2. Forecasting
Forecasts are the financial documents that are used to update the operating
budget of an organization.
Forecasts are flexible and provide the possibilities open to the management
to carry out modifications in the operating budget during the operating cycle.
This permits the management to take into consideration changes caused by
the economic and market conditions as well as adapting to current trends.
Forecasts are used to update the budget so that it reflects current business
levels and conditions.
Forecasting involves using current information and combining this
information with established ratios and formulas to estimate or project future
business levels and operations. Forecasting is the key management tool
used to plan the details of the daily operations in the very short term such as
tomorrow, next week or next month
3. Forecasting
Generally, four types of historical patterns can be recognized: seasonal,
cyclical, trend, and random variations.
1. The seasonal pattern
2. The cyclical pattern
3. The trend pattern
4. Random variations
4. Forecasting
The seasonal pattern
The seasonal pattern exists when the series of data fluctuates in a
regular direction according to a particular period. This period could be
within a day (lunch as opposed to dinners); during the week (week days
as opposed to weekends); during the month (weekly variations within the
month caused for example by the spending patterns of the inhabitants of
the area in relation to their income flows); as well as the year (high
season as opposed to low season). Management should be able to
factor in such seasonal variations in their forecasts.
The cyclical pattern
The cyclical pattern results from the recurring and fluctuating levels of
activity that a business or economy will experience over a long period of
time. The five stages of the business cycle are growth, peak, recession,
trough and recovery. Due to their irregularity, frequency, magnitude and
duration variations it is much more difficult to make forecasts based on
the cyclical pattern. When plotted on a graph, it is similar to the seasonal
pattern except for the length of the pattern.
5. Forecasting
The trend pattern
The trend is the overall projection of the long-term forecast of the activity that
is being analyzed. Trends represent the general movement of a market or of
an activity. This movement is either upwards or downwards. In general, it is
best to move with the trends. This means that if the trend is upward, then
forecasts should reflect that upward tendency and also caution should be
exercised about making forecasts in situations where the trend is downward.
Trends can vary in length from short, to intermediate, to long term.
Random variations
Historical data are also affected by random variations. Random variation
simply indicates the absence of any pattern in the historical data. Statistical
tools such as random factor analysis are normally used to try and understand
if the outlying data is caused by an underlying trend or just simply a random
event. If the random data is caused by an underlying trend, that trend will
need to be addressed and remedied accordingly.