not homogeneous and can be segmented according to a number of dimensions, one of which is demographics. The approach to market segmentation is mainly based on user needs, affordability and the approach towards a specific product or service.

Market segmentation is a critical part of strategic forecasting due to the fact that the analysis of demand drivers is usually done for each identified segment. Each segment's demand is evaluated both quantitatively and qualitatively which provides insights to creating strategies for reaching specific segments. It provides sufficient information about the assumptions applied in the forecasting that are specific to that segment which can be tested to identify weaknesses in assumptions and/or data specifically applicable to that segment.

Demand drivers

When considering the demand drivers in a strategic forecast, one needs to consider the inherent product or service characteristics and if there are possible substitutions, the forces beyond the control of the manufacturer or service provider, as well as the velocity drivers.

Product life cycle

Identifying where products are along the product life cycle provides management with important strategic insights, such as when and how to invest.

A strategic forecasting approach provides a rational and methodical way to project the demand of a product or service and contributes to the enhancement of decision making. It needs to be an ongoing process as part of the strategic planning of an organisation, since consumer needs, the affordability of the product or service and the approach towards a specific product or service, as well as competitors, change over time.

There are certain limitations to forecasts and several strategic forecasting paradoxes that managers should bear in mind, which include:

the most important managerial decisions an organisation can make are based on the least accurate forecasts; or
the most useful forecast information for strategic planning is the least accurate; or
the organisations that need the most accurate forecast have the largest forecast error.

Forecasting considering the economic outlook
Any forecasting approach must consider the economic outlook of the country and the industry it operates within, as these impact directly on various components of forecasting. In considering the current economic environment, an important consideration is that inflation and interest rates are at historic lows and the prospects for 2011 are positive. The expected GDP growth for 2011 is estimated at 3,4% as indicated by the Minister of Finance during his budget speech on 23 February 2011.

The improved outlook stems mainly from a more optimistic projection of household consumption expenditure. While the consumer price inflation (CPI) remained well within the Reserve Bank's 3% to 6% target band during 2010, it is expected to rise close to 6% in the second half of 2011, due to higher fuel and food prices.

The impact of higher household consumption expenditure, fuel and food prices are important considerations for forecasting in 2011 and beyond.

References:
Reference for Business, Encyclopaedia of Business, 2nd ed.
Journal of business strategy by Barbara Cohen

Karyna Pierce CA(SA) is Executive: Finance at the Government Employees Medical Scheme.

You can earn verifiable CPD points from this article – visit the Click2start Website to get your free verifiable points and click here for the manual on how to answer Accountancy SA CPD questions.