Revenue Concepts

Meaning: The amount of money, which the firm receives by the sale of its output in the market, is known as its revenue
.
1. Total Revenue

Total Revenue refers to the total amount of money that a firm receives from the sale of its products.

Mathematically :
TR = P X Q
Where:
TR = Total Revenue;
P = Price;
Q = Quantity sold.

2. Average Revenue

Average revenue is the revenue per unit of the commodity sold. It is calculated by dividing the total revenue by the
number of units sold. Average revenue means price of the product.

AR = TR / Q
Where
AR = Average Revenue
TR = Total Revenue
Q = Quantity sold

3. Marginal Revenue

Marginal Revenue is the addition made to the total revenue by selling one more unit of a commodity.
MRn = TRn – TRn-1

DEMAND FORECASTING
MEANING AND DEFINITION

Demand forecasting means the estimation of expected future demand for a good or service. As demand is
directly related to sales, it is also known as sales forecasting. According to Evan Douglas. “Demand estimation
may be defined as the process of finding values for demand in future time periods.” In the words of Phillip
Kotler. “The demand estimate is the expected level of company’s sales based on a chosen marketing plan and
assumed marketing environment.” Thus demand forecasting is an estimate of the likely demand of a firm’s
product or service in future periods.

Objectives of Demand Forecasting

Demand forecasting serves the main purpose of maintaining equilibrium in the economy. Some of the
objectives are as follows:

(1) To Help Production. Demand forecasts help the producer to take up production planning so that the gap
between demand and supply of goods is eliminated.
(2) To Supply Goods. Demand forecasting induces the producers to maintain sufficient inventory of products
so that when supply falls and demand increases, the product may be released to the market to fill the gap.

(3) To Formulate Price Policy. Demand forecasting helps the management to formulate appropriate price
policies, so that the prices do not fluctuate over a period of time.

(4) To Formulate Sales Policy. One of the objectives of demand forecasting is to formulate sales policy. Since
demand forecasting is made region wise, movement of products may be arranged suitably. It helps the
management to determine sales targets accordingly.

(5) To Arrange for Finance. On the basis of demand forecasting, the management can prepare the budget for
institutional finance to procure materials and labour.

(6) To Determine the Production Capacity. Demand forecasting enables the companies to decide about the
production capacity. By studying the demand pattern for the products, the organization can plan for suitable
plant and desired output.

(7) To Plan for Labour Force. Production of product requires skilled and trained labour force. If the demand
forecasting indicates favourable trend, then management can take up measures to train labour force. This can
ensure labour supply and there will be no hindrance in production process.

Relevance (or Purpose) of Demand Forecasting

The relevance of demand forecasting in management depends on the time span of forecasting: short-run and long-run
forecasting.

Relevance of Short-run Forecasting.

The relevance of short-run demand forecasting is as follows:

1 Suitable Production Policy. In the short run, a firm is often faced with over or under-production leading to
excess or short supply. In the short run, a firm is often faced with over-production non leading to excess or short
supply. To avoid this, the firm has to forecast the demand for its product based on a suitable production policy.

2. Suitable Sales Policy. Demand forecasting requires a suitable sales promotion consisting of sales targets in
different areas, incentives to salesmen and dealers and advertising and propaganda.

3. Suitable Price Policy. Keeping in view the expected demand for its product, a firm may raise the price of its
product when the demand is high and reduce it when the demand is low.

4. Financial Needs. Short-run demand forecasting requires forecasting the financial needs of a firm. The firm
has to arrange for funds from different sources based on its production and sales levels on seasonal terms.

5. Suitable Inputs Policy. Besides finance, the firm has to evolve a suitable inputs policy relating to the
demand for labour, raw materials and other inputs.
Relevance of Long-run forecasting

The relevance of long-run demand forecasting is as follows:

1 To Plan Changes in Production. Long-run demand forecasting requires a firm to change its production
schedule. It has to assess the demand for its product in relation to its competitors. It there is need to change the
quality of its product, it may start a new unit or change the existing unit. This also requires new machines and
latest techniques.

2. To Plan for Financial Needs. In the long-run, a firm requires funds to meet changes in the demand for its
product. Besides, it has to plan the repayment of the borrowed funds and the interest

3.To Plan for Manpower Requirements. On the basis of demand forecasting, a firm has to plan about its
manpower requirements in the long run. For this, it has to recruit persons on permanent, temporary and
contractual basis, keeping in view its future sales. A big firm also gives training to new recruits.

4. To Plan for Machines and Materials. The firm has to plan for materials and machines needed on the basis
of long-run demand forecasts for its products. It may be based on changes in the consumption patterns of the
people.

METHODS OF DEMAND FORECASTING

Demand forecasting is a difficult exercise. Making estimates for future under the changing conditions is a
difficult task. There is no easy method or a simple formula which enables the manager to predict the future.
Economists and statisticians have developed several methods of demand forecasting. Each of these methods has
its relative advantages and disadvantages. Selection of the right method is essential to make demand forecasting
accurate. The more commonly used methods are discussed below.

There are two main methods of demand forecasting:

(1) Qualitative Methods

(2) Quantitative Methods

Methods of
Demand
Forecasting

Qualitative Quantitative
Methods Methods

Trend
Expert Opinion Survey Barometric
Projection
Method Method Method
Method

Buyer Sales Force

Graphical Least Square
intention Opnion
Method Method
Method Method
Experts’ Opinion Method
This method is also known as “Delphi Method” of investigation. The Delphi method requires a panel of experts,
who are interrogated through a sequence of questionnaires in which the responses to one questionnaire are used
to produce the next questionnaire. Thus any information available to some experts and not to others is passed
on, so that all the experts have access to all the information for forecasting. The method is used for long term
forecasting to estimate potential sales for new products. This method presumes two conditions: Firstly, the
panelists must be rich in their expertise, possess wide range of knowledge and experience. Secondly, its
conductors are objective in their job.

Consumers’ Survey or Buyers’ Intentions Methods

In this method, the consumers are directly approached to disclose their future purchase plans. This is done by
interviewing all consumers or a selected group of consumers. Here demand is forecasted on the basis of
information provided by the consumers.

Sales Force Opinion Method.

This is also known as collective opinion method. In this method, the opinion of the salesmen is sought. Each sales person
in the company is required to make an individual forecast for his or her particular sales territory. These individual
forecasts are discussed and agreed with the sales manager. All combined act then constitute the sales forecast for the
organisation.

Trend Projection or Time Series Method

A firm existing for a long time will have its own data regarding sales for past years. Such data when arranged
chronologically yield what is referred to as ‘time series’. Time series shows the past sales with effective demand
for a particular product under normal conditions. Such data can be given in a tabular or graphic form for further
analysis. This is the most popular method among business firms, partly because it is simple and inexpensive and
partly because time series data often exhibit a persistent growth trend.

Time series has got four types of components namely, Secular Trend (T), Secular Variation (S), Cyclical
Element(C), and an Irregular or Random Variation (I). These elements are expressed by the equation O = TSCI.
Secular trend refers to the long run changes that occur as a result of general tendency. Seasonal variations refer
to changes in the short run Weather pattern or social habits. Cyclical variations refer to the changes that occur in
industry during depression and boom. Random variation refers to the factors which are generally able such as
wars, strikes, flood, famine and so on.

When a forecast is made the seasonal, cyclical and random variations are removed from the observed data. Thus
only the secular trend is left. This trend is then projected. Trend projection fits a trend line to a mathematical
equation.

The trend can be estimated by using any one of the following methods:

(a) The Graphical Method,

(b) The Least Square Method.

( a) Graphical Method. This is the most simple technique to determine the trend. All values of output or sale for different
years are plotted on a graph and a smooth free hand curve is drawn passing through as many points as possible. The
direction of this free hand curve-upward or downward shows the trend.
(b) Least Square Method. Under the least square method, a trend line can be fitted to time series data with the
help of statistical techniques such as least square regression. Trend in sales over time is given by straight line,
the equation of this line is of the form: y = a + br. Where ‘a’ is the intercept and b’ shows the impact of the line

We have two variables the independent variable r and the dependent variable y The line of best fit establishes a
kind of mathematical relationship between the two variables x and y. This is expressed by the regression y on x.

In order to solve the equation y = a + bX, we have to make use of the following normal equations:

ΣY = na+bΣx -------------- (1)

ΣXY = aΣx + bΣx2----------------- (2)

Example: An investigation into the demand for coolers in 5 towns has resulted in the following data:

Fit a linear regression of Y on X and estimate the demand for coolers for a town with a population of 20 lakhs.
Solution:

Computation of demand for coolers for a population of 20 lakhs

Regression equation of Y on X.
Y = a + bX
To find the values of a and b the following two regression equations are to be solved :
Σ Y = na + b Σ X ..... (i)
Σ XY = a Σ X + b Σ X 2 ..... (ii)
By putting the values, we get
335 = 5a + 45b .... (iii)
3,275 = 45a + 455b .... (iv)
By multiplying equation (iii) by 9, we get
3,015 = 45a + 405b .... (v)
By subtracting equation (v) from (iv) we get
45a + 455b = 3,275
45a + 405b = 3,015
50b = 260
or
b = 260/50 = 5.2
By putting the value of b in equation (iii), we get
335 = 5a + 45 × 5.2
or 5a = 335 - 234 = 101
or a = 101/5 = 20.2
By putting the value of a, b and X (which is 20) in regression equation of Y on X, we get

Y = a + bX

Y = 20.5 + 5.2 (20)

Y = 20.2 + 104 = 124.2 or 124

or say expected demand for room coolers for a town having a population of 20 lakhs will be 124 room coolers
Barometric Method

A barometer is an instrument of measuring change. Barometric methods are based on the idea that certain
events of the present can be used to predict the directions of change in the future. This is done by the use of
economic indicators which serve as barometers of economic change. These are known as leading indicators
which are economic series that go down or up before gross domestic product (GDP) changes.

Forecasters forecast a firm’s sales fluctuations with three series: Leading Series, Coincident or Concurrent
Series and Lagging Series.

(a) The Leading Series. The leading series comprise those factors which move up or down before the recession
or recovery starts. They tend to reflect future market changes. For example, baby powder sales can be
forecasted by examining the birth rate pattern five years earlier, because there is a correlation between the baby
powder sales and children of five years of age and since baby powder sales today are correlated with birth rate
five years earlier, it is called lagged correlation. Thus we can say that births lead to baby soaps sales.

(b) The Coincident or Concurrent Series. The coincident or concurrent series are those which move up or
down simultaneously with the level of the economy. They are used in confirming or refuting the validity of the
leading indicator used a few months afterwards. Common examples of coinciding indicators are G.N.Pitself,
industrial production, trading and the retail sector.

(C) The Lagging Series. The lagging series are those which take place after some time lag with respect to the
business cycle. Examples of lagging series are, labour cost per unit of the manufacturing output, loans
outstanding, leading rate of short term loans, etc.

UTILITY OR IMPORTANCE OF DEMAND FORECASTING

Demand Forecasting has the following utility:

(1) Useful in Planning. In modern times, most of firms prepare their business plans on the basis of forecasts of
demand for their products. In this way, it proves to be very helpful in decision-making and formulation of
policies.

(2) Mass Production. It provides a prior idea about the fact that which goods are going to be in much demand
in future. It leads to mass production of such goods. Mass production is useful for both the producers and the
consumers. On the one hand, producers enjoy economies of large scale production and on the other, consumers
get goods at reasonable prices.

(3) Research and Development. Demand forecasting makes the business firms to undertake research and
development activities. Such activities are undertaken on the basis of predictions of demand in future. As a
result of research and development new products are made available in the market.

(4) Optimal Utilisation of Resources. If production is done in a haphazard way and environment of
uncertainty, then a number of resources are wasted. But this type of wastage is minimised due to demand
forecasting because there production of such goods which are demanded in casting because the resources are
employed in the helpful in optimal utilisation of resources. which are demanded in the market. Thus, demand
forecasting is

(5) Development of Economy. Demand forecasting of Economy. Demand forecasting is useful in the
development of economy. In fact, demand forecasting creates an environment of certain world which attracts
more investments. As a result creates an environment of certainty in the business acts more investments. As a
result of increase in investment, the economy develops at a faster rate.

(6) Price Stability. The major cause of fluctuations in Demand is the prices. The major cause of fluctuations in
prices is under or over supply of goods. This situation takes place due to imperfect knowledge o on takes place
due to imperfect knowledge of demand conditions. But as a result of demand forecasting, demand for various
goods can be estimated more accuracy ply can be made accordingly. In this way, stability in the price level can
be maintained.

(7) Increase in Knowledge. Demand forecasting is also helpful in increasing the knowledge of the marketing
manager. With the help of demand forecasting, he can know about the various determinants of market demand.
On their basis, he can influence the market demand.

(8) Helpful to Government. Demand forecasting helps the government in a number of ways. Most of the
government’s revenue and expenditure policies are formulated on the basis of demand forecasting. For example,
if the government comes to know that a particular product is going to be in much demand, then it may earn
more revenue by imposing tax on its production and sale.

Limitations of Demand forecasting

Although demand forecasting is very useful for business management yet it has a number of limitations.

(1) Need of Past Data. Most of the methods adopted for the forecasting of demand rely upon the availability of
past data regarding sales. These data are necessary for determining the past trends. But in most cases, these data
are not available and even if available, they are not reliable.

(2) Uncertainty of Future. The modern business world is to a number of changes. As a result, the future has
become highly uncertain. So the forecasting made on the basis of past and present trends may prove to be wrong
in future. Thus, demand forecasting loses its importance due to the uncertainty of future.

(3) Expensive. Forecasting of demand requires a lot of expenses to be made. As a result, demand forecasting
proves to be expensive in terms of both time and money. As small are generally not able to incur these
expenses, they are deprived of the benefits of demand forecasting.

(4) Need of Forecasting Experts. As demand forecasting is a crucial task. so it required a special knowledge
but generally, the experts having this knowledge are not available, it becomes difficult to have an accurate
forecasting of demand.