FORECASTING

IPE 4111

Afia Ahsan
Lecturer
MPE, AUST
 Prediction is very difficult,
especially if it's about the future.
 FORECASTING
Forecasting is a technique that uses historical
data as inputs to make informed estimates
that are predictive in determining the direction
of future trends.
 INTRODUCTION
• Forecasting is an estimate of what is likely to happen in the
future.
• Forecasts are concerned with determining what the future
will look like.
• Forecasting provides a basis for coordinating activities in
various parts of the company.
• Forecasts are an important input to both long-term,
strategic decision-making, as well as for short-term
planning for day-to-day operations
 IMPORTANCE
• Finance uses long-term forecasts for capital planning and
short-term forecasts for budgeting.
• Marketing produces sales forecasts for market planning and
market strategy.
• Operations develop and use forecasts for scheduling,
inventory management, and long-term capacity planning.
• Human Resource Management uses forecasts to estimate
the need for employees
 FORECASTING TIME HORIZONS
Short-range forecast
• Up to 1 year, generally less than 3 months
• Purchasing, job scheduling, workforce levels, job assignments,
production level
Medium-range forecast
• 3 months to 3years
• Sales and production planning, budgeting

Long-range forecast
• 3+ years
• New product planning, facility location, research, and development
 TYPES OF FORECASTS
Economic forecasts
• Address business cycle – inflation rate, money
• supply, housing starts, etc.

Technological forecasts
• Predict the rate of technological progress
• Impacts development of new products

Demand forecasts
• Predict sales of existing products and services
FORECASTING APPROACHES
QUALITATIVE METHODS
• Used when the situation is vague and little data
exist
New products
New technology
• Involves intuition, experience
e.g., forecasting sales on the Internet
FORECASTING APPROACHES
QUANTITATIVE METHODS
• Used when the situation is ‘stable’ and
historical data exist
Existing products
Current technology
• Involves mathematical techniques
e.g., forecasting sales of color televisions
 FORECASTING APPROACHES
QUANTITATIVE METHODS QUALITATIVE METHODS
• Naive approach • Jury of Executive
• Moving average Opinion
• Weighted moving • Sales Force Composite
average • Delphi Method
• Exponential Smoothing • Consumer Market/
• Trend Projection Survey
• Linear Regression
 QUALITATIVE MODELS
Jury of Executive Opinion
• Collect opinions of high-level executives
• Involves small group of high-level managers
• Combines managerial experience with statistical models
• Relatively quick
Sales Force Composite
• Each salesperson projects his or her sales
• Combined at district and national levels
• Tends to be overly optimistic
Consumer /Market Survey
• Ask customers about purchasing plans
• What consumers say, and what they actually do are often different
• Sometimes difficult to answer
 QUALITATIVE MODELS
Delphi Method

• Iterative group process continues until consensus is reached

Steps Involved in Delphi Method

• Choose the experts to participate.
• Through a questionnaire (or E-mail), obtain forecasts from all O
participants.
• Summarize the results and redistribute them to the participants along
with appropriate new questions.
• Summarize again, refine forecasts and conditions, and again develop
new questions.
• Repeat Step 4 if necessary. Distribute the final results to all participants.
.
OVERVIEW OF QUANTITATIVE
APPROACHES
• Naive approach
• Moving averages
Time-Series Models
• Exponential smoothing
• Trend projection
• Linear regression Associative Model
TIME SERIES FORECASTING
Cyclical

Trend

Random

Seasonal
 NAIVE APPROACH
• Assumes demand in the next period is the same as
demand in the most recent period
• e.g., If January sales were 68, then February sales
will be 68
• Sometimes cost-effective and efficient
• Can be a good starting point
 MOVING AVERAGE
• A technique that uses several historical data values to generate a
forecast.
• Involves finding a series of successive averages by dropping the
first data value in the series and adding the last data value.
• Useful for data without trend, seasonality, or cycles

Moving average = demand in previous n periods/n

 Moving Average Example
Actual Shed Three- Month
Month Sales Moving Average
January 10
February 12
March 13
April 16 (10 + 12 + 13)/3 = 11 2/3
May 19 (12 + 13 + 16)/3 = 13 2/3
June 23 (13 + 16 + 19)/3 = 16
July 26 (16 + 19 + 23)/3 = 19 1/3

© 2008 Prentice Hall, Inc. 4 – 22

Graph of Moving Average
Moving
Average
–
30
Forecast
–
28
Actual
26 –
24 –
Sales
Shed Sales

22 –
20 –
18 –
16 –
14 –
12 –
10 –
| | | | | | | | | | | |
J F M A M J J A S O N D
Potential Problems With Moving
Average
❑ Increasing n , smoothens the forecast but makes it less
sensitive to changes
❑ Do not forecast trends well
❑ Require extensive historical data
 Weighted Moving Average
❑ 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
➢ Used when trend is present
➢ Older data usually less important
➢ Weights based on experience and intuition

∑ (weight for period n)

x (demand in period n)
Weighted moving average =
∑ weights
 Weights Applied Period
Weighted Moving Average
3 Last month
2 Two months ago
1 Three months ago
6 Sum of weights

Actual 3-Month Weighted

Month Shed Sales Moving Average
January 10
February 12
March 13
April 16 [(3 x 13) + (2 x 12) + (10)]/6 = 121/6
May 19 [(3 x 16) + (2 x 13) + (12)]/6 = 141/3
June 23 [(3 x 19) + (2 x 16) + (13)]/6 = 17
July 26 [(3 x 23) + (2 x 19) + (16)]/6 = 201/2
Moving Average And Weighted
Moving Average
Weighted
moving
30 – average
25 –
Sales demand

20 – Actual
sales
15 –
Moving
10 – average

5 –

| | | | | | | | | | | |
J F M A M J J A S O N D
Exponential Smoothing
 Form of weighted moving average
 Weights decline exponentially
 Most recent data weighted most
 Requires smoothing constant (α)
 Ranges from 0 to 1
 Subjectively chosen
 Involves little record keeping of past
data
Why use exponential smoothing?
1. Uses less storage space for data
2. Extremely accurate
3. Easy to understand
4. Little calculation complexity
5. There are simple accuracy tests
 Exponential Smoothing

New forecast = Last period’s forecast+ α(Last period’s actual demand

– Last period’s forecast)

Ft = Ft – 1 + α(At – 1 - Ft – 1)

where Ft = new forecast

Ft – 1 = previous forecast
a = smoothing (or weighting)
constant (0 ≤ a ≤ 1)
Exponential Smoothing Example

Predicted demand = 142 Ford

Mustangs
Actual demand = 153
Smoothing constant a = .20
Exponential Smoothing Example
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant a = .20

New forecast = 142 + .2(153 – 142)

Exponential Smoothing Example
Predicted demand = 142 Ford
Mustangs
Actual demand = 153
Smoothing constant a = .20

New forecast = 142 + .2(153 – 142)

= 142 + 2.2
= 144.2 ≈ 144 cars
Effect of Smoothing Constants
Weight Assigned to
Most 2nd Most 3rd Most 4th Most 5th Most
Recent Recent Recent Recent Recent
Smoothing
Period Period Period Period Period
Constant (α) α (1 - α) α (1 - α)2 α (1 - α)3 α (1 - α)4
α = .1 .1 .09 .081 .073 .066

α = .5 .5 .25 .125 .063 .031

 Choosing 
The objective is to obtain the most accurate forecast no
matter the technique
We generally do this by selecting the model
that gives us the lowest forecast error
Forecast error = Actual demand - Forecast value

= At - Ft
 Common Measures of Error
Mean Absolute Deviation (MAD)
∑ |Actual - Forecast|
MAD =
n
Mean Squared Error (MSE)

∑ (Forecast Errors)2
MSE =
n
Mean Absolute Percent Error (MAPE)
n
∑100|Actuali - Forecasti|/Actuali
i=1
MAPE =
n
Sources of Forecast errors
• Model may be inadequate
• Irregular variations
• Incorrect use of forecasting technique
Comparison of Forecast Error
Absolute Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
1 180 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
 Comparison of Forecast Error
∑ |deviations|
Rounded Absolute Absolute
MAD =
Actual Forecast Deviation Forecast Deviation
Tonnage n
with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
For  = .10
1 180 175 5.00 175 5.00
2 168 = 82.45/8
175.5 = 10.31
7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 For  175
= .50 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 = 98.62/8
175.02 = 12.33
29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62

© 2008 Prentice Hall, Inc. 4 – 40

Comparison of Forecast Error
∑ (forecast
Rounded
errors) 2
Absolute
MSE =Actual Forecast Deviation Forecast Absolute
Tonnage
n
with for with Deviation
for
Quarter Unloaded  = .10  = .10  = .50
For  = .10  = .50
1 180 175 5.00 175 5.00
2 = 1,526.54/8
168 175.5 = 190.82
7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 For  175
= .50 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 = 1,561.91/8
205 175.02 = 195.24
29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
MAD 10.31 12.33
Comparison of Forecast Error
n
∑100|deviationi|/actuali
i = 1 Rounded Absolute Round Actualed Absolute
MAPE Forecast
= Deviation Foreca Tonnage with st Deviation
for n with for
Quarter Unloaded  = .10  = .10  = .5 0  = .50
For  = .10
1 180 175 5.00 175 5.00
2 168 = 44.75/8
175.5 = 7.50
5.59% 177.5 0 9.50
3 159 174.75 15.75 172.7 5 13.75
4 For 
175= .50 173.18 1.82 165.8 8 9.12
5 190 173.36 16.64 170.4 4 19.56
6 205 = 54.05/8
175.02 =29.98
6.76% 180.2 2 24.78
7 180 178.02 1.98 192.6 1 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
MAD 10.31 12.33
MSE 190.82 195.24
Comparison of Forecast Error
Absolute Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50

1 180 175 5.00 175 5.00

2 168 175.5 7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
MAD 10.31 12.33
MSE 190.82 195.24
MAPE 5.59% 6.76%
© 2008 Prentice Hall, Inc. 4 – 43
Choosing a Forecasting Technique
• No single technique works in every situation
• Two most important factors
➢ Cost
➢ Accuracy
• Other factors include the availability of:
➢ Historical data
➢ Computers
➢ Time needed to gather and analyze the data
➢ Forecast horizon

© 2008 Prentice Hall, Inc. 4 – 92

THANK YOU