Financial Modelling and Forecasting
Lecture 1 Introduction and Descriptive Statistics

The need for forecasts
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A forecast helps deal with an uncertain future by making decisions today No single forecasting method will lead to an accurate forecast. Forecasts can be wrong! “What’s the point of forecasting?”
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A business requires predictions as inputs
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E.g., Inventory, Personnel, Ordering, Production planning.

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Governments require forecasts to guide monetary and fiscal policy
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Forecasting Considerations
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Application to Finance
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A sensible forecast allows proactive decisions to be made today
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Without it, management decisions are reactive.

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Need to ensure sales forecasts can actually be satisfied Eliminate bias Sometimes forecasting can be too difficult Correct model selection is an important factor
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Financial management decisions are often classified into Investment and Financing The investment decision relates to the analysis and selection of ‘good’ assets
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One critical input the CFO must consider are the future sales of a new project Financial analysts value a business by forecasting the future cash flows of the entire firm
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The entire firm is a just collection of assets
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Not all relationships are linear
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Quantitative Forecasting
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Example
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Forecasts can be classified as quantitative or qualitative. Quantitative forecasting is applicable when:
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Predict the next number in the pattern: 5.7, 5.7, 5.7 17.5

a) 5.7, 5.7, 5.7,

Historical information is available The data can be quantified in numerical form Past behaviour is likely to continue in the future

b) 2.5, 5.5, 8.5, 11.5, 14.5,

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The last point is an underlying assumption of all forecasting methods Quantitative forecasting is