How to forecast smarter
Forecasting key business metrics can help reduce excess inventory and other overhead, offer competitive prices, and keep your business on solid financial footing. These key business metrics include sales demand, receivables, payables, and working capital.
Historical financial statements are often the starting point for forecasts. Still, you’ll need to do more than only multiply last year’s numbers by a projected growth rate, especially in today’s uncertain marketplace. To help determine the suitable forecasting methods for your business, ask yourself these five questions.
1. How far into the future do you plan business forecasting?
Forecasting is generally more accurate in the short term — the longer the time, the more likely it is that customer demand or market trends will change. Whilequantitativemethods, which rely on historical data, are typically the most accurate forecasting methods, they don’t work well for long-term predictions. If you’re planning to forecast over several years, tryqualitativeforecasting methods, which rely on expert opinions instead of company-specific data.
2. How steady is your demand?
Weather, sales promotions, safety concerns, and other factors can cause sales to fluctuate. For example, if you sell ski supplies and apparel, the chances are good that your sales will dip in the summer.
If demand for your products varies, consider forecasting with a quantitative method. For instance, time-series decomposition examines historical data. It allows you to adjust for market trends, seasonal trends, and business cycles. You also may want to adopt forecasting software. That will enable you to plug other variables into the equation, such as individual customers’ short-term buying plans.
3. How much data do you have?
Quantitative forecasting techniques require varying amounts of historical information. For instance, you’ll need about three years of data to use exponential smoothing. This simple yet reasonably accurate method compares historical averages with current demand.
You might use qualitative forecasting for something you don’t have data for, such as a new product. Alternatively, you could base your forecast on historical data for a similar product in your lineup.
4. Do you carry inventory?
Suppose you stock standard inventory items for customers to purchase rather than working on custom orders. In that case, forecasting is critical for establishing proper inventory levels and improving cash flow. For peak accuracy, take the average of multiple forecasting methods. For example, consider forecasting demand by individual products and geographic location. That is, to optimize inventory levels.
5. How many products do you sell?
If you’re forecasting demand for a wide variety of products, consider a relatively simple technique, such as exponential smoothing. On the other hand, suppose you offer only one or two essential products. In that case, it’s probably worth your time and effort to perform a more complex forecasting method for each one, such as a statistical regression model.
Bonus! 6. What’s right for your forecasting your business?
Although these questions focus primarily on retailers, manufacturers, and other businesses that sell products, service providers can ask similar questions to determine the optimal forecasting approach.
Contact our RRBB accountants and advisors to discuss the forecasting practices that make sense for your business.
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