FORECASTING

QUAN 21

Filosofo ᴥ Ponciano ᴥ Quisora ᴥ Tagarino

 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 to 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
 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
 Types of Forecasting
CAUSAL MODELS
• Incorporates the variables or factors that might
influence the quantity being forecasting models
• Relies on Quantitative Data
 Types of Forecasting
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
 Types of Forecasting
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.
 Types of Forecasting
QUALITATIVE MODELS
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
 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 Diagrams
 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.
 MOVING AVERAGE
• Mathematically, moving average is expressed as:
Moving average = ∑ ( most recent n data values )
n
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
 MOVING AVERAGE

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
 MOVING AVERAGE
• 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.
MOVING AVERAGE
 MOVING AVERAGE
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
 EXAMPLE:
The port of Baltimore has unloaded large quantities of
grain from ships during the past eight quarters. The ports'
operation manager wants to test the use of exponential
smoothing to see how well the technique works in
predicting tonnage unloaded. He assumes that the
forecast of grain unloaded in the first quarter was 175
tons. Two value of ά are examined ά = 0.10 and ά = 0.50.
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
• Time Series- is a set of data collected at regular
intervals such as every week , every month, or
every week.
• Regression – in statistics is a term used to describe
the process of estimating the relationship between
two variables , in this case the time and sales.
 LEAST SQUARE METHOD
Where Ft = estimated or forecast value of sales for t
a = intercept , or the point at which the trend line
intercepts . The x axis (sales)
b = slope of the trend line , or the rate of the change in
sales.
t = time , in this case the months from 1 to 6 any series of
number can be used as long as they are consecutive.
 LEAST SQUARE METHOD
• 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
 LEAST SQUARE METHOD
• Second the intercept is calculated as follows:
 SMOOTHING LINEAR TRENDS
• Simple smoothing continually adjusts the forecasts according to
the errors. To start a forecast for a period 1 (F ) is selected. A
1

fraction of error in period 1 is added to F to get F , A fraction of

1 2

in period 2 to get F and so on..

3

• 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.
 SMOOTHING LINEAR TRENDS
Smoothed level of t = forecast for t + a1 x error in t
Smoothed trend at the end of t = smoothed trend at the end of t + a2 x error in t

Forecast for t + 1 = smoothed level at the end of t + smoothed trend 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.
 SMOOTHED LINEAR TRENDS
• To see how model works, we will put the equations into symbols and then
smooth the Computer land sales. The equations are:

Where = is the smoothed level

= is the smoothed trend
= regression forecast
There are two smoothing parameters: for the level and for the 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.
EXPONENTIAL SMOOTHING MODELS
 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.
 NONLINEAR 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 Seasonal 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
 Steps in forecasting Seasonal Data
7. Forecasting the deseasonalized data
8. Seasonalizing the forecast
9. The seasonalized MSE
 Limitation
• Two seasons of data are needed
• Equal weights
• Storage
 Advantage
• Simplicity
• Accuracy