LESSON TITLE: FORECASTING Course Code: Financial Management

What is Forecasting?
 a projection of future sales, revenues, earnings, costs, and other possible
variables that are helpful in the firm's operations*
 primary objective is to reduce the risk or uncertainty that the firm will face in
making decisions
 the starting point of business planning
*(Brigham and Houston, 2011)
Who uses forecasting as a tool for decision-making?
Top Management Makes use of the forecast as a tool for long-
range planning,
particularly in providing a basis for
performance targets, implementing
long-range strategic objectives, and making
capital budgeting
decisions
Production Utilizes the forecasts to determine the
Manager number of raw materials that
will be needed in production, the budget,
schedule of production
activities, inventory levels to maintain so as
not to disrupt the
production, labor hours, and the schedule of
shipments
Purchasing Uses the forecast to ascertain the volume or
Manager bulk of materials that
should be purchased for a particular period
Marketing Manager Makes use of the forecast to estimate how
much sales should be
made in a particular period, and to plan
promotional and advertising
activities for the products
 Finance Manager Uses the forecast to anticipate the funding
needed by the firm

Human Resource Utilizes the forecast to supply the human

Manager resource needed in
achieving the firm’s objectives

FORECASTING APPROACHES
 In general, there are two approaches to forecasting: qualitative and quantitative
(Shim et al., 2006).
Qualitative (or judgment) forecasts.
 Incorporate factors such as the decision maker’s intuition, emotion, personal
experiences, and value system; useful in formulating short-term forecasts.

Qualitative Forecasting Methods

Expert Opinions The views of the managers or a group

with a high level of
expertise, often in a combination with
statistical models, are
synthesized to generate a consensual
forecast.
Delphi Method Similar to the expert opinion except
that member of a group of
experts are asked individually through
a questionnaire about
their forecast of future events
Useful for long-range forecasting and
the results are not by the
group or by strong leadership
Sales Force Polling Every salesperson estimates the sales
in his or her region; the
The responsibility for drawing up the
forecast lies with the people
who will actually work for the
forecasted value; simple and,
 practical
Consumer Market Firms, at times, conduct their own or
Surveys potential customer
surveys to accumulate information
regarding future purchasing
plans. Surveys can help not only in
preparing a forecast but
also, in improving product design,
planning for new products,
and determining consumer behavior.
PERT-derived Program Evaluation and Review
Forecasts Technique methodology
requires that the expert provide three
estimates: pessimistic (a),
the most likely (m), and optimistic (b).
the theory suggests that
these estimates combine to form an
expected value, or
forecast, as follows:
EV = (a + 4m + b)/6
with a standard deviation of
ơ = (b – a)/6 where
EV = expected value (mean) of the
forecast
Ơ = standard deviation of the forecast
It is often easier and more realistic to
ask the expert to give
optimistic, pessimistic, and most likely
estimates than a specific
forecast value
includes measure of dispersion (the
standard deviation), which
makes it possible to develop
probabilistic statements regarding
the forecast