Forecasting: A Tool for Performance

Improvement
A forecast is an educated guess that looks into the future and attempts to determine what and how much you are going to sell, to
whom you are going to sell it, and when delivery will be required. Forecasting is used to project financial, personnel, production,
material, and capacity needs beyond the immediate horizon. It helps develop a “single demand view” that an organization can use to
plan its operations. If successful, it maximizes capacity, helps promote customer satisfaction, and helps you take advantage of market
opportunities.

Note: As used in this article, the term “forecast” is not intended to have its more technical accounting meaning.

Why Forecasting Is Necessary

Forecasting is necessary for manufacturers because customers demand delivery of products in less time than is required to obtain raw
materials and component parts. In some cases, customers demand delivery of products in less time than it actually takes to
manufacture those products. This could require the stocking of finished goods as well as components and raw materials. But how do
you determine what to stock and how much? Given the high cost of carrying inventory, it is important to use forecasting to make sure
you have the right materials in the right amounts at the right time.

A forecast usually consists of two numbers that make up a range, or spread. Forecasts are more accurate for families of products than
for individual items and are more accurate in the short term than in the long run. They should never be used as a substitute for
calculated demand, if available. While forecast accuracy is important, it is more important to learn to manage the variation of
“forecast versus actual.” The reliability of management’s prediction increases with the frequency of use. The more you do it, the
better you get, and the more accurate the forecast will become.

Methods of Forecasting
There are three generally accepted methods of forecasting: (1) past history and experience, (2) economic, and (3) the company
marketing plan. Each method uses different information to arrive at the same result. In some cases, using all three methods can
maximize the accuracy of the forecast.

Past history and experience. This method involves looking back over the immediate past (usually the last 13 weeks) and using the
information gathered (on sales, orders, deliveries, etc.) to project the same information for the next 13-week period. It is accurate in
the short term, but it only works if the company has stable demand or can adjust for trends, seasonality, or product life-cycle changes.

Economic. This type of forecasting relies on the state of the economy and its relation to the business. Items such as leading indicators,
GNP, economic models, and/or market surveys may be used. Economic forecasting provides a more long-term look at the horizon.

Company marketing plan. This method involves keying in on product strategies, promotions, and flagship products. While it is
narrow and pertains to a limited number of items, it can be very accurate if the plan succeeds.
Why Forecasts Fail
Following are some common pitfalls to guard against when forecasting:

Unrealistic expectations. Don’t allow your forecast to turn into a wish list. To avoid this result, never permit the sales staff alone to
make the forecast.

Second guessing. This can happen as the forecast moves up or down the chain of command, as the manufacturing staff tries to
outguess marketing, and vice versa.

One-person forecast. Forecasting should not be an individual effort. A good forecast requires input from a number of sources (the
most important of which is the customer).

Conflicting objectives. Conflicts often arise between what marketing wants to sell and what manufacturing wants to make.

Playing with the numbers. This is sometimes done to make the forecast reflect sales, or vice versa.

© 2009 Principa. All Rights Reserved. 19

Forecasting: A Tool for Performance Improvement
(Cont’d)
Failure to track forecast accuracy. It is important to hold the producers of the forecast accountable for its becoming a reality, within
reasonable parameters.

Reasons for Forecast Error

Some of the common factors that can lead to errors in forecasting include changes in basic data, data entry errors, omission of data,
external and internal factors, and normal variation. These items must be watched closely in a monthly forecast review.

Another factor that may create significant error is demand (from external sources) for components or raw materials. These include
spare parts for service, parts for internal repairs, interplant requirements in multi-plant companies, and all other forms of demand not
directly related to production. This information is easily obtained from the Master Schedule, but is frequently ignored in forecasting
future demand.

Monitoring the Forecast

It is critical to measure the accuracy of the forecast, preferably on a monthly basis, by comparing forecasted sales to actual sales at
both the product family and product code levels. (The former will be more accurate than the latter; this is the purpose of the spread in
the forecast.) Other items that should be measured are volatility and planned versus actual production.

Two other indirect measures of the forecast are the level of customer service and the inventory turnover ratio. If customer satisfaction
is high and the rate of on-time shipments of customer orders approaches 98%, the forecasting process is working well. It is important
to track the inventory turnover ratio to determine whether the high customer service level is being achieved through excess inventory.
If both customer satisfaction and inventory turnover level are high, you most likely have a successful forecasting program.

What to Do Now
If you already use forecasting, continue to work at improving forecast versus actual by attempting
to reduce the spread. Measure forecast results monthly using a twelve-month rolling horizon. Use your monthly Sales and Inventory
Production Planning (SIPP) meeting to examine and measure last month, firm up this month, project next month, and then roll that
number out another eleven months. This method allows you to measure forecast effectiveness, plan and execute in a short time frame
(which allows time for adjustment), and perform the forecasting exercise frequently. All of these steps will improve forecast accuracy
and, therefore, overall performance.

If you are not currently forecasting, start now. You have nowhere to go but up.

Rick Titone is an international consultant and educator and president of The Why How Consulting Company in Clifton, New Jersey.

Forecasting Techniques
Generally accepted forecasting techniques include the following. In all cases, consideration must be given to leveling, trends, and
seasonality:
•Qualitative: an intuitive or judgmental evaluation
•Quantitative: compiled using number data
•Intrinsic: based on historical data and patterns
•Extrinsic: based on external patterns, such as the economy or shifts in the industry

Uses of Forecasting
•Control raw material, component parts, and finished goods inventories
•Develop budgets for direct and indirect expenses
•Plan and adjust the work forces
•Plan and adjust plant capacity
•Develop and maintain channels of distribution
•Purchase long lead time items for manufacturing

© 2009 Principa. All Rights Reserved. 20