As a manufacturer, one of your main goals is balancing the right amount of product in stock. With too little, you run at inopportune times, which causes customers to purchase elsewhere. With too much, you pay unnecessarily high costs for inventory management.
To find a reliable middle ground, you need to implement supply, demand, and price forecasting practices:
- Supply forecasting analyzes data about your suppliers, including their supply of complete products, parts, or raw materials, and uses it to project how much they will have available.
- Demand forecasting analyzes the amount of product that your customers are likely to purchase during a specific week, month, or quarter.
- Price forecasting analyzes the data related to supply and demand to determine how each factor will affect prices.
Ultimately, implementing the proper methods for price forecasting can be one of the most accurate and reliable ways to determine future revenue.
The Top Three Types of Price Forecasting Methods
There are three primary methods of forecasting in financial analysis that are used to predict future revenues, expenses, and capital costs for a business: straight-line, moving average, and regression analysis.
The straight-line method is one of the simplest and easiest-to-follow forecasting methods. This method measures constant growth rate by analyzing historical data to predict future revenue growth.
Here is an example of straight-line forecasting:
- A procurement team for a manufacturing company assumes that paper and pulp prices increase by 5% for the next five years based on historical performance.
- An analyst takes the previous year’s revenue and multiples it by the growth rate to forecast revenue.
- The forecasted earnings are multiplied by 5% until you arrive at the final year in your determined timeline.
Not only is this method easy to use, but it also tends to have a high accuracy rating for a broader predictive field.
Moving averages is a smoothing technique that analyzes a set of data to establish an estimate of future values and prices.
Typically, analysts look at moving averages for three-month and five-month periods:
- A three-month moving average is calculated by taking the revenue average of the current and past two months.
- Similarly, a five-month moving average forecasts revenue of the current and previous four months.
Translating this information to a line chart shows the difference between actual and moving average forecasted revenue values. With enough historical data, analysts can better understand pricing patterns during certain times of the year, which allows a procurement department to make more informed purchasing decisions.
Regression analysis establishes relationships between two or more independent inputs with a dependent output by using a statistical process and a sample of relevant observations.
Say you want to determine the price quote by a supplier for routes of a transportation network. In this example:
- The price quote is your dependent variable.
- Distance traveled, fuel cost, and maintenance costs are your independent variables.
With this analysis, you can:
- Better understand the logic behind the supplier’s pricing.
- Identify where to concentrate on creating an optimal negotiation situation.
- Predict the costs of new independent variables.
- Determine changes to future budgets.
Advantages Derived from Price Forecasting Data
Once price forecasting has been determined, procurement teams have an advantage in supplier negotiations. Accurate forecasts can inform procurement strategies in the following ways:
- Time buys: By identifying the best time to purchase raw materials, you can avoid price increases later.
- Cost benchmarking: By evaluating costs, market conditions, and regional price differences, you can have more informed market opportunities.
- Market intelligence: Quantifying key inputs and examining critical supply issues provides a more valuable insight into the market.
- Evaluated pricing: Contract negotiations can improve cost planning, analysis, and savings over the life of a contract.
- Identified sourcing partners: Determine the stability and reliability of long-term sourcing partners and diversify rules and partners in your cost-saving strategy.
- Insight into a changing supply chain: Nearly every item on the bill of procured materials is increasing due to several factors, including the impact of natural disasters, requiring new perspectives on the supply chain to avoid eroding margins.
To receive the advantages from accurate price forecasting, you need eyes in the market daily.
Gain Price Forecasting Insights from a Strategic Growth Partner
In a strategic growth partnership with SRM, you will work with experienced procurement consultants who create forecasting strategies that are derived from their daily exposure to the market. We can help find the cost savings you might be leaving on the table with more accurate price forecasting.
Ready to grow with a new price forecasting strategy? Request a consultation today.