BUSINESS INTELLIGENCE ANALYTICS

Forecasting Models

Learning Objectives
1. Explain the importance of forecasting in 2. 3. 4. 5.

6.
7.

organizations. Describe the three major approaches to forecasting. Use a variety of techniques to make forecasts. Measure the accuracy of a forecast over time using various methods. Determine when a forecast can be improved. Discuss the main considerations in selecting a forecasting technique. Utilize Excel to solve various forecasting problems.

Importance of Forecasting
Forecasting
is important because it helps reduce uncertainty. provides decision makers with an improved picture

of probable future events and, thereby, enable decision makers to plan accordingly. is used for planning the system itself. is used for planning the use of the system

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The Forecasting Process
1. Determine the purpose of the forecast. 2. Determine the time horizon. 3. Select an appropriate technique. 4. Identify the necessary data, and gather it if

necessary. 5. Make the forecast. 6. Monitor forecast errors in order to determine if the forecast is performing adequately. If it is not, take appropriate corrective action.

Categories of Forecast
Qualitative Forecasts
are based on judgment and/or opinion rather than

on the analysis of hard data.

Forecasts That Use Time Series Data
involve the assumption that past experience reflects

probable future experience (i.e., the past movements or patterns in the data will persist into the future).
Explanatory Models
incorporate one or more variables that are related

to the variable of interest and, therefore, they can be used to predict future values of that variable.

Selecting a Particular Technique

Factors affecting the choice of the forecasting

technique to be used:
the importance (purpose) of the forecast the desired accuracy of the forecast the cost of developing the forecast

resources available to support and conduct the

forecasting process the planning horizon (long- or short-term) the sophistication of the users of the forecast A good rule is to choose the simplest technique that gives acceptable results.

Forecasting approaches

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Graphs to understand pattern

Data with trend and seasonal Variation

Averaging applied to smoothen data

Problem 1

A moving average data change helps to smoothen the data

Problem 2

How to solve on spreadsheet

Moving Average

Relative Weights in Exponential Smoothing

Exponential Smoothing
This is an averaging technique that reduces these

difficulties In addition, the weights given to previous values are not equal; instead, they decrease with the age of the data The exponential smoothed forecast can be computed using this formula: Ft = Ft-1 + ( At-1 F t-1) Where Ft= the forecast for period t F t-1= the forecast for period t-1 = smoothing constant (it should be Greek alpha ) At-1= actual demand or sales for period t-1

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The smoothing constant, , represents a

percentage of the forecast error. Each new forecast is equal to the previous forecast plus a percentage of the previous error. For example, forecast is 100 units, actual demand is 90 units, and = .10. The new forecast computed would be as follows: Ft= 100 + .10(90-100)= 99 Suppose next actual demand turns out to be 102, then the next forecast would be Ft=99 + .10(102-99)= 99.3

Exponential Smoothing Input, Output and Chart

Techniques for trend analysis

Trend is a persistent upward and downward

movement in a time series. The trend may be linear or non linear. There are two important techniques that can be used to develop forecasts when trend is present. One involves use of a trend equation and other is an extension of exponential smoothing.

Trend equation
Yt= + bt

t= a specified number of time periods from t=0 Yt= the forecast for period t = value of yt at t=0 b= slope of line

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The model is a Simple Regression model. To define

the relationship between Y and t, we need to know the value of coefficients a and b, which are estimates of and . and represents population of parameters which are almost always unknown. is the y intercept (the expected value of the dependent variable when t is zero) is the slope and indicates the amount of change in Y per unit change in t. We need to find a straight line or trend which fits well with data The best fit can be defined as the line that minimizes the sum of the squared difference between the actual data points and their respective forecasted values. This technique that produces this line is called the linear trend equations or the regression line

Example
Yt= 45 + 5t

The value of Yt when t=0 is 45, and the slope of

the line is 5, which means that the value of yt will increase by five units for each one unit increase in t. If t=10, the forecast, yt , is 45+5 (10)= 95 units. We can plot the same by finding two points on the line.

Value of

t, t and t
2

Equation

n yt t y n t t
2

y b t a
n
n= the number of periods Y= a value of the time series

Problem
Monthly demand for Dans Doughnuts over the

past nine months for trays (six dozen per tray) of sugar doughnuts was Mar 112 Apr 125 May 120 Jun 133 Jul 136 Aug 146 Sept 140 Oct 155

The data shows an upward trend

Solution

Solution
N=9

t=45
t2= 285

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Regression Assumptions
Normality For any given value of x, there is a distribution of possible y values that has a mean equal to the expected value (i.e., y = a + bx) and the distribution is normal. Homoscedasticity The conditional distributions for all values of x have the same dispersion. Linearity. The requirement of uniform scatter also means that there should not be any patterns around the line.

Independence. Values of y should not be correlated over time. If they are, it may be more appropriate to use a time series model.