GROUP 7 THEORIES BEHIND THE BUSINESS CYCLE FORECASTING

BUSINESS CYCLE FORECASTING Business Forecasting

A company’s planning and operations can be severely  The tools and techniques used to predict developments in
affected by a significant change in the business environment, such business, such as sales, expenditures, and profits.
as can be caused by the vagaries of a business cycle.
Theories that have been raised in the past century
Business is an organization economic activity that involves the regarding the reasons for business cycles:
exchange of goods or services for money or other considerations. 1. Consumer Demand
-One theory states that a rise in consumer demand causes
Cycle is a series of occurrences that repeats or repeated.
a demand for more production equipment, so that
Forecasting is a technique that uses historical data as inputs to manufacturers can meet the demand. Manufacturers then
make informed estimate that are predictive in determining the install an excessive amount of equipment, which leads to
direction of future trends. overcapacity
2. Inventory Expectations
Business cycle is a recurring series of expansions and
-Theory states that inventory is at the core of business
contractions.
cycles. Producers build inventories in expectation of
ALTERING PHASE OF BUSINESS CYCLE creating new sales volume. The added production
increases the number of jobs in the economy.
3. Cost of Capacity Utilization
EXPANSION CONTRACTION -Another theory holds that, as a company enters the late
stages of a business expansion, the costs of operating at
EXPANSION- the phase of the business cycle where real
very high levels of capacity utilization will reduce profits,
gross domestic product (GDP) grows for two or more because the costs of overtime, machine maintenance, and
consecutive quarters, moving from a trough to a peak high-demand supplies will rise
4. Debt Accumulation
CONTRACTION- refers to a phase of the business cycle in
-Another (and very similar) theory is that companies
which the economy as a whole is in decline
gradually burden themselves with more and more debt,
NATURE OF BUSINESS CYCLE which they need to build more capacity to fuel additional
grow Eventually, they are unable to pay back the debt,
A business cycle is a recurring series of expansions and
which causes lenders to tighten their credit terms, which
contractions, involving and driven by a vast number of
in turn reduces lending on new projects until demand
economic variables, that manifests itself as changes in the “catches up” with the current level of production capacity.
level of income, production, and employment 5. Money Supply
TWO (2) TYPES OF VARIABLES -Another theory says that a moderate, positive growth rate
in the money supply will avoid business contractions, while
Cause business cycle changes occur. a reduction in the money supply will bring about a
Exogenous variable this variable affects the economic system, recession or depression. The money supply can be affected
though it is not an integral component of the system. by government actions, as well as by the retention,
investment, or spending of funds by consumers.
Endogenous variable this variable impacts an economic system 6. Innovation Basis
from within. -Theory states that economic growth is founded on
IMPACT OF THE BUSINESS CYCLE ON A CORPORATION bursts of innovation, which tends to be sector specific,
and has a trickle-down effect on other parts of the
Business Downturn economy
 Reduce Inventories 7. Long-term Growth
 Reduce the production staff - A final view is that long-term boom periods will eventually
 Companies will buck the industry trend and expand end due to a loss of investor prudence (when they assume
that the growth period will go on forever), resulting in
increasingly poor and risky investments, growing
Business Upturn/Upwards indebtedness, and a loss of liquidity.
 Ramp up the existing production capacity
 Reacting slowly ELEMENTS OF BUSINESS CYCLE FORECASTING
HISTORY OF BUSINESS CYCLE Forecasting is conducted not only by various branches of
The preceding discussion on how a business cycle can affect a the federal government, such as the Department of
company may seem like Chicken Little’s warning that the sky is Commerce and the Federal Reserve Board, but also by a
falling, because the United States has not suffered a severe
number of universities and private institutions.
business downturn in many years. To deter the reader from
becoming too complacent, however, here are a few facts FOUR (4) PRIMARY METHODS USED TO FORECAST
regarding the 14 business contractions in the period from 1920
to 2005. 1. Anticipation Surveys
- These are surveys of key people in the business
 For the Great Depression, the GNP dropped 33 percent. community. The purpose of these surveys is to collect
 For two major depressions, the GNP dropped by 13 information about the intentions of the survey participants to
percent. engage in capital purchases, acquisitions, changes in
 For eleven severe or mild depressions, the GNP headcount, or any other steps
dropped by 2 to 3 percent. 2. Time Series Model
- These are trend lines that are based on historical
Great Depression was the worst economic downturn in the history information. For a forecast, one finds the trend line that
of the industrialized world. fits a similar set of previous conditions and fits it to the
 current conditions to arrive at a trend line of future Throughout this chapter, the key issues behind business
expectations. cycles have been reinforced—they are caused by a multitude of
3. Econometric Models constantly shifting variables that are very difficult to interpret or use
- These are highly complex and iterative models that to affect future business conditions, and their impact on a company
simulate the real economy and are frequently composed can be terminal if not properly anticipated. The last two sections of
of hundreds of variables that interact with each other the chapter noted the extreme complexity of the data gathering and
4. Cyclical Indicators interpretation now being conducted by a variety of organizations in
- This method is a good way to confirm the existence of an effort to predict the future, and why the bulk of this analysis is
business cycle changes that have been predicted by other well beyond the comprehension and available time of the average
forecasting methods. con- troller. However, by segmenting a business cycle down into
the smallest possible niches and diligently searching for the key
drivers that have an impact on those niches, it is possible for a
These are the leading and lagging indicators that foretell controller to report on the key drivers of “mini” business cycles that
changes in the economy most directly affect a company’s operations.

 LEADING INDICATOR is something that changes in

advance of an alteration in a business cycle, such as the
number of new business formations, new capital
expenditure requests, construction contracts, the length of
the average workweek.
 LAGGING INDICATOR is something that changes after
an alteration in the business cycle has occurred, and is
used by forecasters to confirm the business cycle change
that was indicated by leading indicators. Examples of
lagging indicators are investments in nonresidential
structures, unit labor costs, and the amount of consumer
credit out- standing.
BUSINESS CYCLE FORECASTING AT THE
CORPORATE LEVEL
Some possible actions to take to obtain, analyze, and report on
business cycle forecasts.
 Report on published forecast
-There are forecasts published by nearly every major
business magazine for the economy at large, which can be
easily extracted, reformatted into an internal report, and
presented to management, perhaps as part of the monthly
financial statements
 Subscribe to a forecasting service
- company can pay a significant fee, to a forecasting service
for more specific reports that relate to the industry in which
it operates. This is a good approach for those organizations
that do not have the resources to gather, summarize, and
interpret economic data by themselves.
 Develop an in-house forecasting model
- a company either wants to run its own forecasting model
or there are no forecasting services available that can
provide the information, and it is deemed relevant, This
effort can range from a minimalist approach to a
comprehensive one, with each level of effort yielding better
result

SUMMARY: