II. FORECASTING Forecasting is the art and science of predicting future events. Forecast is a statement about the future.

Forecasts can help managers by reducing some of the uncertainties that cloud the planning horizon, making it difficult for a manager to plan effectively. Business forecasting pertains to more than predicting demand. Forecasts are also used to predict profits, revenues, costs, productivity changes, prices and availability of energy and raw materials, interest rates, movements of economic indications, and prices of stocks and bonds, as well as other variables. There are two uses of forecasts. 1. plan the system 2. plan the use of the system Features Common to All Forecasts 1. Forecasting techniques generally assume that the same underlying causal system that existed in the past will continue to exist in the future. 2. Forecasts are rarely perfect; predicted values usually differ from actual results 3. Forecasts for group of items tend to be more accurate than forecasts for individual items 4. Forecast accuracy decreases as the time period covered by the forecast increases. Elements of a Good Forecast 1. The forecast should be timely 2. The forecast should be accurate and the degree of accuracy should be stated 3. The forecast should be reliable 4. The forecast should express in meaningful units 5. The forecast should be in writing 6. The forecasting technique should be simple to understand and use Steps in the Forecasting Process 1. Determine the purpose of the forecast and when it will be needed 2. Establish a time horizon that the forecast must cover 3. Select a forecasting technique 4. Gather and analyze the appropriate data and then prepare the forecast. 5. Monitor the forecast Approaches to Forecasting I. Qualitative Forecast

A. Judgmental Forecasts rely on analysis of subjective inputs obtained from various sources, such as consumer surveys, the sales staff, managers, and executives, panels of experts etc. B. Associative Model forecasting technique that uses explanatory variables to product future demand.

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1. Executives Opinion often used as a part of long-range planning and new product development 2. Sales Force Composite is a good source of information because of its direct contrast with consumers 3. Consumer Surveys It can tap information that might not be available elsewhere 4. Outside Opinion this may concern advice on political or economic conditions is a foreign country or some other aspects of interest with which an organization lacks familiarity 5. Opinions of Managers and Staff At times, a manager may solicit from a number of other managers and/or staff. The Delphi Method is useful in this regard. II. Quantitative Forecast time series a time ordered sequence of observations taken at regular intervals over time. Plotting the data and visually examining the plot. - Forecast based on Historical Data a technique that depends on uncovering relationships between variables that can be used to predict future values of one of them. - Averaging Technique generate forecasts that reflect recent values of a timeseries - Trend long term upward of downward movement in a data 1. Seasonal short-term regular variations related to weather or other factors 2. Cyclical wavelike variation lasting more than one year 3. Irregular variations caused by unusual circumstances not by reflective or typical behavior 4. Random residual variations after all other behaviors are accounted for.

A. Nave Forecast a forecast for any period equals the previous periods actual value. B. Moving Average making use of the most recent data to get the forecast. Moving average = Demand in previous n periods n Where: n is the number of period in the moving average Example: Compute a three-period moving average forecast given the following demand for cars for the last five periods. Demand Supply 1 70 2 80 3 65 4 90 5 85 C. Weighted Moving Average weight can be used to place more emphasis in recent values, when there is a trend or pattern. This makes the technique more responsive to changes since more recent period may be more heavily weighted.

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A Weighted Moving Average = (weight for period n)(demand in period n) Weights

Example: Compute a three-period weighted moving average forecast given the following demand for cars for the last five periods; with an assigned weight of 1, 2, and 3. Demand Supply 1 70 2 80 3 65 4 90 5 85 D. Exponential Smoothing Each new forecast is based on the previous forecast plus a percentage of the difference between that forecast and the actual value of the series at that point. New forecast = Last Periods Forecast + (Last Periods Actual Demand Last Periods Forecast) Where: represents the value of a weighing factor smoothing factor value is 0 and 1. Ft = Ft 1 + [At 1 Ft - 1] Where: Ft the new forecast or forecast for period Ft-1 the previous forecast or forecast for period t-1 - smoothing constant At-1 actual demand or sales for period t-1 The smoothing constant, , represents percentage of the forecast error. Each new forecast is equal to the previous forecast plus a percentage of the previous error. Example: 1. A car dealer predicted a January demand for Honda V-tech cars. Actual January demand was 680 Honda V-tech cars and = 0.10. Forecast demand for January would be? 2. Use exponential smoothing model to develop a series of forecast for the following data and compute. a. use a smoothing factor of 0.10 b. use a smoothing factor of 0.40 c. plot the actual data and both sets of forecasts on a single graph PERIOD ACTUAL DEMAND 1 50 2 52 3 48 4 51 5 50 6 54 7 52 8 50 9 55 10 53 Mark J. Santiago; Pamantasan ng Lungsod ng Valenzuela Page 3

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E. Trend Line Forecast a linear trend equation has the form Yt = a + bt Where: t - specified number of time periods from t = 0 Yt - forecast for period t a - value of Yt at t = 0 b - slope of the line the coefficient of the line a and b can be computed using two equations: b = nty - t y nt2 (t)2 y - bt n

where: n number of periods y value of the time series Example: 1. The total sales of television sets of a Manila-based firm over the last 10 weeks is shown in the following table. Plot the data, and visually check if a linear trend line would be appropriate. Then determine the equation of the line and predict the sale for weeks 11 and 12. WEEK 1 2 3 4 5 6 7 8 9 10 UNIT SALES 800 810 830 820 850 810 825 840 805 830

F. Simple Linear Regression the simple and most widely used for of regression involves a linear relationship between two variables. The objective in linear regression is to obtain an equation of a straight line that minimizes the sum of equation vertical deviations of points around the line. This least squares line has the equation: Mark J. Santiago; Pamantasan ng Lungsod ng Valenzuela Page 4

Yt = a + bX Where: Yt predicted (dependent) variable X predictor (independent) variable b slope of the line a value of Yt when X = 0 (Note that it is conventional to represent values of the predicted variable on the y axis and values of the predictor variable on the x axis). The coefficients a and b of the line are computed using these two equations: b = n(xy) (x) (y) n(x2) (x)2 a = y b (x) n or a = y bx where: n number of period observations Example: 1. Mark Hamburgers has a chain of 10 stores in Metro Manila. Sales figures and profiles for the stores are given in the following table. Obtain a regression line for the data, and predict profit for a store assuming sales of 30 million. SALES, x PROFITS, y (millions) (millions) 15 8 17 9 21 13 18 10 19 11 22 14 16 8.5 17 10 25 15 20 13

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