Watch this with a 10-15 minute audiotrack at http://vimeo.com/novusprogram/lesson6 This lesson will introduce the principles of forecasting, including gathering data, simple statistics, seasonal adjustments, common forecasting methods, and practical application. The Novus project is a combination of video tutorials designed to be used in conjunction with a free business simulation software program. The Novus Business and IT Program contains 36 business and IT training videos, covering basic finance, accounting, marketing, economics, business strategy, Word, Excel, and PowerPoint. Users will have an opportunity to apply the lessons in the Novus Business Simulator. Over six rounds, the user or teams will have to make decisions on capital purchases, financing, production, financing, and human resources for a microbrewery. This channel has arranged the 36 video lessons into the order in which they are meant to be used with the simulator. To watch this slideshow as a video, please go to our Vimeo page at: https://vimeo.com/novusprogram. To download our free business simulation software, please go to our SourceForge page at: http://sourceforge.net/projects/novus/.

1. Forecasting
Objective: To introduce the basic methods and uses of forecasting for small
businesses.
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2. Forecasting
• Essential for a Business
• Usually Based on Historical Information
• Gathering Data Very Important
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3. Gathering Data
• Characteristics of Good Data:
– Sufficient Quantity
– Objective
– Representative
– Consistent
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4. Measures of Average: The Mean
• The Mean is the sum of all the observations,
divided by the number of observations
• For the data set {0, 0, 1, 1, 1, 2, 7}:
Mean = (0+0+1+1+1+2+7)/7 = 12/7 = 1.7
• Used for data sets with:
– Strong central tendency
– Few unusual items
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5. Measures of Average: The Median
• The Median is the center-most observation in
the data set
• For the data set {0, 0, 1, 1, 1, 2, 7}:
Median = 1
• Used for data sets with:
– Strong Central Tendency
– Unusual Items
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6. Measures of Average: The Mode
• The Mode is the most frequently occurring
observation
• For the data set {0, 0, 1, 1, 1, 2, 7}:
Mode = 1
• Used for data sets with:
– Repeating observations
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7. Measures of Distribution
• Finding high and low estimates
• Simple Method: Margin of Error
– Based on experience or observation
• Example:
– Fancy Gift Company
• Forecasted 2012 Sales = $92,000
• Margin of Error = 10%
1. Find the Margin: $92,000 x 10% = $9,200
2. Add & Subtract the Margin from the Forecasted Sales:
$92,000 +/- $9,200 = $101,200 and $82,800
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8. Seasonal Adjustment
1. Find the Average Seasonal Sales
Fancy Gift Company - Quarterly Sales - 2011
Q1 Q2 Q3 Q4
2011 Sales Revenue $20,000 $16,000 $18,000 $26,000
• Average Seasonal Sales =
($20,000 + $16,000 + $18,000 + $26,000) / 4 = $20,000
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9. Seasonal Adjustment
2. Divide Actual Quarterly Sales Amounts by Average Quarterly
Sales
– Q1 = $20,000 / $20,000 = 1.0
– Q2 = $16,000 / $20,000 = 0.8
– Q3 = $18,000 / $20,000 = 0.9
– Q4 = $26,000 / $20,000 = 1.3
Fancy Gift Company - Quarterly Sales - 2011
Q1 Q2 Q3 Q4
2011 Sales Revenue $20,000 $16,000 $18,000 $26,000
Seasonal Adjustment
1.0 0.8 0.9 1.3
Ratio
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10. Seasonal Adjustment
3. Find the Average Seasonal Sales for the
Forecast
– Fancy Gift Company 2012 Sales Forecast: $92,000
– 2012 Average Seasonal Sales: $92,000 / 4 = $23,000
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11. Seasonal Adjustment
4. Multiply the forecasted average seasonal sales
by the seasonal adjustment ratios
– Q1 = 1.0 x $23,000 = $23,000
– Q2 = 0.8 x $23,000 = $18,400
– Q3 = 0.9 x $23,000 = $20,700
– Q4 = 1.3 x $23,000 = $29,900
• Note:
$23,000 + $18,400 + $20,700 + $29,900 = $92,000
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12. Forecasting Method 1: Delta Analysis
• Analyze Period-to-Period Changes
Fancy Gift Company - Historical Annual Sales
Year Sales Delta
2007 $70,000 -
2008 $72,500 $2,500
2009 $75,000 $2,500
2010 $77,000 $2,000
2011 $80,000 $3,000
Average $2,500
2012 Sales Forecast $82,500
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13. Forecasting Method 2: Moving Average
• Analyze Selected Years: 3-Year Moving Average
Fancy Gift Company - Historical Annual Sales
Year Sales Delta
2007 $70,000 -
2008 $72,500 $2,500
2009 $75,000 $2,500
2010 $77,000 $2,000
2011 $80,000 $3,000
Average $2,500
2012 Sales Forecast $82,500
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14. Forecasting Method 3: Weighted Moving Average
• Analyze Selected Years: 3-Year Weighted Moving Average
• Weight each year differently
– Weights must sum to 100%
Fancy Gift Company - Historical Annual Sales
Year Sales Delta Weight Adjusted Delta
2007 $70,000 - -
2008 $72,500 $2,500 -
2009 $75,000 $2,500 20% $500
2010 $77,000 $2,000 30% $600
2011 $80,000 $3,000 50% $1,500
Weighted Average $2,600
2012 Sales Forecast $82,600
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15. Forecasting Method 4: Common Size Analysis
• Analyze financial statement items as proportions
– Automatically calculate several useful financial ratios
– Easily identify trends
• To Common Size an Income Statement…
Divide everything by Total Revenue
• To Common Size a Balance Sheet…
Divide everything by Total Assets
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16. Forecasting Method 4: Common Size Analysis
Fancy GiftCompany - Income Statement
2011
Sales $80,000 100.0%
Cost of Goods Sold $28,800 36.0%
Gross Income $51,200 64.0%
Sales, General & Administrative $9,600 12.0%
Other Operating Expenses $4,000 5.0%
Total Operating Expenses $13,600 17.0%
Operating Income $37,600 47.0%
Taxes $7,896 9.9%
Net Income $29,704 37.1%
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17. Forecasting Method 4: Common Size Analysis
Fancy Gift Company – Common Sized Income Statements
2011 2010 2009
Sales $80,000 100.0% $77,000 100.0% $75,000 100.0%
Cost of Goods Sold $28,800 36.0% $28,490 37.0% $28,500 38.0%
Gross Income $51,200 64.0% $48,510 63.0% $46,500 62.0%
Sales, General &
$9,600 12.0% $9,240 12.0% $9,000 12.0%
Administrative
Other Operating Expenses $4,000 5.0% $2,310 3.0% $750 1.0%
Total Operating Expenses $13,600 17.0% $11,550 15.0% $9,750 13.0%
Operating Income $37,600 47.0% $36,960 48.0% $36,750 49.0%
Taxes $7,896 9.9% $7,762 10.1% $7,718 10.3%
Net Income $29,704 37.1% $29,198 37.9% $29,033 38.7%
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18. Forecasting Method 4: Common Size Analysis
Fancy Gift Company – Forecasted 2012 Income Statement
2012
Sales $92,000 100.0%
Cost of Goods Sold $32,200 35.0%
Gross Income $59,800 65.0%
Sales, General & Administrative $11,040 12.0%
Other Operating Expenses $6,440 7.0%
Total Operating Expenses $17,480 19.0%
Operating Income $42,320 46.0%
Taxes $8,887 9.7%
Net Income $33,433 36.3%
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19. Practical Application
• Statistics and methods provide a starting point
– Use experience and research to improve your
forecasts
– Refine your models over time
– Use high and low estimates to help you plan for best
and worst cases
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