A good forecast should satisfy the following criteria:
- Time frame: The first factor that can influence the choice of forecasting is the time frame of the forecasting situation. Forecasts are generally for points in time that may be a number of days, weeks, months, quarters, or years in the future. This length of time is called the time frame or time horizon. The length of the time frame is usually categorized as Immediate, Short term, Medium or Long term. In general, the length of the time frame will influence the choice of the forecasting technique. Typically a longer time frame makes accurate forecasting more difficult with qualitative forecasting techniques becoming more useful as the time frame lengthens.
- Pattern of the data: The pattern of the data must also be considered when choosing a forecasting model. The components present i.e. trend, cycle, seasonal or some combination of these will help determine the forecasting model that will be used. Thus it is extremely important to identify the existing data pattern.
- Cost/Economy of forecasting: Though the firm is interested in accurate forecasts, the benefits of accurate results must be weighed against the cost of the method. While choosing a forecasting technique, several costs are relevant. First, the cost of developing the model must be considered. Second the cost of storing the necessary data must be considered. Some forecasting methods require the storage of a relatively small amount of data, while other methods require the storage of large amounts of data. Last, the cost of the actual operation of the forecasting technique is obviously very important. Some forecasting methods are operationally simple, while others are very complex. The degree of complexity can have a definite influence on the total cost of forecasting.
- Accuracy desired: Accuracy in forecasting is very important. The previous method must be checked for want of accuracy by observing that the predictions made in the past are accurate or not. The accuracy of past forecasting can be checked against present performance and of present forecasts against future performance. In some situations a forecast that is in error by as much as 20% may be acceptable. In other situations a forecast that is in error by 1% might be disastrous. The accuracy that can be obtained using any particular forecasting method is always an important consideration.
- Availability of data: Immediate availability of data is an important requirement and the method employed should be able to produce good results quickly. The technique which takes much time to produce useful information is of no use. Historical data on the variable of interest are used when quantitative forecasting methods are employed. The availability of this information is a factor that may determine the forecasting method to be used. Since various forecasting methods require different amounts of historical data, the quantity of data available is important. Beyond this, the accuracy and the timeliness of the data that are available must be examined, since the use of inaccurate or outdated historical data will obviously yield inaccurate predictions. If the needed historical data are not available, special data-collection procedures may be necessary.
- Plausibility/Ease of operation and understanding: The ease with the forecasting method is operated and understood is important. Management must be able to understand and have confidence in the technique used. It has to understand clearly how the estimate was made. Mathematical and statistical techniques should be avoided if the management cannot understand what the forecaster does. Managers are held responsible for the decisions they make and if they are to be expected to base their decisions on predictions, they must be able to understand the techniques used to obtain these predictions. A manager simply will not have confidence in the predictions obtained from a forecasting technique he or she does not understand, and if the manager does not have confidence in these predictions, they will not be used in the decision-making process. Thus, the managers understanding of the forecasting system is of crucial importance.
- Durability: The forecast should be durable and should not be changed frequently. The durability of the forecasts depends on the simplicity and ease of comprehension as well as on continuous link between the past and the present and between present and the future.
- Flexibility: The technique used in forecasting must be able to accommodate and absorb frequent changes occurring in the economy.
Credit: Managerial Economics-MGU