Financial Management: Intro to Forecasts and Trends

Question 1

Business Forecasting Defined:

Answer 1

Business Forecasting: The estimation of the value of a variable at some future point in time.

Forecasting Uses: Use of forecasting is common in various business circumstances, including:

• Forecasting macro-economic factors - market growth, inflation rate, tax rate, etc.
• Budgeting process - sales forecast, etc.
• Forecasting demand for products - for inventory and production purposes
• Forecasting for investment decisions - interest rates, commodity prices, currency exchange rates, etc.
• And others

Question 2

What are the two major types of Forecasting Approaches?

Answer 2

Business Forecasting Types:

1. Qualitative Forecasting:
   
   • Based on judgment and opinion
   • Subjective - (based on experience)
   • Often bases on consensus
   • Useful when quantitative data is lacking
   • Useful for long-range forecasting
2. Quantitative Forecasting:
   
   • Based on quantitative data and models
   • Objective - (based on observable phenomena)
   • Often based on mathematical calculations and determinations

Question 3

Qualitative Methods:

Answer 3

Qualitative Methods:

1. Executive Opinion – Jury of executive opinion using collective judgment of executives and managers
2. Market Research – Employs customer or other surveys to determine belief, preferences, etc.
3. Delphi Method – Develops a consensus of an expert group using a multi-stage process to converge on a forecast.

Question 4

Quantitative Methods:

Answer 4

Quantitative Methods:

1. Time Series Models – Use patterns in past data to predict future values
   
   • Also called the Extrapolation Method
     
     • Extrapolation: To estimate (a value of a variable outside a known range) from values within a known range by assuming that the estimatedvalue follows logically from the known values.
   • The approach is not concerned with cause, just patterns in data.
2. Causal Models – Assume the variable being forecasted is related to other variables and makes projections based on assumptions.

Question 5

Business Forecasting Time Horizons:

Answer 5

There are 3 time frames for forecasting purposes:

• Short-term - From immediate future up to 3 months out
  
  • Time-series are most appropriate
• Medium-term - From 3 mos to 2 years
  
  • Time series and causal methods are appropriate
• Long-term - Periods longer than 2 years
  
  • Causal and qualitative methods are appropriate, especially Delphi.

Question 6

Business Forecasting Error:

Answer 6

Forecast Error: Measures how accurate a given forecast was for a prior forecast period.

• It’s measured as the difference between actual value and forecasted value
• Smaller the difference = better the forecast

Three Common Forecast Error Measures:

1. Mean Absolute Deviation (MAD): measures the average absolute values of forecast errors
2. Mean Squared Error (MSE): measures the average sum of forecast errors squared
3. Mean Average Percentage Error (MAPE): forecast error divided by actual value

Question 7

Question:

Which one of the following sets shows the most likely method appropriate for short-term and long-term forecasting?

Short-term Forecasting Long-term Forecasting
Time series models Market research surveys
Causal models Time series models
Time series models Delphi method
Delphi method Time series models

Answer 7

Short-term Forecasting Long-term Forecasting

Time series models Delphi method

Times series models are most likely appropriate for short-term forecasting and the Delphi method is most likely appropriate for long-term forecasting. Time series models use past values or patterns to predict a future value or values, but the longer the forecasting period, the less likely will the past values or patterns be relevant to those future values. The Delphi method is a qualitative forecasting method that involves a group of experts developing a consensus using a multi-stage process to converge on a forecast, which is a particularly useful approach for long-term forecasting.