ES 516 - Activity No.

08 – Forecasting

Names: Boga,Ivan Carr

Answer the follow questions:

1. Why is forecasting important to business?

Forecasting is important to business because it helps business owners make informed business
decisions. Forecasting approaches include qualitative and quantitative methods which provide business
owners an idea on the economic conditions and then make appropriate financial and operational
decisions.

2. Differentiate quantitative and qualitative forecast.

Qualitative forecast is based off on information that can’t be measured. It allows one to use their
judgement and knowledge in forecasting. The challenge in this approach is to make unbiased logical
judgement despite having sparse data in order to arrive in a quantitative estimate. This approach is best
for long-term forecasts, to forecast new business ventures and forecasts of margins. On the other hand,
quantitative forecast relies on past data that can be measured and manipulated. Past records on sales and
performance are evaluated to determine whether the business is stagnant or flourishing and the rate at
which it is happening. This type of analysis is best for short-term forecasting as making assumptions about
the future based on past performance is much more likely to be accurate in the near future.

3. State different forecasting methods. Explain each.

There are four main types of forecasting methods that financial analysts use to predict future
revenues, expenses, and capital costs for a business. While there are a wide range of frequently used
quantitative budget forecasting tools, in this article we focus on the top four methods: (1) straight-line,
(2) moving average, (3) simple linear regression, and (4) multiple linear regression.

(1). Straight-line Method

The straight-line method is one of the simplest and easy-to-follow forecasting methods. A financial analyst
uses historical figures and trends to predict future revenue growth.

In the example provided below, we will look at how straight-line forecasting is done by a retail business
that assumes a constant sales growth rate of 4% for the next five years.
 a. The first step in straight-line forecasting is to determine the sales growth rate that will be used to
calculate future revenues. For 2016, the growth rate was 4.0% based on historical performance.
We can use the formula =(C7-B7)/B7 to get this number. Assuming the growth will remain
constant into the future, we will use the same rate for 2017 – 2021.
b. To forecast future revenues, take the previous year’s figure and multiply it by the growth rate.
The formula used to calculate 2017 revenue is =C7*(1+D5).
c. Select cell D7 to H7, then use the shortcut Ctrl + R to copy the formula all the way to the right.

(2). Moving Average

Moving averages are a smoothing technique that looks at the underlying pattern of a set of data to
establish an estimate of future values. The most common types are the 3-month and 5-month moving
averages.

a. To perform a moving average forecast, the revenue data should be placed in the vertical column.
Create two columns, 3-month moving averages and 5-month moving averages.
b. The 3-month moving average is calculated by taking the average of the current and past two
months revenues. The first forecast should begin in March, which is cell C6. The formula used is
=AVERAGE(B4:B6), which calculates the average revenue from January to March. Use Ctrl + D to
copy the formula down through December.
c. Similarly, the 5-month moving average forecasts revenue starting the fifth period, which is May.
In cell D8, we use the formula =AVERAGE(B4:B8) to calculate the average revenue for January to
May. Copy the formula down using shortcut Ctrl + D.
d. It is always a good idea to create a line chart to show the difference between actual and MA
forecasted values in revenue forecasting methods. Notice that the 3-month MA varies to a greater
degree, with a significant increase or decrease in historic revenues compared to the 5-month MA.
When deciding the time period for a moving average technique, an analyst should consider
whether the forecasts should be more reflective of reality or if they should smooth out recent
fluctuations.

(3). Simple Linear Regression

Regression analysis is a widely used tool for analyzing the relationship between variables for prediction
purposes. In this example, we will look at the relationship between radio ads and revenue by running a
regression analysis on the two variables.

a. Select the Radio ads and Revenue data in cell B4 to C15, then go to Insert > Chart > Scatter.
b. Right-click on the data points and select Format Data Series. Under Market Options, change the
color to desired and choose no borderline.
c. Right-click on data points and select Add Trendline. Choose Linear line and check the boxes for
Display Equation on the chart and Display R-squared value on the chart. Move the equation box
to below the line. Increase line width to 3 pt to make it more visible.
d. Choose no fill and no borderline for both chart area and plot area. Remove vertical and horizontal
grid lines in the chart.
 e. In the Design ribbon, go to Add Chart Element and insert both horizontal and vertical axis titles.
Rename the vertical axis to “Revenue” and the horizontal axis to “Number of radio ads.” Change
chart title to “Relationship between ads and revenue.”
f. Besides creating a linear regression line, you can also forecast the revenue using the forecast
function in Excel. For example, the company releases 100 ads in the next month and wants to
forecast its revenue based on regression. In cell C20, use the formula =
FORECAST(B20,$C$4:$C$15,$B$4:$B$15). The formula takes data from the Radio ads and
Revenue columns to generate a forecast.
g. Another method is to use the equation of the regression line. The slope of the line is 78.08 and
the y-intercept is 7930.35. We can use these two numbers to calculate forecasted revenue based
on certain x value. In cell C25, we can use the formula =($A$25*B25)+$A$26 to find out revenue
if there are 100 radio ads.

(4). Multiple Linear Regression

A company uses multiple linear regression to forecast revenues when two or more independent variables
are required for a projection. In the example below, we run a regression on promotion cost, advertising
cost, and revenue to identify the relationships between these variables.

a. Go to Data tab > Data Analysis > Regression. Select D3 to D15 for Input Y Range and B3 to C15 for
Input X Range. Check the box for Labels. Set Output Range at cell A33.
b. Copy the very last table from the summary output and paste it in cell A24. Using the coefficients
from the table, we can forecast the revenue given the promotion cost and advertising cost. For
example, if we expect the promotion cost to be 125 and advertising cost to be 250, we can use
the equation in cell B20 to forecast revenue: =$B$25+(B18*$B$26)+(B19*$B$27).

4. What is trend line forecasting?

Use the FORECAST function to add a trend line to a report. The trend line uses linear regression
to predict future periods based on existing data. For example, you could use a trend line to predict
future sales based on historical data. Forecast reports must have one date/time attribute on the X
axis, and no other attributes.

References:

https://www.investopedia.com/articles/financial-theory/11/basics-business-forcasting.asp

https://www.freshbooks.com/hub/accounting/accounting-forecasting-techniques