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
Models
Time Series
Methods
Causal
Methods
Delphi
Method
Jury of Executive
Opinion
Sales Force
Composite
Consumer Market
Survey
Naive
Moving
Average

Weighted
Moving Average

Exponential
Smoothing

Trend Analysis

Seasonality
Analysis

Simple
Regression
Analysis
Multiple
Regression
Analysis
Multiplicative
Decomposition
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
Iterative group 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
Bias - The arithmetic sum of
the errors
Mean Square Error - Similar to
simple sample variance
Variance - Sample variance
(adjusted for degrees of
freedom)
Standard Error - Standard
deviation of the sampling
distribution
MAD - Mean Absolute
Deviation
MAPE Mean Absolute
Percentage Error


t t
F A Error Forecast =
T F A MAD
t t
T
t
/ | | /T | error forecast |
1
T
1 t
= =

= =
T A F A MAPE
t t t
T
t
/ ] / | [| 100
1
=

=
T F A
MSE
t t
T
t
/ ) (
/T | error forecast |
2
1
T
1 t
2
=
=

=
=
Quantitative Forecasting Models
Time Series Method
Nave
Whatever happened
recently will happen
again this time (same
time period)
The model is simple
and flexible
Provides a baseline to
measure other models
Attempts to capture
seasonal factors at the
expense of ignoring
trend
data Monthly :
data Quarterly :
12
4

=
=
t t
t t
Y F
Y F
1
=
t t
Y F
Nave Forecast
Wallace Garden Supply
Forecasting
Period
Actual
Value
Nave
Forecast Error
Absolute
Error
Percent
Error
Squared
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
Storage Shed Sales
Nave Forecast Graph
Wallace Garden - Naive Forecast
0
5
10
15
20
25
February March April May June July August September October November December
Period
S
h
e
d
s
Actual Value
Nave Forecast
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 periods) k previous in value (Actual average moving period - k
k
1

=
=
k
Moving Averages
Wallace Garden Supply
Forecasting
Period
Actual
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
Storage Shed Sales
Moving Averages Forecast
Wallace Garden Supply
Forecasting 3 period moving average
Input Data Forecast Error Analysis
Period Actual Value Forecast Error
Absolute
error
Squared
error
Absolute
% 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
Actual Value - Forecast
Moving Averages Graph
Three Period Moving Average
0
5
10
15
20
25
1 2 3 4 5 6 7 8 9 10 11 12
Time
V
a
l
u
e
Actual Value
Forecast
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.

(weights) / periods) k previous in value i)(Actual period each for (Weight
average moving weighted period - k
k
1 i
k
1

= =
=
i
Weighted Moving Average
Wallace Garden Supply
Forecasting
Period
Actual
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
Storage Shed Sales
Weighted Moving Average
Wallace Garden Supply
Forecasting 3 period weighted moving average
Input Data Forecast Error Analysis
Period Actual value Weights Forecast Error
Absolute
error
Squared
error
Absolute
% 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 with a value between
0 and 1. (Usual range 0.1 to 0.3)
) - t period for forecast - - t period in value (actual - t period for forecast
t period for Forecast
1 1 1 o +
=
Exponential Smoothing Data
Wallace Garden Supply
Forecasting
Exponential Smoothing
Period
Actual
Value F
t A
t
F
t
F
t+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
Storage Shed Sales
Exponential Smoothing
Wallace Garden Supply
Forecasting Exponential smoothing
Input Data Forecast Error Analysis
Period Actual value Forecast Error
Absolute
error
Squared
error
Absolute
% 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
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10
15
20
25
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Actual value
Forecast
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
Scatter Diagram
Actual
value (or)
Y
Period
number
(or) X
74 1995
79 1996
80 1997
90 1998
105 1999
142 2000
122 2001
Sales(in units) vs. Time
0
20
40
60
80
100
120
140
160
1994 1996 1998 2000 2002
Period number (or) X
Least Squares for Linear Regression
Midwestern Manufacturing
Least Squares Method
Time
V
a
l
u
e
s

o
f

D
e
p
e
n
d
e
n
t

V
a
r
i
a
b
l
e
s
Least Squares Method
bX a Y
^
+ =
Where

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

a = Y-axis intercept

b = slope of the regression line
] X n - XY [
_ _
Y

_
2 2
X n - X
b =
Linear Trend Data & Error Analysis
Midwestern Manufacturing Company
Forecasting Linear trend analysis
Input Data Forecast Error Analysis
Period
Actual value
(or) Y
Period number
(or) X Forecast Error
Absolute
error
Squared
error
Absolute
% 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
y = 10.536x + 56.714
0
20
40
60
80
100
120
140
160
1 2 3 4 5 6 7
Time
V
a
l
u
e
Actual values Linear (Actual values)
Seasonality Analysis
Eichler Supplies
Year Month
Demand
Average
Demand
Ratio
Seasonal
Index
1 January 80 94 0.851 0.957
February 75 94 0.798 0.851
March 80 94 0.851 0.904
April 90 94 0.957 1.064
May 115 94 1.223 1.309
June 110 94 1.170 1.223
July 100 94 1.064 1.117
August 90 94 0.957 1.064
September 85 94 0.904 0.957
October 75 94 0.798 0.851
November 75 94 0.798 0.851
December 80 94 0.851 0.851
2 January 100 94 1.064
February 85 94 0.904
March 90 94 0.957
April 110 94 1.170
May 131 94 1.394
June 120 94 1.277
July 110 94 1.170
August 110 94 1.170
September 95 94 1.011
October 85 94 0.904
November 85 94 0.904
December 80 94 0.851
Seasonal Index ratio of the
average value of the item in a
season to the overall average
annual value.

Example: average of year 1
January ratio to year 2 January
ratio.
(0.851 + 1.064)/2 = 0.957
Ratio = demand / average demand
If Year 3 average monthly demand is
expected to be 100 units.
Forecast demand Year 3 January:
100 X 0.957 = 96 units
Forecast demand Year 3 May:
100 X 1.309 = 131 units
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