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What is Forecasting?
Process of predicting a future event
Uses of Forecasts
Accounting
Cost/profit estimates
Finance
Human Resources
Hiring/recruiting/training
Marketing
MIS
Operations
Schedules, workloads
Product/service design
Medium-range forecast
3 months to 3 years
Sales and production planning, budgeting
Long-range forecast
3+ years
New product planning, facility location,
research and development
Reliable
Accurate
Written
Types of Forecasts
Economic forecasts
Address business cycle inflation
rate, money supply, etc.
Technological forecasts
Predict rate of technological progress
Impacts development of new
products
Demand forecasts
Predict sales of existing product
Forecasting Approaches
Qualitative Methods
Used when situation is vague and
little data exist
New products
New technology
Forecasting Approaches
Quantitative Methods
Judgmental Models
Judgmental models are qualitative and essentially use
estimates based on expert opinion.
Survey of Sales Forces: most appropriate for manufacturing and
wholesale firms.
Surveys of Customers: applicable to all firms. Customers express
preference for new or modified products.
Historical Analogy: most appropriate for firms that have several
outlets. Introduction of new product which has characteristics similar to
previous products.
Market Research: can include surveys, tests, and observations.
Results are statistically extrapolated to develop forecasts of demand
for products.
Delphi Method uses a panel of experts to obtain a consensus of
opinion. Used primarily for unique new products or processes for
which no previous data exists.
Overview of Quantitative
Approaches
.
1. Naive approach
2. Moving averages
3. Exponential
smoothing
4. Trend projection
5. Linear regression
Time-Series
Models
Associative
Model
Cyclical
Seasonal
Random
Forecast Variations
Irregular
variation
Trend
Cycles
90
89
88
Seasonal variations
Trend Component
Persistent, overall upward or
downward pattern
Changes due to population,
technology, age, culture, etc.
Typically several years
duration
Seasonal Component
Regular pattern of up and
down fluctuations
Due to weather, customs, etc.
Occurs within a single year
Period
Week
Month
Month
Year
Year
Year
Length
Day
Week
Day
Quarter
Month
Week
Number of
Seasons
7
4-4.5
28-31
4
12
52
Cyclical Component
Repeating up and down movements
10
15
20
Random Component
Erratic, unsystematic, residual
fluctuations
Due to random variation or
unforeseen events
Short duration and
nonrepeating
Naive Approach
Assumes demand in next
period is the same as
demand in most recent period
e.g., If January sales were 68, then
February sales will be 68
Sometimes cost effective and efficient
Can be good starting point
The forecast for any period equals the
previous periods actual value.
January
February
March
April
May
June
July
Actual
Shed Sales
10
12
13
16
19
23
26
3-Month
Moving Average
Weights Applied
3
2
1
6
Period
Last month
Two months ago
Three months ago
Sum of weights
Month
January
February
March
April
May
June
July
Actual
Shed Sales
3-Month Weighted
Moving Average
10
12
13
16
19
23
26
30
Sales demand
25
Actual
sales
20
15
Moving
average
10
5
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Exponential Smoothing
New forecast = last periods forecast
+ a (last periods actual demand
last periods forecast)
Ft = Ft 1 + a(At 1 - Ft 1)
where
Ft =
Ft 1 =
a =
new forecast
previous forecast
smoothing (or weighting)
constant (0 a 1)
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
e = (actual forecast)
MAD =
n
Tracking Signal
(actual forecast)
MAD
TS=
100
i=1
Causal Models
Causal models are also known as external
or exogenous models.
Causal models take into account variables in the general
economy that affect the revenue obtained by a company.
Causal models can be simple or very complex.
Most of them require multiple regression analysis, which is
normally beyond the scope of a small business manager.
y = a + bx
b=
Sxy - nxy
Sx2 - nx2
a = y - bx
1999
2000
2001
2002
2003
2004
2005
Time
Period (x)
Electrical Power
Demand
1
2
3
4
5
6
7
x = 28
x=4
b=
74
79
80
90
105
142
122
y = 692
y = 98.86
xy - nxy
x2 - nx2
x2
xy
1
4
9
16
25
36
49
x2 = 140
74
158
240
360
525
852
854
xy = 3,063
3,063 - (7)(4)(98.86)
=
= 10.54
140 - (7)(42)
Time
Period (x)
Electrical Power
Demand
1999
2000
2001The
2002
2003
2004
2005
1
2
trend
3 line is
4
^
y =5 56.70 +
6
7
Sx = 28
x=4
b=
xy
1
4
9
16
25
36
49
74
158
240
360
525
852
854
Sx2 = 140
Sxy = 3,063
74
79
80
90
105
10.54x
142
122
Sy = 692
y = 98.86
Sxy - nxy
Sx2 - nx2
x2
3,063 - (7)(4)(98.86)
=
140 - (7)(42)
= 10.54
Power demand
Trend line,
^y = 56.70 + 10.54x
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1999
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2000
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2001
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2002
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2003
Year
|
2004
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2005
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2006
|
2007
Deviation7
Deviation5
Deviation6
Deviation3
Deviation4
Deviation1
Deviation2
Trend line, y =^ a + bx
Time period
Correlation
Measures the strength of the relationship
between the dependent and independent
variable
Once a model has been developed and tested,
the effectiveness of the model needs to be
determined. Correlation is used to determine
how strong the relationship between the
dependent and independent variables are.
nSxy - SxSy
[nSx2 - (Sx)2][nSy2 - (Sy)2]
r = correlation coefficient
n = number of periods
x = the independent variable
y = the dependent variable
y
Correlation
(b) Positive
correlation:
0<r<1
(c) No correlation:
r=0
Coefficient of Determination
Coefficient of Determination, r2, measures the
percent of change in y predicted by the change in x
Values range from 0 to 1
A high value of r2, say .80 or more, would indicate
that the independent variable is a good predictor of
values of the dependent variable.
A low value say .25 or less, would indicate a poor
predictor
A value Between .25 and .80 would indicate a
moderate predictor.
2.
3.
4.
5.
Demand
2003 2004 2005
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sept
Oct
Nov
Dec
80
70
80
90
113
110
100
88
85
77
75
82
85
85
93
95
125
115
102
102
90
78
72
78
105
85
82
115
131
120
113
110
95
85
83
80
Average
2003-2005
Average
Monthly
90
80
85
100
123
115
105
100
90
80
80
80
94
94
94
94
94
94
94
94
94
94
94
94
Seasonal
Index
Demand
2003 2004 2005
Average
2003-2005
Average
Monthly
Jan
80
85 105
90
94
Feb
70
85
85
80
94
Mar
80
93 average
82 2003-2005
85monthly demand
94
Seasonal index
Apr
90 = 95 115average monthly
100 demand 94
May
113 125 131
123
94
= 90/94 = .957
Jun
110 115 120
115
94
Jul
100 102 113
105
94
Aug
88 102 110
100
94
Sept
85
90
95
90
94
Oct
77
78
85
80
94
Nov
75
72
83
80
94
Dec
82
78
80
80
94
Seasonal
Index
0.957
Demand
2003 2004 2005
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sept
Oct
Nov
Dec
80
70
80
90
113
110
100
88
85
77
75
82
85
85
93
95
125
115
102
102
90
78
72
78
105
85
82
115
131
120
113
110
95
85
83
80
Average
2003-2005
Average
Monthly
Seasonal
Index
90
80
85
100
123
115
105
100
90
80
80
80
94
94
94
94
94
94
94
94
94
94
94
94
0.957
0.851
0.904
1.064
1.309
1.223
1.117
1.064
0.957
0.851
0.851
0.851
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sept
Oct
Nov
Dec
Demand
2003 2004 2005
Average
2003-2005
80
85 105
90
for 2006 80
70
85 Forecast
85
80
93
82
85
90Expected
95 annual
115 demand = 1,200
100
113 125 131
123
110 115 120 1,200
115
Jan
x
.957 = 96
100 102 113 12
105
88 102 110 1,200
100
Feb
x .851
85
90
95 12
90 = 85
77
78
85
80
75
72
83
80
82
78
80
80
Average
Monthly
94
94
94
94
94
94
94
94
94
94
94
94
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
140
130
Demand
120
110
100
90
80
70
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