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Corporatefinanceinstitute.com Forecasting Methods

The document outlines four main budget forecasting methods used by financial analysts: straight-line, moving average, simple linear regression, and multiple linear regression. Each method has specific applications and requires different levels of statistical knowledge and historical data. The article provides detailed steps for implementing each forecasting technique, including formulas and examples.

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Fagner F Souza
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3 views

Corporatefinanceinstitute.com Forecasting Methods

The document outlines four main budget forecasting methods used by financial analysts: straight-line, moving average, simple linear regression, and multiple linear regression. Each method has specific applications and requires different levels of statistical knowledge and historical data. The article provides detailed steps for implementing each forecasting technique, including formulas and examples.

Uploaded by

Fagner F Souza
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Forecasting Methods

corporatefinanceinstitute.com/resources/financial-modeling/forecasting-methods

Main methods of budget forecasting


Written by Jeff Schmidt
Published April 2, 2020

Updated May 1, 2023

Top Forecasting Methods


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 four
main methods: (1) straight-line, (2) moving average, (3) simple linear regression and (4)
multiple linear regression.

Math
Technique Use involved Data needed

1. Straight Constant growth rate Minimum Historical data


line level

2. Moving Repeated forecasts Minimum Historical data


average level

3. Simple Compare one independent with one Statistical A sample of


linear dependent variable knowledge relevant
regression required observations

4. Multiple Compare more than one Statistical A sample of


linear independent variable with one knowledge relevant
regression dependent variable required observations

Key Highlights

Four of the main forecast methodologies are: the straight-line method, using
moving averages, simple linear regression and multiple linear regression.
Both the straight-line and moving average methods assume the company’s
historical results will generally be consistent with future results.
The regression methodologies forecast results based on the relationship
between two or more variables.

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.

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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.

1. 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.

2. 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).

3. Select cells 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.

1. To perform a moving average forecast, the revenue data should be placed in the
vertical column. Create two columns: 3-month moving average and 5-month moving
average.

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2. 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.

3. Similarly, the 5-month moving average forecasts revenue starting in 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.

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4. 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.

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1. Select the Radio ads and Revenue data in cell B4 to C15, then go to Insert > Chart >
Scatter.

2. Right-click on the data points and select Format Data Series. Under Marker Options,
change the color to desired and choose no borderline.

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3. 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.

4. Choose no fill and no borderline for both chart area and plot area. Remove vertical and
horizontal grid lines in the chart.

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5. 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.”

6. 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

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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.

7. 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.

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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.

1. 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.

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2. 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 the
advertising cost to be 250, we can use the equation in cell B20 to forecast revenue:
=$B$25+(B18*$B$26)+(B19*$B$27).

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