Module Seven: Advanced Forecasting Techniques

Forecasting is essential to assess how much the budget should be. Various techniques and tools can be used to help forecast costs. While no technique is a guarantee, using a standard tool will help you be more consistent in forecasting.

In this module, the following forecasting techniques will be discussed:

• Using the average
• Regression analysis
• Extrapolation
• Forma financial models

Using averages helps in forecasting. So that is our next topic.  

Using the Average

Taking the average of actual yearly numbers can help to forecast what the next budget could be. Of course, you may need to factor in economic data like inflation or increases in taxes. Averaging the numbers is an easy process when using a spreadsheet program.

You can use information from the past five years and average them. You can also average the percent change between the years to determine how much to increase the new budget for the new term.

Regression Analysis

Regression analysis is a statistical tool used to find the relationships between variables. This tool is used to predict future values. Using this tool as a method of forecasting requires knowledge of statistics. You may not use this tool yourself, but understanding that this is a forecasting tool could help you find resources and experts when you need to make forecasts.  

Extrapolation

An extrapolation is a mathematical tool using historical data to determine what will happen in the future. Using this tool as a method of forecasting requires knowledge of advanced mathematics. You may not use this tool yourself, but understanding that this is a forecasting tool could help you find resources and experts when you need to make forecasts.  

Formal Financial Models

When determining capital budgets, there are formal financial models used by accounting to determine specific numbers. However, having a basic understanding of what is calculated and how they are determined will allow you to hold meaningful discussions with employees and managers that deal with this regularly.

The following are some formal models:

• Accounting rate of return
• Net present value
• Profitability index
• Internal rate of return
• Modified internal rate of return
• Equivalent annuity

Lesson Summary

Advanced forecasting techniques are essential for budgeting and allow for accurate cost predictions. This module covers several techniques to help users make informed forecasting decisions, including: - Taking the average of actual yearly numbers - Regression analysis - Extrapolation - Formal financial models, such as accounting rate of return, net present value, profitability index, internal rate of return, modified internal rate of return, and equivalent annuity.