Forecasting

Eight Steps to Forecasting

 Determine the use of the forecast
 What objective are we trying to obtain?
 Select the items or quantities that are to be forecasted.
 Determine the time horizon of the forecast.
 Short time horizon – 1 to 30 days
 Medium time horizon – 1 to 12 months
 Long time horizon – more than 1 year
 Select the forecasting model or models
 Gather the data to make the forecast.
 Validate the forecasting model
 Make the forecast
 Implement the results
Forecasting Models
Forecasting
Techniques

Qualitative Time Series

Models Methods

Delphi
Naive
Method
Moving
Jury of Executive
Average
Opinion
Weighted
Sales Force
Moving Average
Composite
Exponential
Consumer Market
Smoothing
Survey

Trend Analysis
Causal
Methods
Seasonality
Simple Analysis
Regression
Analysis Multiplicative
Decomposition
Multiple
Regression
Analysis
Model Differences
 Qualitative – incorporates judgmental &
subjective factors into forecast.
 Time-Series – attempts to predict the
future by using historical data.
 Causal – incorporates factors that may
influence the quantity being forecasted
into the model
Qualitative Forecasting Models
 Delphi method
 Iterativegroup process allows experts to make
forecasts
 Participants:
 decision makers: 5 -10 experts who make the forecast
 staff personnel: assist by preparing, distributing, collecting,
and summarizing a series of questionnaires and survey
results
 respondents: group with valued judgments who provide input
to decision makers
Qualitative Forecasting Models (cont)
 Jury of executive opinion
 Opinions of a small group of high level managers, often in
combination with statistical models.
 Result is a group estimate.
 Sales force composite
 Each salesperson estimates sales in his region.
 Forecasts are reviewed to ensure realistic.
 Combined at higher levels to reach an overall forecast.
 Consumer market survey.
 Solicits input from customers and potential customers regarding
future purchases.
 Used for forecasts and product design & planning
Forecast Error Forecast Error  At  Ft

 Bias - The arithmetic sum of T

the errors MSE  

t 1
| forecast error | 2
/T
 Mean Square Error - Similar to T
simple sample variance   (At  Ft ) 2 / T
 Variance - Sample variance t 1
(adjusted for degrees of
freedom)
 Standard Error - Standard
deviation of the sampling
distribution T T
 MAD - Mean Absolute MAD   | forecast error | /T   |At  Ft | / T
Deviation t 1 t 1
 MAPE – Mean Absolute
Percentage Error T
MAPE  100 [|At  Ft | / At ] / T
t 1
 Quantitative Forecasting Models
 Time Series Method
 Naïve
 Whatever happened
recently will happen
again this time (same
Ft  Yt 1
time period)
 The model is simple
and flexible
 Provides a baseline to
Ft  Yt  4 : Quarterly data
measure other models Ft  Yt 12 : Monthly data
 Attempts to capture
seasonal factors at the
expense of ignoring
trend
Naïve Forecast
Wallace Garden Supply
Forecasting
Storage Shed Sales

Actual Naïve Absolute Percent Squared

Period Value Forecast Error Error Error Error
January 10 N/A
February 12 10 2 2 16.67% 4.0
March 16 12 4 4 25.00% 16.0
April 13 16 -3 3 23.08% 9.0
May 17 13 4 4 23.53% 16.0
June 19 17 2 2 10.53% 4.0
July 15 19 -4 4 26.67% 16.0
August 20 15 5 5 25.00% 25.0
September 22 20 2 2 9.09% 4.0
October 19 22 -3 3 15.79% 9.0
November 21 19 2 2 9.52% 4.0
December 19 21 -2 2 10.53% 4.0
0.818 3 17.76% 10.091
BIAS MAD MAPE MSE

Standard Error (Square Root of MSE) = 3.176619

Naïve Forecast Graph
Wallace Garden - Naive Forecast

25

20

15
Actual Value
Sheds

Naïve Forecast
10

0
February March April May June July August September October November December
Period
 Quantitative Forecasting Models
 Time Series Method
 Moving Averages
 Assumes item
forecasted will stay
steady over time.
 Technique will smooth
out short-term
irregularities in the time
series.
k
k - period moving average   (Actual value in previous k periods) /k
k 1
Moving Averages
Wallace Garden Supply
Forecasting
Storage Shed Sales

Actual
Period Value Three-Month Moving Averages
January 10
February 12
March 16
April 13 10 + 12 + 16 / 3 = 12.67
May 17 12 + 16 + 13 / 3 = 13.67
June 19 16 + 13 + 17 / 3 = 15.33
July 15 13 + 17 + 19 / 3 = 16.33
August 20 17 + 19 + 15 / 3 = 17.00
September 22 19 + 15 + 20 / 3 = 18.00
October 19 15 + 20 + 22 / 3 = 19.00
November 21 20 + 22 + 19 / 3 = 20.33
December 19 22 + 19 + 21 / 3 = 20.67
Moving Averages Forecast
Wallace Garden Supply
Forecasting 3 period moving average
Actual Value - Forecast

Input Data Forecast Error Analysis

Absolute Squared Absolute
Period Actual Value Forecast Error error error % error
Month 1 10
Month 2 12
Month 3 16
Month 4 13 12.667 0.333 0.333 0.111 2.56%
Month 5 17 13.667 3.333 3.333 11.111 19.61%
Month 6 19 15.333 3.667 3.667 13.444 19.30%
Month 7 15 16.333 -1.333 1.333 1.778 8.89%
Month 8 20 17.000 3.000 3.000 9.000 15.00%
Month 9 22 18.000 4.000 4.000 16.000 18.18%
Month 10 19 19.000 0.000 0.000 0.000 0.00%
Month 11 21 20.333 0.667 0.667 0.444 3.17%
Month 12 19 20.667 -1.667 1.667 2.778 8.77%
Average 12.000 2.000 6.074 10.61%
Next period 19.667 BIAS MAD MSE MAPE
Moving Averages Graph
Three Period Moving Average

25

20

15

Actual Value
Value

Forecast

10

0
1 2 3 4 5 6 7 8 9 10 11 12
Time
 Quantitative Forecasting Models
 Time Series Method
 Weighted Moving Averages
 Assumes data from some periods are more
important than data from other periods (e.g.
earlier periods).
 Use weights to place more emphasis on some
periods and less on others.

k - period weighted moving average 

k k

 (Weight for each period i)(Actual value in previous k periods) /  (weights)

i 1 i 1
Weighted Moving Average
Wallace Garden Supply
Forecasting
Storage Shed Sales

Actual
Period Value Weights Three-Month Weighted Moving Averages
January 10 0.222
February 12 0.593
March 16 0.185
April 13 2.2 + 7.1 + 3 / 1 = 12.298
May 17 2.7 + 9.5 + 2.4 / 1 = 14.556
June 19 3.5 + 7.7 + 3.2 / 1 = 14.407
July 15 2.9 + 10 + 3.5 / 1 = 16.484
August 20 3.8 + 11 + 2.8 / 1 = 17.814
September 22 4.2 + 8.9 + 3.7 / 1 = 16.815
October 19 3.3 + 12 + 4.1 / 1 = 19.262
November 21 4.4 + 13 + 3.5 / 1 = 21.000
December 19 4.9 + 11 + 3.9 / 1 = 20.036

Next period 20.185

Sum of weights = 1.000

Weighted Moving Average
Wallace Garden Supply
Forecasting 3 period weighted moving average

Input Data Forecast Error Analysis

Absolute Squared Absolute
Period Actual value Weights Forecast Error error error % error
Month 1 10 0.222
Month 2 12 0.593
Month 3 16 0.185
Month 4 13 12.298 0.702 0.702 0.492 5.40%
Month 5 17 14.556 2.444 2.444 5.971 14.37%
Month 6 19 14.407 4.593 4.593 21.093 24.17%
Month 7 15 16.484 -1.484 1.484 2.202 9.89%
Month 8 20 17.814 2.186 2.186 4.776 10.93%
Month 9 22 16.815 5.185 5.185 26.889 23.57%
Month 10 19 19.262 -0.262 0.262 0.069 1.38%
Month 11 21 21.000 0.000 0.000 0.000 0.00%
Month 12 19 20.036 -1.036 1.036 1.074 5.45%
Average 1.988 6.952 6.952 10.57%
Next period 20.185 BIAS MAD MSE MAPE

Sum of weights = 1.000

Quantitative Forecasting Models
 Time Series Method
 Exponential Smoothing
 Moving average technique that requires little
record keeping of past data.
 Uses a smoothing constant α with a value between

0 and 1. (Usual range 0.1 to 0.3)

Forecast for period t 

forecast for period t - 1   (actual value in period t - 1 - forecast for period t - 1)
Exponential Smoothing Data
Wallace Garden Supply
Forecasting
Storage Shed Sales

Exponential Smoothing
Actual
Period Value Ft α At Ft Ft+1
January 10 10 0.1
February 12 10 + 0.1 *( 10 - 10 ) = 10.000
March 16 10 + 0.1 *( 12 - 10 ) = 10.200
April 13 10 + 0.1 *( 16 - 10 ) = 10.780
May 17 11 + 0.1 *( 13 - 11 ) = 11.002
June 19 11 + 0.1 *( 17 - 11 ) = 11.602
July 15 12 + 0.1 *( 19 - 12 ) = 12.342
August 20 12 + 0.1 *( 15 - 12 ) = 12.607
September 22 13 + 0.1 *( 20 - 13 ) = 13.347
October 19 13 + 0.1 *( 22 - 13 ) = 14.212
November 21 14 + 0.1 *( 19 - 14 ) = 14.691
December 19 15 + 0.1 *( 21 - 15 ) = 15.322
Exponential Smoothing
Wallace Garden Supply
Forecasting Exponential smoothing

Input Data Forecast Error Analysis

Absolute Squared Absolute
Period Actual value Forecast Error error error % error
Month 1 10 10.000
Month 2 12 10.000 2.000 2.000 4.000 16.67%
Month 3 16 10.838 5.162 5.162 26.649 32.26%
Month 4 13 13.000 0.000 0.000 0.000 0.00%
Month 5 17 13.000 4.000 4.000 16.000 23.53%
Month 6 19 14.675 4.325 4.325 18.702 22.76%
Month 7 15 16.487 -1.487 1.487 2.211 9.91%
Month 8 20 15.864 4.136 4.136 17.106 20.68%
Month 9 22 17.596 4.404 4.404 19.391 20.02%
Month 10 19 19.441 -0.441 0.441 0.194 2.32%
Month 11 21 19.256 1.744 1.744 3.041 8.30%
Month 12 19 19.987 -0.987 0.987 0.973 5.19%
Average 2.608 9.842 14.70%
Alpha 0.419 MAD MSE MAPE

Next period 19.573

Exponential Smoothing
Exponential Smoothing

25

20

15
Sh ed s

Actual value
Forecast

10

0
Trend & Seasonality
 Trend analysis
 technique that fits a trend equation (or curve) to a series of
historical data points.
 projects the curve into the future for medium and long term
forecasts.
 Seasonality analysis
 adjustment to time series data due to variations at certain
periods.
 adjust with seasonal index – ratio of average value of the item in
a season to the overall annual average value.
 example: demand for coal & fuel oil in winter months.
Linear Trend Analysis
Midwestern Manufacturing Sales

Sales(in units) vs. Time

Scatter Diagram 160

Actual Period 140

value (or) number
Y (or) X 120
74 1995
79 1996 100
80 1997
90 1998 80 Period number (or) X
105 1999
142 2000 60
122 2001
40
20
0
1994 1996 1998 2000 2002
Least Squares for Linear Regression
Midwestern Manufacturing
Least Squares Method
Values of Dependent Variables

Time
Least Squares Method
^
Y  a  bX
Where

^
Y = predicted value of the dependent variable (demand)

X = value of the independent

variable (time)

_ _
a = Y-axis intercept
[ XY - n X Y ]
b= 
b = slope of the regression line 2
_


2
X - n X 
 
Linear Trend Data & Error Analysis
Midwestern Manufacturing Company
Forecasting Linear trend analysis

Input Data Forecast Error Analysis

Actual value Period number Absolute Squared Absolute
Period (or) Y (or) X Forecast Error error error % error
Year 1 74 1 67.250 6.750 6.750 45.563 9.12%
Year 2 79 2 77.786 1.214 1.214 1.474 1.54%
Year 3 80 3 88.321 -8.321 8.321 69.246 10.40%
Year 4 90 4 98.857 -8.857 8.857 78.449 9.84%
Year 5 105 5 109.393 -4.393 4.393 19.297 4.18%
Year 6 142 6 119.929 22.071 22.071 487.148 15.54%
Year 7 122 7 130.464 -8.464 8.464 71.644 6.94%
Average 8.582 110.403 8.22%
Intercept 56.714 MAD MSE MAPE
Slope 10.536

Next period 141.000 8

Least Squares Graph
Trend Analysis

160

140

y = 10.536x + 56.714
120

100
Value

80

60

40

20

0
1 2 3 4 5 6 7
Tim e

Actual values Linear (Actual values)

Seasonality Analysis
Ratio = demand / average demand
Eichler Supplies
Average Seasonal
Year Month Demand Demand Ratio Index
1 January 80 94 0.851 0.957
February 75 94 0.798 0.851
Seasonal Index – ratio of the
March 80 94 0.851 0.904 average value of the item in a
April 90 94 0.957 1.064 season to the overall average
May 115 94 1.223 1.309
June 110 94 1.170 1.223 annual value.
July 100 94 1.064 1.117
August 90 94 0.957 1.064 Example: average of year 1
September 85 94 0.904 0.957
October 75 94 0.798 0.851 January ratio to year 2 January
November 75 94 0.798 0.851 ratio.
December 80 94 0.851 0.851
(0.851 + 1.064)/2 = 0.957
2 January 100 94 1.064
February 85 94 0.904
March 90 94 0.957
April 110 94 1.170 If Year 3 average monthly demand is
May 131 94 1.394
June 120 94 1.277 expected to be 100 units.
July 110 94 1.170 Forecast demand Year 3 January:
August 110 94 1.170 100 X 0.957 = 96 units
September 95 94 1.011 Forecast demand Year 3 May:
October 85 94 0.904
November 85 94 0.904
100 X 1.309 = 131 units
December 80 94 0.851
Deseasonalized Data
 Going back to the conceptual model, solve
for trend:
 Trend = Y / Season
(96 units/ 0.957 = 100.31)
 This eliminates seasonal variation and
isolates the trend
 Now use the Least Squares method to
compute the Trend
Forecast
 Now that we have the Seasonal Indices
and Trend, we can reseasonalize the data
and generate the forecast
 Y = Trend x Seasonal Index