Business forecasting is an essential procedure for the gap analysis. Gap analysis is a method used in business. It indicates the difference between a current state and a desired, future state. This is the gap. The managers make plans to fill the gap.
Forecasting helps the planner to agree targets. The forecast quantifies the benefit for shareholders or owners. It uses corporate performance indicators. Examples include -
‘Those who cannot remember the past are condemned to repeat it’ George Santayana, The Life of Reason Volume 1, Reason in Common Sense.
Useful information about the organization lies in its past. Making the effort to understand this can help in forecasting. Major changes in its patterns of performance raise issues important in the planning process. With these insights, planners are better able to find the organization's strengths and weaknesses. The planning team can make better-informed forecasts of the enterprise's future.
Most long-term forecasts are of poor quality, bordering on completely useless. Why?
First, forecasters do not use systematic processes. These reduce careless errors.
Second, forecasts fail because the future is uncertain.
There is a huge margin of error on long-range forecasts. You cannot use a forecast with huge errors.
Short-term forecasts usually contain masses of detail. This is because short-term forecasts help in day-to-day operational control, such as in budgets. Short-term forecasts are not as subject to big errors as are long-range forecasts.
Long-term forecasts, used in strategic planning must show the potential errors. They need little detail.
It is folly to put much store by single point forecasts. Yet, it is important o keep forecasts simple. For more on the value of simplicity in forecasting see Why Forecasts Fail.
The key is simplicity.
What we need at this stage is a forecast of profits over the next five years. Base it on the recent past. Take account of changes in the environment. Do not count any possible response by the company. Assume that the company will continue on its present course unaltered. This assumption has the great advantage of reducing the scope for errors. It avoids unreal optimism over some new untried idea to improve company performance.
This forecasting of the current strategies into the future is the ‘base case’. It is the do-nothing scenario, or forecast-zero (Fo).
Even with this Fo forecast, big errors may be present. This is because the future is so uncertain. Be ready to face these uncertainties. How do we do this? We use a bracket of forecasts. We make a pessimistic and an optimistic forecast. You might also include a central 'most likely' forecast.
This diagram shows a simplified version of such business forecasting. The vertical axis displays the indicator of corporate performance. This may be profits. The horizontal axis shows the planning time horizon in years. Fopt is the most optimistic forecast by the planning team. Fpes is the most pessimistic.
Now bring results of the target setting exercise together with these forecasts to conduct the gap analysis. The planning team can now compare the bracket target with the bracket forecast to determine the gas. Closing the gap is the strategic task for the organization.
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Software to help with
Some business planning and accounting software packages include forecasting tools that can integrate with other planning procedures. Some examples include-