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 Delphi Method Jury of Executive Opinion Sales Force Composite Consumer Market Survey Causal Methods Simple Regression Analysis Multiple Regression Analysis Time Series Methods Naive Moving Average Weighted Moving Average Exponential Smoothing Trend Analysis Seasonality 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. Each salesperson estimates sales in his region. Forecasts are reviewed to ensure realistic. Combined at higher levels to reach an overall forecast. Solicits input from customers and potential customers regarding future purchases. Used for forecasts and product design & planning

Sales force composite

Consumer market survey.

Forecast Error

Forecast Error = At Ft

T Bias - The arithmetic sum of MSE = | forecast error | 2 /T the errors t =1 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 T Percentage Error MAPE = 100 [|At Ft | / At ] / T

t =1

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

Ft = Yt 1
Ft = Yt 4 : Quarterly data Ft = Yt 12 : Monthly data

Nave Forecast
W allace Garden Supply
Forecas ting
Storage Shed Sales

Period January February March April May June July August September October Nov ember December

Actual Value 10 12 16 13 17 19 15 20 22 19 21 19

Nav e Forecast N /A 10 12 16 13 17 19 15 20 22 19 21

Error 2 4 -3 4 2 -4 5 2 -3 2 -2 0.818 BIAS

Absolute Error 2 4 3 4 2 4 5 2 3 2 2 3 MAD

Percent Error 16.67% 25.00% 23.08% 23.53% 10.53% 26.67% 25.00% 9.09% 15.79% 9.52% 10.53% 17.76% MAPE

Squared Error 4.0 16.0 9.0 16.0 4.0 16.0 25.0 4.0 9.0 4.0 4.0 10.091 MSE 3.176619

Standard E rror (Square Root of MSE = )

Nave Forecast Graph

W a lla c e G a r d e n - N a iv e Fo r e c a s t 25 20

15 Sheds A c tu a l V a lu e N a v e Fo r e c a s t 10

0 February Ma r c h A p r il Ma y Ju n e Ju ly P e r io d A ugus t S e p te mb e r O c to b e r No v e m b e r De c e m b e r

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

Period January February March April May June July August September October November December

Actual Value 10 12 16 13 17 19 15 20 22 19 21 19

Three-Month Moving Averages

10 12 16 13 17 19 15 20 22

+ + + + + + + + +

12 16 13 17 19 15 20 22 19

+ + + + + + + + +

16 13 17 19 15 20 22 19 21

/ / / / / / / / /

3 3 3 3 3 3 3 3 3

= = = = = = = = =

12.67 13.67 15.33 16.33 17.00 18.00 19.00 20.33 20.67

Moving Averages Forecast

Wallace Garden Supply
Forecasting 3 period moving average
Actual Value - Forecast

Input Data Period Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Month 7 Month 8 Month 9 Month 10 Month 11 Month 12 Next period Actual Value 10 12 16 13 17 19 15 20 22 19 21 19 19.667

Forecast Error Analysis Forecast Error Absolute error Squared error Absolute % error

12.667 13.667 15.333 16.333 17.000 18.000 19.000 20.333 20.667 Average

0.333 3.333 3.667 -1.333 3.000 4.000 0.000 0.667 -1.667 12.000 BIAS

0.333 3.333 3.667 1.333 3.000 4.000 0.000 0.667 1.667 2.000 MAD

0.111 11.111 13.444 1.778 9.000 16.000 0.000 0.444 2.778 6.074 MSE

2.56% 19.61% 19.30% 8.89% 15.00% 18.18% 0.00% 3.17% 8.77% 10.61% MAPE

Moving Averages Graph

T h re e P e rio d M o vin g A ve ra g e
25

20

15 Value A c tu a l V a lu e For ec as t 10

0 1 2 3 4 5 6 T im e 7 8 9 10 11 12

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 =

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

i =1 i =1

Weighted Moving Average

W allace Garden Supply
Storage Shed Sales

Forecasting

Period January February March April May June July August September October November December Next period Sum of weights =

Actual Value

Weights Three-Month Weighted Moving Averages 10 0.222 12 0.593 16 0.185 / 1 = 13 2.2 + 7.1 + 3 / 1 = 17 2.7 + 9.5 + 2.4 / 1 = 19 3.5 + 7.7 + 3.2 + 3.5 / 1 = 15 2.9 + 10 + 2.8 / 1 = 20 3.8 + 11 / 1 = 22 4.2 + 8.9 + 3.7 + 4.1 / 1 = 19 3.3 + 12 + 3.5 / 1 = 21 4.4 + 13 + 3.9 / 1 = 19 4.9 + 11

12.298 14.556 14.407 16.484 17.814 16.815 19.262 21.000 20.036

20.185 1.000

Weighted Moving Average

Wallace Garden Supply
Forecasting 3 period weighted moving average Input Data Period Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Month 7 Month 8 Month 9 Month 10 Month 11 Month 12 Next period Sum of weights = Actual value 10 12 16 13 17 19 15 20 22 19 21 19 20.185 1.000 Weights 0.222 0.593 0.185 Forecast Error Analysis Forecast Error Absolute error Squared error Absolute % error

12.298 14.556 14.407 16.484 17.814 16.815 19.262 21.000 20.036 Average

0.702 2.444 4.593 -1.484 2.186 5.185 -0.262 0.000 -1.036 1.988 BIAS

0.702 2.444 4.593 1.484 2.186 5.185 0.262 0.000 1.036 6.952 MAD

0.492 5.971 21.093 2.202 4.776 26.889 0.069 0.000 1.074 6.952 MSE

5.40% 14.37% 24.17% 9.89% 10.93% 23.57% 1.38% 0.00% 5.45% 10.57% MAPE

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

Exponential Smoothing
Wallace Garden Supply
Forecasting Exponential smoothing Input Data Period Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Month 7 Month 8 Month 9 Month 10 Month 11 Month 12 Alpha Next period Actual value 10 12 16 13 17 19 15 20 22 19 21 19 0.419 19.573 Forecast Error Analysis Forecast 10.000 10.000 10.838 13.000 13.000 14.675 16.487 15.864 17.596 19.441 19.256 19.987 Average Error 2.000 5.162 0.000 4.000 4.325 -1.487 4.136 4.404 -0.441 1.744 -0.987 Absolute error 2.000 5.162 0.000 4.000 4.325 1.487 4.136 4.404 0.441 1.744 0.987 2.608 MAD Squared error 4.000 26.649 0.000 16.000 18.702 2.211 17.106 19.391 0.194 3.041 0.973 9.842 MSE Absolute % error 16.67% 32.26% 0.00% 23.53% 22.76% 9.91% 20.68% 20.02% 2.32% 8.30% 5.19% 14.70% MAPE

Sheds 10 15 20 25 0 5
Ja nu ar y F eb ru ar y

M ar c h

A pr i l

M ay

Ju ne

Ju ly

E xponential Smoothing

A ug us t

S ep

te m be r O

Exponential Smoothing

ct ob e

r N ov em be r D ec em be r

Forecast

Actual value

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. 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.

Seasonality analysis

Linear Trend Analysis

Midwestern Manufacturing Sales
Sales(in units) vs. Time
Scatter Diagram
Actual value (or) Y 74 79 80 90 105 142 122 Period number (or) X 1995 1996 1997 1998 1999 2000 2001

160 140 120 100 80 60 40 20 0 1994 1996 1998 2000 2002

Period number (or) X

Least Squares for Linear Regression

Midwestern Manufacturing
Least Squares Method

Values of Dependent Variables

Time

Least Squares Method

Y = a + bX
Where
^

= predicted value of the dependent variable (demand)

X = value of the independent

variable (time) a = Y-axis intercept b = slope of the regression line

b=

[ XY - n X Y ]
_ 2 X - n X2

_ _

Linear Trend Data & Error Analysis

M idw estern M anufacturing C om pany
F o recasting Linear trend analysis

In p ut D ata Period Y ear 1 Y ear 2 Y ear 3 Y ear 4 Y ear 5 Y ear 6 Y ear 7 Intercept S lope N ext perio d Actual v alue eriod num ber P (or) Y (or) X 74 1 79 2 80 3 90 4 105 5 142 6 122 7 56.714 10.536 141.000 8

F o recast Erro r An alysis Forecast 67.250 77.786 88.321 98.857 109.393 119.929 130.464 Average E rror 6.750 1.214 -8.321 -8.857 -4.393 22.071 -8.464 Absolute Squared A bsolute error error % error 6.750 45.563 9.12% 1.214 1.474 1.54% 8.321 69.246 10.40% 8.857 78.449 9.84% 4.393 19.297 4.18% 22.071 487.148 15.54% 8.464 71.644 6.94% 8.582 110.403 8.22% M AD MSE M AP E

Least Squares Graph

Tre nd Analysis
160 140

y = 10.536x + 56.714
120

100

Value

80

60

40

20

0 1 2 3 4 Tim e A ctual values Linear (A ctual values) 5 6 7

Seasonality Analysis
Eichler Supplies
Year 1 Month January February March April May June July August September October November December January February March April May June July August September October November December Demand 80 75 80 90 115 110 100 90 85 75 75 80 100 85 90 110 131 120 110 110 95 85 85 80

Ratio = demand / average demand

Average Demand 94 94 94 94 94 94 94 94 94 94 94 94 94 94 94 94 94 94 94 94 94 94 94 94 Ratio 0.851 0.798 0.851 0.957 1.223 1.170 1.064 0.957 0.904 0.798 0.798 0.851 1.064 0.904 0.957 1.170 1.394 1.277 1.170 1.170 1.011 0.904 0.904 0.851 Seasonal Index 0.957 0.851 0.904 1.064 1.309 1.223 1.117 1.064 0.957 0.851 0.851 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 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