Question

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Identify the differnt forms of financial forecasting methods. What do you think are the weaknesses and strengths of each?

Answer 1

There are wide range of methods for financial forecasting. All these methods fall into just two general categories, which are quantitative and qualitative.

A quantitative approach relies upon quantifiable data and later it can be statistically used for forecasting.

A qualitative approach relies upon information that cannot actually be measured under quantitative approach.

Some methods of quantitative approach are discussed below along with its pros and cons.

1. Causal method. Methods under this category assume that the item being forecasted has cause and effect with another one or more variables. Example : 'Petrol and Car price' and 'Movie theatre and canteen'. In the above scenario if the movie ticket sales increases it in turn increases the canteen sales. Regression analysis is the major method used in this category.

• Pros: Causal method is advantageous in replicating the approach whenever required
• Cons: In some cases coincidence might be taken into account as cause and effect relation. As it is a drawback of this method. In some cases it is difficult to achieve appropriate conclusion

1. Time series methods : In this method historical data of sales or any other variables are taken and analyzed in equally spaced time intervals. Here we assume that the same historical pattern may reflect in the future. Types of this method are Rule of thumb, Smoothing and Decomposition.

Pros: Widespread methods and technologies along with the availability of data, we can generate different types of trends and analysis. Since it is based on verifiable data, it can be subjected to thorough examination for its validation and forecasting. It can be replicated, checked, updated and refined according to our requirements.

Cons: Historical data may not give a true picture of an underlying trend. There is a greater chance of error in the forecasting.

In general quantitative methods are usually expensive.

Qualitative methods;

In this category the major classifications are Market research, Opinions of knowledgeable personnel and Delphi method.

Qualitative methods are especially necessary during the early stages of a company or product, where we do not have much historical data for this. It is done by using the market research and using the opinions of the well knowledgeable personnel in that particular field/industry.

Pros: Qualitative research allows one person/organization to analyze each topics/variables deeply and logically . Qualitative research is often less expensive than quantitative research.

Cons: A Qualitative research does not allow you to use your findings as a basis for a broader audience or the public in general. As we might do research for a sample population but it cannot be applicable for the whole public/population.