Planning for what lies ahead is an important part of running a healthy business. Forecasting your company’s financial statements can help you manage inventory and other working capital accounts, offer competitive prices, identify impending cash flow shortages and keep your business on solid financial footing.
No forecast will be 100% accurate, especially during these uncertain times. However, answering the following questions can help make your predictions more relevant.
How far into the future do you plan to forecast?
Forecasting is generally more accurate in the short term — the longer the time period, the more likely it is that customer demand or market trends will change. While quantitative methods, which rely on historical data, are typically the most accurate forecasting methods, they don’t work well for long-term predictions or when market conditions change. If you’re planning to forecast over several years, try qualitative forecasting methods, which rely on expert opinions instead of company-specific data.
How steady is your demand?
Weather, sales promotions and other factors can cause sales to fluctuate. For example, if you operate an ice cream truck, chances are good your sales dip in the winter. If demand for your products varies, consider forecasting with a quantitative method, such as time-series decomposition, which examines historical data and allows you to adjust for market trends, seasonal trends and business cycles. You also may want to adopt forecasting software, which allows you to plug other variables into the equation, such as individual customers’ short-term buying plans.
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, a simple yet fairly accurate method that compares historical averages with current demand. If you want to forecast for something you don’t have data for, such as a new product, you’ll need to either use qualitative forecasting or base your forecast on historical data for a similar product in your arsenal.
How do you fill your orders?
If your business uses “push” production methods (such as a factory that makes and stores large quantities of standard products) rather than “pull” methods (such as a retailer that takes custom orders), forecasting is particularly critical for establishing accurate inventory levels and improving cash flow. For peak accuracy, take the average of multiple forecasting methods. To optimize inventory levels, consider forecasting demand by individual products as well as at the local warehouse level, which will help you ensure speedy delivery.
How many types of products do you sell?
If you’re forecasting demand for a wide variety of products, consider a relatively simple technique, such as exponential smoothing. If you offer only one or two key products, it’s probably worth your time and effort to perform a more complex, time-consuming forecast for each one, such as a statistical regression.
New year, new forecast
The right forecasting techniques will help you predict your company’s future with much more accuracy. We can help you establish the forecasting practices that make sense for your business.
We highly recommend you confer with your Miller Kaplan advisor to understand your specific situation and how this may impact you.