FREE online courses on Refresher on Financial Planning - Chapter 4 - Quantitative and Qualitative Techniques

 

You should forecast for a specific reason - to help make better decisions. Forecasting is extremely difficult and you must pull from all relevant sources. We previously discussed the Percent of Sales Method and Trend Analysis as a way of forecasting. These forecasting techniques are quantitative. Quantitative techniques of forecasting are best used when changes are infrequent. In today's world of rapid change, quantitative techniques tend to be of little use.

 

We need to add more qualitative techniques into the budgeting process. Qualitative techniques include surveys, interviews with people who are "in the know", market reports, articles, and other information sources that allow us to make a better judgement. Qualitative or Judgmental Forecasting can help improve the budgeting process, especially if we are operating in a rapidly changing environment.

 

The Delphi Method is an example of a qualitative technique where a group of experts gets together and reaches a consensus on what will happen in the future. A questionnaire is sometimes used to facilitate the process. Two disadvantages of the Delphi Method are low reliability with the consensus and inability to reach a clear consensus.

Smoothing out the Numbers

 

One simple approach to forecasting is to setup a model that relies on averages from past historical data. For example, we can take an average of the last five years. As we move forward to the next planning period, a new moving average is calculated and used as the forecast for the next planning period. Exponential smoothing can be used whereby we place more weight on the most recent set of actual numbers. This can be important where changes have occurred, making older data less reliable.