Demand Forecasting – Meaning, Scope, Types and Importance – Managerial Economics

Posted on Jun 4 2020 - 1:41pm by Preeti

Importance of Demand Forecasting

Forecasting of demand by some technique or the other is highly essential. An entrepreneur can forecast on the basis of hunch or intuition or personal judgement. Alternatively he can employ more definite methods which can bring down demand forecasts in measurable terms.
An organised forecasting system play not be necessary as long as the concerned firms are small and their operations are simple. The estimates of demand in case of small firms can safely be left to the guess-work and foresight of the entrepreneurs themselves. But as a business unit grows in size, in complexity and in diversity of its products and processes, forecasting becomes a specialized and a separate function of management. The necessity of forecasting can be summarised as follows :

1. Achievement of Planned Objectives
Every firm aims at certain predetermined objectives. For attainment of these objectives, the firm needs a reasonably accurate forecast of trends in the economy ill general, and of its sales income in particular.

2. Preparing a Budget
Every firm has to prepare a well conceived budget incorporating costs of production and expected earnings. The expectations of earnings must be backed by a forecast of annual sales and prices. Such a budget enables the firm to control its costs and to reduce the area of avoidable risks. Such a systematic exercise is also better than personal judgement of the entrepreneur as a guide to business.

3. Stabilization of Production and Employment
Market demand fluctuates due to seasonal, cyclical and erratic changes in the situation but the level of production cannot be changed every now and then. If an annual forecast of demand is ready, a plan of production can be prepared for the whole year and seasonal variations can be met by depletion or replenishment of stocks. This policy would also enable the firm to maintain a stable labour force. Such a stable labour force is essential because one cannot recruit and retrench workers at will, following variations in market conditions.

4. Future Expansion
Every firm has to think in terms of its plans of expansion in future. Such a long term plan has to be based upon forecasts of demand.

5. Long-term Investment Programmes
Expansion plans for the future, necessitate a long-term programme of investment as well as a plant of future recruitment. For example, a firm has to consider various alternatives of raising funds as well as alternatives of deploying these funds. Similarly, future requirement of personnel must be anticipated so as to evolve satisfactory programmes of training and apprenticeship.

6. Sales Budgeting
Demand forecasting is crucial for sales budgeting. It determines production and inventory plans, the level of costs and the level of employment. Sales budgets are also useful in computing standard costs, in establishing profit goals and in preparation of capital budgets, future cash flows and sources of funds. Sales forecasts and sales budget act as regulators of a firm’s operations and serve to improve the quality of business decisions.

7. Control of Inventories
A satisfactory method of control of raw materials semi finished products, finished goods, spare parts and work-in-process must depend upon a satisfactory estimate of future requirements and availability of all these as well as their estimated prices. The use of standard costing for the purposes of setting prices and controlling costs depends upon a satisfactory forecast of demand. Thus forecasting can be of great help in introducing business discipline and scientific management.

Limitations of demand forecasting

The following are the limitations of demand Forecasting:

1. Change in fashion
Change in fashion is an inevitable consequence of advancement of civilization. Results of demand forecasting have short lasting impacts in a dynamic business environment.

2. Consumers’ Psychology
Results of forecasting depend largely on consumers’ psychology, understanding which itself is difficult. Thus demand forecasting becomes an uphill task.

3. Uneconomical
forecasting requires collection of data in huge volumes and their analysis, which may be too expensive for small firms to afford. Moreover, estimation process may take a lot of time, which may not always be affordable by firms.

4. Lack of Experts
Accurate forecasting necessitates experienced experts, who may not be easily available. Forecasting by less experienced individuals may lead to erroneous estimates.

5. Lack of Past Data
Demand forecasting requires past sales data, which may not be correctly available. This may be a typical problem in case of forecasting for a new product.

Criteria for a Good Method of Demand-Forecasting

There are various methods-of demand-forecasting. Out of these alternative methods available to a firm, it has to choose the best method. Which method would be the best ? For answering this question we can outline the following criteria, which would serve as parameters for testing the various methods of demand forecasting.

1. Plausibility
The method of demand forecasting should be intelligible to the executives who are going to use it. At the same time they should feel confident that the technique used by a method will be helpful to them in formulating a particular forecast.

2. Simplicity
Various mathematical and economic models can be used with an advantage but they are highly sophisticated and complex. Majority of these models therefore are not acceptable to small and medium-sized firms. Such models may be used by national and multinational corporations because they can afford to have special cells for demand-forecasting. -Majority of the managements however require a method which is simple and easy to understand.

3. Economy
Techniques of demand forecasting involve costs. These costs must be weighed against returns. A method yielding high level of accruals but involving huge amount of costs may not be acceptable simply on grounds of costs.

4. Accuracy
Accuracy is the most important criterion of a demand forecast, even though cent percent accuracy about the future demand the future demand cannot be assured. It is generally measured in terms of the past forecasts on the present sales and by the number of times it is correct.

5. Durability
Durability of demand forecast depends on the relationships of the variables considered and the stability underlying such relationships, as for instance, the relation between price and demand, between advertisement and sales, between the level of income and the volume of sales, and so on.

6.Flexibility
There should be scope for adjustments to meet the changing conditions. This imparts durability to technique.

7. Availability of data
Immediate availability of required data is of vital importance to business. It should be made available on up-to-date basis. There should be scope for making changes in the demand relationships as they occur.

8. Quickness
It should be capable of yielding quick and useful results. This helps the management to take quick and effective decisions.

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