FORECASTING

Presented to Dr. Roderick Rupido

College Dean

College of Ecconomics, Management, and Development Studies

Cavite State University

Indang, Cavite

In partial fulfillment

Of the Requirements for QUAN 21 (Quantitative Techniques to

Management)

Filosofo, Kristine May J.

Ponciano, Riza O.

Quuisora, Edlene P.

Tagarino, Hannah Gayle Q.

BS Accountancy
October 2010
 Forecasting
Forecasting

• the process of making statements about events whose actual outcomes

(typically) have not yet been observed.

• the term "forecasting" are sometimes reserved for estimates of values at

certain specific future times, while the term "prediction" is used for more
general estimates.

• Forecasting can be described as predicting what the future will look like,
whereas planning predicts what the future should look like.

Eight Steps in Forecasting

1. Determine the use of the forecast.

2. Select the items or quantities that are to be forecasted.

3. Determine the time horizon of the forecast.

4. Select the forecasting model or models.

5. Gather the data needed to make the forecast.

6. Validate the forecasting model.

7. Make the forecast.

8. Implement the results.

Types of Forecasting
TIME-SERIES MODELS

• Attempt to predict the future by using historical data

• Look at what has happened over a period of time and use a series of past
data to make a forecast

• Relies on Quantitative Data

• Includes Moving Average, Exponential Smoothing, and Trend Projection

CAUSAL MODELS

• Incorporates the variables or factors that might influence the quantity being
forecasting models

• Relies on Quantitative Data

QUALITATIVE MODELS

• Relies on Qualitative Data

• Attempts to incorporate judgmental or subjective factors into the forecasting

model

• Especially useful when subjective factors are expected to be very important

or when accurate quantitative data are difficult to obtain
QUALITATIVE MODELS

1. Delphi Method – allows experts, who may be located in different places, to

make forecasts; three diff. types of participants: decision makers, staff
personnel, and respondents.

2. Jury of Executive Opinion – takes opinions of a small high level managers,

often in combination with statistical models, and results in a group estimate
of demand.

3. Sales Force Composite – each salesperson estimates what sales will be in his
or her region.

4. Consumer Market Survey – solicits input from customers or potential

customers regarding their future purchasing plans.

Scatter Diagrams

• A two-dimensional graph plotted to get a quick idea if any relationship exists

between two variables

• Independent variable – horizontal (X) axis

• Dependent Variable – vertical (Y) axis

• A time series is based on a sequence of evenly spaced data points.

• Forecasting time-series data implies that future values are predicted only
from past values and that other variables, no matter how potentially
valuable, are ignored.

Time Series Forecasting Models

• A time series is based on a sequence of evenly spaced data points.

 • Forecasting time-series data implies that future values are predicted only
from past values and that other variables, no matter how potentially
valuable, are ignored.

Examples of Scatter Diagram:

Moving Average

• A forecasting technique that averages the past values in computing the

forecast.

• The term moving indicates that as a new observation becomes available for
the time series, it replaces the oldest observation in equation.

• Mathematically, moving average is expressed as:

Moving average = ∑ ( most recent n data values )

Where: n = is the number of periods in the moving average.

To use moving average, the number of data value to be included in the moving
average must be selected.
The data below show the number of gallons of gasoline sold by Wallace Company, a
gasoline distributor, over past 12 weeks.

Week Sales(000s of galloons)

1 17

2 21

3 19

4 23

5 18

6 16

7 20

8 18

9 22

10 20

11 15

12 22

Given : Computation:

Week 1 = 17 Moving Average = (17+21+19) / 3

Week 2 = 21 Moving Average = 19

Week 3 = 19

n =3

• The moving average value is the forecasted sales in week 4.

Summary of 3 –week moving average calculation

 • An important consideration in selecting forecasting method is the accuracy of
the forecast.

• The error associated with the forecast is the difference between the observed
value of the time series and the forecast.

• Mean Squared Error (MES), or the average of the sum of squared errors can
be used to develop measures of forecast accuracy.

MSE = 16+9+16+1+0+16+0+25+9
 9

MSE = 10.22

The number of data values that minimized MSE is considered as more accurate.

Weighted Moving Average

• A moving average forecasting method that places different weight on past

values.

• Mathematically, moving average is expressed as:

• Weighted Moving average = ∑ (weight for period n) x (data value in period

n) / ∑ weight

Example:

Using the previous example, find the weighted

moving average for week 4 given the following

weight: Week 1 = 1; Week 2 = 2; and Week 3 = 3.

Given: Computation:

Week 1 = 17 (3 x 19) + ( 2 x 21 ) (1 x 17)

Week 2 = 21 3+2+1

Week 3 = 19 = 19.33

Exponential smoothing

• A forecasting method that is a combination of last forecast and last observed

value.
 • Exponential smoothing is expressed as :

New Forecast =last period’s forecast +ά (last periods actual demand – last
periods forecast)

Where : ά = smoothing constant

Example:

In January ,a demand for 142 for a certain car model for February was predicted by
a dealer. Actual demand for February was 153 autos. Using a smoothing constant of
ά = 0.20, what could be the forecast demand for March?

Given:

last periods actual demand = 153

last periods forecast = 142

ά = 0.20

Computation:

New Forecast = 142 + 0.20(153 – 142)

New Forecast = 144.2

Selecting the smoothing constant

• The overall accuracy of a forecasting model can be determined by comparing

the forecast value with actual or observed value.

• Forecast Error = demand – forecast

• Mean Absolute Deviation(MAD) – a technique for determining the accuracy of

a forecasting model by taking the average of the absolute deviations.

MAD = ∑|forecast errors |

 n

Absolute Deviation and MADs for Port of Baltimore

Sum of the absolute deviation :

For ά=0.10 = 84

For ά=0.50 = 100

MAD(ά=0.10 ) = 84 / 8

= 10.5

MAD(ά=0.50) = 100 / 8

= 12.50

* Smoothing constant, ά=0.10 , is preferred to ά=0.50 because its MAD is smaller.

Time Series Regression

A least square regression in which the independent variable is some function of
time. It used to predict the average rate of growth in a time series.
Example of Time Series Regression

Least Square Method

Where = estimated or forecast value of sales for t

= intercept , or the point at which the trend line intercepts . The x axis
(sales)

= slope of the trend line , or the rate of the change in sales.

= time , in this case the months from 1 to 6 any series of number can be
used as long as they are consecutive.

 Two equations are used to find the slope and intercept of the best fitting
trend line. The slope is always computed as follows:

where : b = slope

t = time
 X = dependent variable of sales

= mean of the value of x

t = mean of the values of t

Second the intercept is calculated as follows:

where:

= intercept

= mean of the values of x

= slope

= mean of the values of t

Forecasting:
Smoothing Linear Trends

 Simple smoothing continually adjusts the forecasts according to the errors.

To start a forecast for a period 1 (F1) is selected. A fraction of error in period
1 is added to F1 to get F2 , A fraction of in period 2 to get F3 and so on..

 Smoothing the linear trend works the same way except that the errors are
used to continually adjust to things : the intercept and the slope of the trend
line.

 The adjustments are made with sequence of equations repeated each period.

Smoothed Level of X error in t

Smoothed trend at the end of

X error in t

Forecast for

at the end of t

 The smoothing equations for a linear trend compute a new trend line at the
end of each period . The intercept of the trend line is called smoothed level

 This is not quiet the same as the regression intercept of a . In regression

trend line starts at period 1 in smoothing the trend line starts at current
period.

 The slope of a new trend line is called smoothed trend and is similar to the
slope b in regression.

Exponential smoothing Linear Trends

Smoothing Picks Up a Changing Trend

Smoothing Non Linear Trends

NON LINEAR TRENDS

• Exponential Trends

– A model in which the amount of growth increases continuously in the

future.

• Damped Trends

– A model used for long-range forecasting in which the amount of trend

declines each period.

Trend Modification Parameter (φ)

The effect of φ is to accelerate or decelerate the trend.

• Φ > 1 - exponential trend

• 0 < Φ < 1 - damped trend

• Φ = 1 - nonlinear is same as linear

Forecasting More than One Step Ahead

Damped Forecasting
 • The Damped version is more likely similar to the Exponential version. The
only difference is the φ value which is made over the range 0 < φ < 1.

Non-Linear Trends

• Asymptote

– Limiting the value of the forecasts using a damped trend. When sales
reach asymptote, growth disappears.

• Selecting Trend Alternative

• Limitation of Data

Decomposition of Seasonalized Data

• Classical Decomposition

– A method which attempts to separate a time series into as many as

four components.

Four Components of a Time Series

• Trend - gradual movement of the data

• Seasonality – pattern of demand fluctuation

• Cycle – patterns in data

• Random Variation – blips in data caused by chance

Questions to Verify Seasonality

 Are the peaks and the troughs consistent?

 Is there an explanation for the seasonal pattern?

If the answer is no, we should decomposed the seasonal data.

Decomposition

 Removing of the seasonal pattern from the data

 Deseasonalized data will be forecasted

 Forecast will be seasonalized

Steps in Forecasting Seasonalized Data

1. Centering the Moving Average

2. Ratios are approximate indices

3. The mean ratios

4. Norminalization

5. The final indices

6. Deseasonalizing the data

7. Forecasting the deseasonalized data

8. Seasonalizing the forecast

9. The seasonalized MSE

Step 1:
Step 2:

Step 3:

Step 4:
Step 5:

Step 6:
 Step 7:

Step 8:

Step 9:
Limitation:

• Two seasons of data are needed

• Equal weights

• Storage

Advantage:

• Simplicity

• Accuracy