Forecasting: A Comprehensive Guide to Predicting the Future

Forecasting refers to the practice of predicting what will happen in the future by taking into consideration events in the past and present. Basically, it is a decision-making tool that helps businesses cope with the impact of the future’s uncertainty by examining historical dataData Sources in Financial ModelingCollecting and using the right data sources in financial modeling is critical to the success of a business. Financial modeling requires gathering and and trends. It is a planning tool that enables businesses to chart their next moves and create budgets that will hopefully cover whatever uncertainties may occur.

Budgeting vs. Forecasting

One thing that is definitely true is that budgeting and forecasting are both tools that help businesses plan for their future. However, the two are distinctly different in many ways. Let’s consider the following points:

• Budgeting involves creating a statement that consists of numerous financial activities of a company for a specific period, such as projected revenueRevenueRevenue is the value of all sales of goods and services recognized by a company in a period. Revenue (also referred to as Sales or Income), expenses, cash flow, and investments. It is usually not conducted solely by one department, say, the finance department, because it requires input from other departments in order to come up with a holistic and detailed report. Therefore, the budgeting process takes time to complete. The company uses the budget to guide it in its financial activities.
• While budgets are usually made for an entire year, forecasts are usually updated monthly or quarterly. Through forecasting, a company is able to adjust its budget and allocate more funds to a department, as needed, depending on what is foreseen. In summary, budgets depend on the forecast.

Forecasting Methods

Businesses choose between two basic methods when they want to predict what can possibly happen in the future, namely, qualitative and quantitative methods.

1. Qualitative method

Otherwise known as the judgmental method, qualitative forecasting offers subjective results, as it is comprised of personal judgments by experts or forecasters. Forecasts are often biased because they are based on the expert’s knowledge, intuition, and experience, and rarely on data, making the process non-mathematical.

One example is when a person forecasts the outcome of a finals game in the NBA, which, of course, is based more on personal motivation and interest. The weakness of such a method is that it can be inaccurate.

2. Quantitative method

The quantitative method of forecasting is a mathematical process, making it consistent and objective. It steers away from basing the results on opinion and intuition, instead utilizing large amounts of data and figures that are interpreted.

Features of Forecasting

Here are some of the features of making a forecast:

1. Involves future events

Forecasts are created to predict the future, making them important for planning.

2. Based on past and present events

Forecasts are based on opinions, intuition, guesses, as well as on facts, figures, and other relevant data. All of the factors that go into creating a forecast reflect to some extent what happened with the business in the past and what is considered likely to occur in the future.

3. Uses forecasting techniques

Most businesses use the quantitative method, particularly in planning and budgetingBudgetingBudgeting is the tactical implementation of a business plan. To achieve the goals in a business’s strategic plan, we need some type of budget that finances the business plan and sets measures and indicators of performance..

The Process of Forecasting

Forecasters need to follow a careful process in order to yield accurate results. Here are some steps in the process:

1. Develop the basis of forecasting

The first step in the process is developing the basis of the investigation of the company’s condition and identifying where the business is currently positioned in the market.

2. Estimate the future operations of the business

Based on the investigation conducted during the first step, the second part of forecasting involves estimating the future conditions of the industry where the business operates and projecting and analyzing how the company will fare.

3. Regulate the forecast

This involves looking at different forecasts in the past and comparing them with the actual things that happened with the business. The differences in previous results and current forecasts are analyzed, and the reasons for the deviations are considered.

4. Review the process

Every step is checked, and refinements and modifications are made.

Sources of Data for Forecasting

1. Primary sources

Information from primary sources takes time to gather because it is first-hand information, also considered the most reliable and trustworthy sort of information. The forecaster himself does the collection, and may do so through things such as interviewsInterviewsAce your next interview! Check out CFI's interview guides with the most common questions and best answers for any corporate finance job position. Interview questions and answer for finance, accounting, investment banking, equity research, commercial banking, FP&A, more! Free guides and practice to ace your interview, questionnaires, and focus groups.

2. Secondary sources

Secondary sources supply information that has been collected and published by other entities. An example of this type of information might be industry reports. As this information has already been compiled and analyzed, it makes the process quicker.

Additional Resources

Thank you for reading CFI’s guide to forecasting. CFI offers the Financial Modeling & Valuation Analyst (FMVA)™Become a Certified Financial Modeling & Valuation Analyst (FMVA)®CFI's Financial Modeling and Valuation Analyst (FMVA)® certification will help you gain the confidence you need in your finance career. Enroll today! certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following CFI resources will be helpful:

• DCF Modeling GuideDCF Model Training Free GuideA DCF model is a specific type of financial model used to value a business. The model is simply a forecast of a company’s unlevered free cash flow
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