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# Lesson 6: Forecasting

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Watch this with a 10-15 minute audiotrack at http://vimeo.com/novusprogram/lesson6

This lesson will introduce the principles of forecasting, including gathering data, simple statistics, seasonal adjustments, common forecasting methods, and practical application.

The Novus project is a combination of video tutorials designed to be used in conjunction with a free business simulation software program. The Novus Business and IT Program contains 36 business and IT training videos, covering basic finance, accounting, marketing, economics, business strategy, Word, Excel, and PowerPoint. Users will have an opportunity to apply the lessons in the Novus Business Simulator. Over six rounds, the user or teams will have to make decisions on capital purchases, financing, production, financing, and human resources for a microbrewery. This channel has arranged the 36 video lessons into the order in which they are meant to be used with the simulator. To watch this slideshow as a video, please go to our Vimeo page at: https://vimeo.com/novusprogram. To download our free business simulation software, please go to our SourceForge page at: http://sourceforge.net/projects/novus/.

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### Lesson 6: Forecasting

1. 1. Forecasting Objective: To introduce the basic methods and uses of forecasting for small businesses.Novus Business and IT Training Program
2. 2. Forecasting• Essential for a Business• Usually Based on Historical Information• Gathering Data Very ImportantNovus Business and IT Training Program 1
3. 3. Gathering Data• Characteristics of Good Data: – Sufficient Quantity – Objective – Representative – ConsistentNovus Business and IT Training Program 2
4. 4. Measures of Average: The Mean• The Mean is the sum of all the observations, divided by the number of observations• For the data set {0, 0, 1, 1, 1, 2, 7}: Mean = (0+0+1+1+1+2+7)/7 = 12/7 = 1.7• Used for data sets with: – Strong central tendency – Few unusual itemsNovus Business and IT Training Program 3
5. 5. Measures of Average: The Median• The Median is the center-most observation in the data set• For the data set {0, 0, 1, 1, 1, 2, 7}: Median = 1• Used for data sets with: – Strong Central Tendency – Unusual ItemsNovus Business and IT Training Program 4
6. 6. Measures of Average: The Mode• The Mode is the most frequently occurring observation• For the data set {0, 0, 1, 1, 1, 2, 7}: Mode = 1• Used for data sets with: – Repeating observationsNovus Business and IT Training Program 5
7. 7. Measures of Distribution• Finding high and low estimates• Simple Method: Margin of Error – Based on experience or observation• Example: – Fancy Gift Company • Forecasted 2012 Sales = \$92,000 • Margin of Error = 10% 1. Find the Margin: \$92,000 x 10% = \$9,200 2. Add & Subtract the Margin from the Forecasted Sales: \$92,000 +/- \$9,200 = \$101,200 and \$82,800Novus Business and IT Training Program 6
8. 8. Seasonal Adjustment1. Find the Average Seasonal Sales Fancy Gift Company - Quarterly Sales - 2011 Q1 Q2 Q3 Q4 2011 Sales Revenue \$20,000 \$16,000 \$18,000 \$26,000• Average Seasonal Sales = (\$20,000 + \$16,000 + \$18,000 + \$26,000) / 4 = \$20,000 Novus Business and IT Training Program 7
9. 9. Seasonal Adjustment2. Divide Actual Quarterly Sales Amounts by Average Quarterly Sales – Q1 = \$20,000 / \$20,000 = 1.0 – Q2 = \$16,000 / \$20,000 = 0.8 – Q3 = \$18,000 / \$20,000 = 0.9 – Q4 = \$26,000 / \$20,000 = 1.3 Fancy Gift Company - Quarterly Sales - 2011 Q1 Q2 Q3 Q4 2011 Sales Revenue \$20,000 \$16,000 \$18,000 \$26,000 Seasonal Adjustment 1.0 0.8 0.9 1.3 Ratio Novus Business and IT Training Program 8
10. 10. Seasonal Adjustment3. Find the Average Seasonal Sales for the Forecast – Fancy Gift Company 2012 Sales Forecast: \$92,000 – 2012 Average Seasonal Sales: \$92,000 / 4 = \$23,000Novus Business and IT Training Program 9
11. 11. Seasonal Adjustment4. Multiply the forecasted average seasonal sales by the seasonal adjustment ratios – Q1 = 1.0 x \$23,000 = \$23,000 – Q2 = 0.8 x \$23,000 = \$18,400 – Q3 = 0.9 x \$23,000 = \$20,700 – Q4 = 1.3 x \$23,000 = \$29,900• Note: \$23,000 + \$18,400 + \$20,700 + \$29,900 = \$92,000Novus Business and IT Training Program 10
12. 12. Forecasting Method 1: Delta Analysis• Analyze Period-to-Period Changes Fancy Gift Company - Historical Annual Sales Year Sales Delta 2007 \$70,000 - 2008 \$72,500 \$2,500 2009 \$75,000 \$2,500 2010 \$77,000 \$2,000 2011 \$80,000 \$3,000 Average \$2,500 2012 Sales Forecast \$82,500Novus Business and IT Training Program 11
13. 13. Forecasting Method 2: Moving Average• Analyze Selected Years: 3-Year Moving Average Fancy Gift Company - Historical Annual Sales Year Sales Delta 2007 \$70,000 - 2008 \$72,500 \$2,500 2009 \$75,000 \$2,500 2010 \$77,000 \$2,000 2011 \$80,000 \$3,000 Average \$2,500 2012 Sales Forecast \$82,500Novus Business and IT Training Program 12
14. 14. Forecasting Method 3: Weighted Moving Average• Analyze Selected Years: 3-Year Weighted Moving Average• Weight each year differently – Weights must sum to 100% Fancy Gift Company - Historical Annual Sales Year Sales Delta Weight Adjusted Delta 2007 \$70,000 - - 2008 \$72,500 \$2,500 - 2009 \$75,000 \$2,500 20% \$500 2010 \$77,000 \$2,000 30% \$600 2011 \$80,000 \$3,000 50% \$1,500 Weighted Average \$2,600 2012 Sales Forecast \$82,600Novus Business and IT Training Program 13
15. 15. Forecasting Method 4: Common Size Analysis• Analyze financial statement items as proportions – Automatically calculate several useful financial ratios – Easily identify trends• To Common Size an Income Statement… Divide everything by Total Revenue• To Common Size a Balance Sheet… Divide everything by Total AssetsNovus Business and IT Training Program 14
16. 16. Forecasting Method 4: Common Size Analysis Fancy GiftCompany - Income Statement 2011 Sales \$80,000 100.0% Cost of Goods Sold \$28,800 36.0% Gross Income \$51,200 64.0% Sales, General & Administrative \$9,600 12.0% Other Operating Expenses \$4,000 5.0% Total Operating Expenses \$13,600 17.0% Operating Income \$37,600 47.0% Taxes \$7,896 9.9% Net Income \$29,704 37.1%Novus Business and IT Training Program 15
17. 17. Forecasting Method 4: Common Size Analysis Fancy Gift Company – Common Sized Income Statements 2011 2010 2009Sales \$80,000 100.0% \$77,000 100.0% \$75,000 100.0% Cost of Goods Sold \$28,800 36.0% \$28,490 37.0% \$28,500 38.0%Gross Income \$51,200 64.0% \$48,510 63.0% \$46,500 62.0%Sales, General & \$9,600 12.0% \$9,240 12.0% \$9,000 12.0%AdministrativeOther Operating Expenses \$4,000 5.0% \$2,310 3.0% \$750 1.0%Total Operating Expenses \$13,600 17.0% \$11,550 15.0% \$9,750 13.0%Operating Income \$37,600 47.0% \$36,960 48.0% \$36,750 49.0%Taxes \$7,896 9.9% \$7,762 10.1% \$7,718 10.3%Net Income \$29,704 37.1% \$29,198 37.9% \$29,033 38.7% Novus Business and IT Training Program 16
18. 18. Forecasting Method 4: Common Size Analysis Fancy Gift Company – Forecasted 2012 Income Statement 2012 Sales \$92,000 100.0% Cost of Goods Sold \$32,200 35.0% Gross Income \$59,800 65.0% Sales, General & Administrative \$11,040 12.0% Other Operating Expenses \$6,440 7.0% Total Operating Expenses \$17,480 19.0% Operating Income \$42,320 46.0% Taxes \$8,887 9.7% Net Income \$33,433 36.3%Novus Business and IT Training Program 17
19. 19. Practical Application• Statistics and methods provide a starting point – Use experience and research to improve your forecasts – Refine your models over time – Use high and low estimates to help you plan for best and worst casesNovus Business and IT Training Program 18
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