13 Business Forecasting Methods for Better Strategies: Know How to Use Your Data
Business forecasting refers to the group of methods used to predict business developments. Find out how to increase your efficiency with these 13 methods.
- What is Business Forecasting?
- Seven Quantitative Business Forecasting Methods
- Six Qualitative Business Forecasting Methods
What is Business Forecasting?
Business forecasting refers to the set of methods and techniques used to determine and predict future business developments. These include sales numbers, expenditures, and profit margins. Business forecasting is a crucial practice that represents an integral part of any well-functioning organisation, regardless of its nature or volume.
The practice of business forecasting rests on what is essentially an investigation. Your business will inevitably face some problems, and forecasting examines these issues and tries to determine their root causes. The goal is to eventually modify particular business operations according to a prediction of better performance.
The name of the game is data analysis. Whether quantitative or qualitative, the data that’s acquired and collected throughout the company’s activities ideally means something. Data analysis is the process of extracting meaning from your raw data in a way that helps you improve your future operations.
Business forecasting techniques can be split into two general categories: quantitative and qualitative. Both are valuable and critical for a company’s functioning and general management.
“Forecasting is the essence of management. The success of a business greatly depends upon the efficient forecasting and preparing for future events.” - Henri Fayol (Source: Economic Discussions)
Seven Quantitative Business Forecasting Methods
1. Trend Analysis
Trend analysis refers to the observation of recent and current trend data and the subsequent prediction of future trend movements based on this data. This method relies on the assumption that past trends can indicate what might happen in the future.
One of the most well-known and widely used types of trend analysis is what’s called failure analysis, whereby early indicators of potential problems are spotted and subsequently avoided.
Using trend analysis, you could also forecast or anticipate your future sales growth, market trends, interest rates, and inventory levels based on data you already have. This is incredibly useful because it is the basis for all of your business decisions and can determine whether you grow, stay stagnant, or fail. Generally, trend analyses can be done at three different time horizons: short-, mid-, and long-term.
2. Regression Analysis
As a general definition, regression analysis measures the correlation between an independent variable and a dependent variable. In other words, its goal is to predict the direction of a relationship between an intervention and an existing, “background” state - for example, the effect of a two-week-long targeted ad campaign on the company’s sales.
This allows you to carry out an actual experiment to observe how your audience responds to a new marketing, advertising, or branding strategy. This is especially useful if you’re just starting out or if your business is undergoing major changes in terms of your visual identity, your inventory, your commitments… The list goes on.
Extrapolation is a general term that refers to using past trends to predict future occurrences based on the assumption of trend constancy. This means that when you extrapolate, you take for granted that a trend that has been ongoing, most likely over a long period, will continue to go in the same direction.
Extrapolation is therefore a sort of fundamental presupposition businesses have to make at certain points. Once you establish a marketing strategy that works or you discern a market trend that doesn’t seem to be affected by acute events, for example, your best bet generally is to assume it will take the same direction for the foreseeable future. Extrapolation is therefore typically a long-term strategy.
4. Business Barometers
This method involves observing economic indicators and using them to determine the potential direction of trends. The concept was created based on the way meteorologists forecast weather conditions based on the movement of mercury in a barometer.
Typically, economic indicators are classified into several time series for the analysts to study them and predict future trends. These time series are the following:
- Leading series
This is a series whose indicators move in either direction ahead of other series. In other words, leading indicators predict a change in other series. Examples of leading indicators are corporate profit after tax, change in inventory values, and the net business investment index.
- Lagging series
The lagging series is considered to be the inverse of the leading series. Lagging indicators follow a particular change in trends after a time lag. This means that following the change in a related variable, lagging indicators change in turn. Examples of lagging indicators are labour cost per unit production and lending rates for loans.
- Coincidental series
The coincidental series is a series whose indicators move according to the movement of general economic activities. Coincidental indicators include elements such as the unemployment rate in a given country, gross domestic product, and the number of employees in a given sector.
5. Econometric Model
An econometric model of forecasting refers to a model whose entire set of equations is able to correctly predict changes in the values of its variables. The process of econometrics typically goes as follows:
- Stating the hypothesis
- Determining the mathematical model
- Determining the model’s framework
- Collecting data and evidence
- Estimating the model’s parameters
- Testing the hypothesis
- Making predictions
6. Input-Output Model
The input-output model of economics is meant to represent a picture of the current state of the market. This means it includes factors such as the transactions and general flow between institutions and industries in a country or region, and it uses these factors to create an accurate image of the economy in that region.
The purpose is to eventually be able to predict certain changes in different sectors of the economy including the different behaviours of consumers, government entities, and foreign suppliers.
7. Input-Output Analysis
Input-Output (I-O) analysis refers to statistical macroeconomic analysis that takes place as part of a forecasting process based on the input-output model. It is conducted based on the interdependencies that exist between different industries of the economy.
I-O analysis is typically used to predict the short- or long-term impact of instances of economic shocks, such as a significant increase in unemployment rates, on the overall state of the economy. The instance of shock can also be a beneficial one such as a steep decline in the number of individuals living below the poverty line.
I-O analysis’s goal is to predict the influence of such changes on the existing interdependencies between sectors, industries and institutions in a given country or region.
Six Qualitative Business Forecasting Methods
As the name indicates, brainstorming is the effort carried out by a group of people to come up with a set of ideas. The goal of brainstorming in forecasting is to predict changes in the market or anticipate fluctuations within a company’s transactions as a result of past and current trends.
This is based on the supposition that a group of experts in the field will come up with more informed, generally better ideas compared to any single individual working alone. Demand rates, sales numbers, or profit margins can then be forecasted based on these ideas.
2. Direct vs. Indirect Forecasting
When it comes to cash flow forecasting, there are two distinct methods you could use. The goal of direct cash flow forecasting is to predict the exact dates at which money will be coming in and going out of the company. Conversely, indirect cash flow forecasting uses accounting information to predict business growth in the longer term.
Generally speaking, the indirect method is simpler to adopt and thus more widely used - especially in large companies that have a high volume of transactions taking place regularly. This is because it is less time-consuming and more useful for making long-term forecasts. However, it’s good to keep in mind that this method can yield somewhat inaccurate results over the short term.
Smaller companies may find they benefit more from the direct method as they can be focusing on shorter-term predictions and have the time to make exact predictions. The direct method can generate accurate forecasts - however, the accuracy of predictions tends to decrease the more long-term the forecasts are. It becomes more difficult for a company to record every single transaction over time, especially when it experiences rapid or exponential growth.
3. Market Research
One qualitative method of forecasting involves analysing the data that comes up in your market research. By definition, forecasting is the use of gathered data to anticipate future movements in trends. When you use market research to determine the direction of these trends, you are focusing on changes in your specific market or sector.
This is an extremely valuable tool, especially for your company’s marketing team. It goes without saying that to be able to advertise your product properly and successfully communicate with your target audience, you should constantly be aware of the current state of the market.
Depending on your industry, different sectors of the economy tend to have different trends. This fluctuation also depends on several other factors such as social events, the economic landscape of your country or region, the bigger global picture…
Market research consists of polling a group of people, typically your target audience, on how they would react if a product or service is launched. This includes information about whether they would respond positively to it, whether they will buy it, what its use will be to them, etc.
Market research is an excellent way to get a comprehensive, all-encompassing view of how your sector is and has been behaving. Analysing the data you get from market research allows you to predict future changes and adjust your marketing and advertising strategies accordingly.
4. Internal Forecast
Internal forecasting simply means using an accumulation of previous forecasts within a given company’s own sales channels to predict the company’s future sales rates and trends.
As part of an overarching, more complete forecasting process, internal forecasting is useful because it allows you to establish patterns within your company and determine what needs to be improved and implemented to increase sales.
5. SalesForce Composite Method
SalesForce composite forecasting is a method used in companies that make sales throughout several territories or countries. Each sales agent makes a regional sales forecast, and the regional factors are then aggregated to create an overall sales forecast for the entire company.
For businesses with sales activity taking place over several regions and in several countries, composite forecasting is effective and can provide a detailed view of the company’s success in each of its bases.
It is also an effective tool for the sales and accounting teams to visualise what may be lacking in their overall strategy and adjust their operations based on other factors such as the differential states of the market in each country.
6. Past Performance
This method is self-explanatory: you look at the company’s past performance to predict future trends in your sales, expenditures, and other elements.
As qualitative forecasting methods often overlap, this can be part of a brainstorming process amongst experts of different specialities. It is also a necessary part of either a direct or an indirect forecasting method. In general, forecasting involves evaluating the company’s own past sales performance and basing predictions on that data.
Business forecasting is an incredibly powerful tool for any business, big or small, regardless of its volume of transactions. As we’ve seen, there are many different methods of forecasting - and the choice depends entirely on the nature of your company, your overall goals, your market, and your preferences.
It is advisable to make use of both quantitative and qualitative methods of forecasting, as they offer different results and are both equally valuable for the success of your business. While quantitative methods aim to provide detailed, reliable, and precise predictions, don’t underestimate the power of a simple brainstorming session in the presence of individuals who are experts in their respective fields. Forecasting ideally takes a holistic approach that combines both strict statistical analysis and the creative exchange of ideas.