Introduction to Forecasting

Every business enterprise interested in planning its activities must have clear idea about the demand for its product .Important business planning decisions, including the strategies to be followed, the amount of capital that is likely to be necessary, labor requirement and skills, the necessary distribution and after-sale service networks, sales incentives, sourcing of raw material, etc. are all critically dependent on the perception of the demand of its product. If this perception is substantially faulty, most of these decisions of the enterpriser likely to prove to be erroneous and lead to avoidable losses. A reasonably correct estimate of demand on the other hand can prove to be the key for a successful venture.

Every organization invariably engages in annual planning exercise. The heads of various functional areas such as marketing, production, materials and finance take part in this exercise with specific objectives. The marketing function provides data on sales that the organization should target in coming year. This is primarily achieved through forecasting. Based on this inputs, the production function prepares an annual production plan and projects various requirements on the basis of this plan. The material function prepares a procurement plan to match the requirements projected by the production function. Finally, on the basis of all these, the finance function undertakes cash planning and funds management. Therefore, forecasting plays a vital role in every organization

What is Demand Forecasting?

The formulation of appropriate and useful production policy is an important aspect for an enterprise. This involves determination of level of production, manpower requirements equipment and inventory level etc. All these decisions are basically related to the size of production which in turn can be determined from potential demand of the product. Thus, the starting point of decision related to production strategy is the product demand forecast for a specified period. To know what a business should perform we must know its future Sales. In the absence of this information , both short and long term planning will rest on the foundation which is much less substantial than sand. A poor job of demand forecasting will lead to an ineffective production planning and towards an inventory that is either too large or too small.

In a literal sense forecasting means prediction. Forecasting may be defined as a technique of translating past experience in the prediction of things to come. It tries to evaluate the magnitude and significance of forces that will affect future operating conditions in an enterprise.

In the words of Garfield, “Production is an integral part of any of any scientific generalization that holds the relationship between two or more factors. The generalization must hold not only with respect to past observations related to the same phenomenon but also for all future observations related to the same phenomenon. Production is even more organically related to these that those generalization which establish a definite time sequence in the occurrence of certain factors; Due to dynamic nature of market phenomenon demand forecasting has become a continuous process and requires regular monitoring of the situation. Demand forecasts are first approximations to production planning. These provide foundation s upon which plans may rest and adjustments may be made.

“Demand forecast is an estimate of sales in monetary or physical units for a specified future period under a proposed business plan or program or under assumed set of economic and other environmental forces, planning premises outside the business organization for which the forecast estimate is made.”

Sales forecast is an estimate based on some past information, the prevailing situation and prospect of future. It is based on an effective system and is valid only to some specified period. The following are some main components of a sales forecasting system:

  • Market Research Operations to get the relevant and reliable information about the trends in the market
  • A data processing and analyzing system to estimate and evaluate the sales performance in the various markets
  • Proper co-ordination of steps (i) and (ii) and then to place the findings before the top Management for making final decisions

Why do we forecast? Since forecasting activity typically precedes a planning process one can identify specific reasons for the use of forecasting in organizations. Organizations face a different set of issues while they engage in planning and in each of these, forecasting plays an important role as a tool for planning process. The key areas of application of forecasting are summarized below:

  • Dynamic and complex environment: Only if an organization has complete control over market forces and knows exactly what the sale of its products is going to be in the future is there no role for forecasting.
  • Short term fluctuation in production: A good forecasting system will be able to predict the occurrence of short fluctuations in demand. Therefore, from this knowledge, organizations can avoid knee-jerk reactions to the unfolding reality. Production planning decisions could utilize this information and develop plans that minimize the cost of adjusting the production system for short term fluctuations.
  • Better material management: Since the impending events in an organization are predicted through a forecasting system, organizations can benefit from better material management and ensure better resource availability.
  • Rationalized man-power decisions: A forecasting system provides useful information on the nature of resources required, their timing and magnitude.

Therefore, organizations could minimize hiring and lying off decisions. Moreover, better planning on overtime and idle time could also be done based on this information

  • Basis for planning and scheduling: With proper forecasting, planning and scheduling activities can be done on a rational basis.
  • Strategic decisions: Forecasting plays an important role in long term strategic decision making. This includes planning for product line decisions

Importance of Forecasting

Production and distribution are two main activities of a business enterprise. Demand forecasts tries to maintain a balance between production and distribution policies of the enterprise. With decentralization of functions and increase in the size of the organizations, forecasting of demand is of great value for proper control and co-ordination of various activities.

An efficient demand forecast helps the management to take suitable decisions regarding plant capacity, raw material requirements space and building needs and availability of labor and capital. Production schedules can be prepared in conformity with demand requirements minimizing inventory, production and other related costs.

Demand forecasting also helps evaluating the performance of the sales department. Thus, demand forecasting is a necessary and effective tool in the hands of management of an enterprise to have finished goods of right quality and quantity at right time with minimum cost.

Steps in Forecasting: The following are the main steps in demand forecasting;

  • Determine the objective of forecast,
  • Select the period over which the forecast is to be made,
  • Select the technique to be used for forecasting,
  • Collect the information to be used,
  • Make the forecast.

Techniques of forecasting

Implicit in forecasting is that there exist a pattern in the past demand data which can be extrapolated or generalized for the future with the desired measure of certainty. The demand pattern though regular is found to be stable in statistical sense. Since the only input to the forecasting system is the past history of the demand of an item, no direct information concerning the market, the industry, the economy, the sale of competition and complementary products, products price changes, advertising campaigns and so on is used. Forecasting methods involve construction of suitable mathematical relationship to describe the appropriate demand pattern. Management experts have developed many forecasting techniques to help managers to handle the increasing complexity in management decision making it is tricky and experimental process. No one method of forecasting can be applied to all enterprises. In many cases the decisions are based on a combination of several, if not all of these approaches. Final forecast generally include the contributions of many men of varied experience. The use of particular method depends upon the nature of the enterprise, the products manufactured, information system in use.

Elements of Forecasting: Forecasting consists basically of analysis of the following elements;

 Internal factors:  

  • Past
  • Present
  • Proposed or future

 External Factors:

  • Controllable: (a) Past (b) Present (c) Future
  • Non controllable: (a)Past (b) Present (c) Future

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