Chapter_3

Forecasting
INTRODUCTION
Forecasting is a method to use the past experience and
estimate the future. It can be used for sales forecasting,
demand forecasting and technology forecasting.

In production engineering, demand estimation is an

important part of production planning.

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INTRODUCTION
Forecasting is the initial phase of production planning in
which the quantity of product required in the near future is
estimated and production schedule is prepared accordingly.
The term ‘forecasting’ can be defined in many ways.

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Forecasting Definition
(Golden et al. 1994)‘Forecasting is predicting, projecting, or estimating
some future event and condition which is outside the organization’s
control and provide for basis of managerial planning’.
(Waddell 1994) ‘Forecasting is generally used to predict or describe
what will happen given a set of circumstances or assumptions’.
(Mentzer and Moon 2005) ‘Forecasting is a projection into the future of
expected demand, given a standard set of environmental conditions’.

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characteristics of Forecasts
1. Forecasts are normally wrong since it is an approximation
of demand estimates in the future.
2. A good forecast has more than a single number, as it
includes (a) A mean value and standard deviation.
(b) An accuracy range (high and low).
3- Aggregated (combined) forecasts are usually more
accurate because it can adjust the variation in actual
demand of individual products.

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characteristics of Forecasts
4. The increase in time horizon increases the uncertainty in
demand pattern.

5. Forecasts should not be used to the exclusion (rejection)

of known information.

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Forecasting
Horizons

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Steps of Forecasting
1- Determination of objectives of forecasting: The
objectives of forecasting should be clear.
2. Selection of the items to be forecast: The forecast
for one item cannot be used for the other item.
3. Determination of the time horizon of the forecast:
The nature of the product decides the time horizon of
its demand forecast.

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Steps of Forecasting
4. Selection of the suitable forecasting model: There
are a number of forecasting models.
5. Collection of the data: Future is predicted on the
basis of the past data.
6. Validation of the forecasting model: The selected
forecasting model is to be validated using the
collected data.

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Steps of Forecasting
7. Forecasting the demand: After data collection and
model validation, forecast is made for a specific time
in the future.
8. Implementation of the results: Finally, the results
are implemented to fulfil the objectives.
Here, results mean the quantity/volume of product
forecasting.

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Forecasting Methods
Forecasting methods are divided into two categories: qualitative
forecasting and quantitative forecasting

Qualitative Forecasting
Qualitative forecasting is usually based on judgements about
causal factors that underlie the demand of particular products or
services.
It can be used to formulate forecasts for new products for which
there are no historical data.

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Quantitative Forecasting
It is based on the assumption that the ‘forces’ that
generated the past demand will also generate the future
demand,
i.e., history will tend to repeat itself. Analysis of the past
demand pattern provides a good basis for forecasting the
future demand.
Quantitative methods of forecasting are divided into two
categories: (a) time-series methods and (b) causal methods.

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Time-series Forecasting Methods
The time-series forecasting methods are based on the
analysis of historical data.
The assumption is that the past patterns in the data can be
used to forecast future data points

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Time-series
Forecasting
Pattern

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Time-series Forecasting Methods
(A) Naive Method
The naive forecasting model is a special case of the moving
average forecasting model where the number of periods used
for smoothing is 1.
Therefore, in the naive method, the forecast for a period, t, is
simply the observed value of the previous period, t – 1.
Due to the simplistic nature of the naive forecasting model, it
can only be used to forecast up to one period in the future. It is
not at all useful as a medium-/long-range forecasting tool.

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 Time-series Forecasting Methods
(B) Simple Moving Average Method : Suppose t, represents
the current period and we want to forecast for the period t + 1

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Time-series Forecasting Methods
(B) Simple Moving Average Method
example 3.1: The monthly demands for an office furniture
(in units) are given in Table 3.2. Forecast the demand using
3-period and 5-period SMA for the 12th month. Also, show
the variation in forecasting graphically.

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For 3-period moving average method
We use the formula

Here, the average value of last three periods is used as

forecast for the fourth period as shown in the formula
below:

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For 3-period moving average method

Similarly, F , F , …, F can be calculated as:

5 6 12

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For 5-period moving average method
Here, the average value of last five periods is used as
forecast for the sixth period as shown in
the formula below

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For 5-period moving average method
Similarly, F7, F8, …, F12 can be calculated as:

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The
forecasting of
the demand
for the 12
months is
shown in
Table 3.3
using 3-
period simple
average and
5-period
SMA.

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(C) Weighted Moving Average Method
The WMA method is very similar to SMA method, but in the
former method different weights are provided for the
periods.

where n is the total number of periods in the average, Wt is

the weight applied to period t’s demand, W
1 > W2 >…> Wn, sum of all the weights = 1, Forecast Ft+ 1 =
forecast for period t + 1.

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The assumptions in making the forecast using the SMA
method are as follows:
1. Adjustments in the moving average to more closely reflect
fluctuations in the data.
2. Weights are assigned to the most recent data.
3. Requires some trial and error to determine precise
weights.

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Eexample 3.2
:Using the data shown in Table 3.3, forecast the demand for
the periods with the three-period WMA method. The most
recent data should be given 50 per cent weightage, second
year past data, 30 per cent, and third year past data, 20 per
cent. Also, compare the result with the result of three-
Period SMA graphically.

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Similarly, F5, F6, …, F12 can be calculated as:

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Comparison
In Figure 3.3, we observe that the WMA forecast closer to the actual demand
compared to the SMA method, i.e. the forecasts from WMA pursuing the actual
demand closely since the recent period is given more weightage.

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(D) Exponential Smoothing Method
Exponential smoothing is the most popular and cost
effective of the statistical methods. It is based on the
principle that the latest data should be weighted more
heavily and ‘smoothers’ out cyclical variations to forecast
the trend (Armstrong et al. 2005)

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(D) Exponential Smoothing Method
Figure 3.4
shows the
decreasing pattern
for the value of α as
we move towards
the past; this
decrease
follows an
exponential pattern.
Thus, this method is
known as
exponential
smoothing method.

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The forecast for the period t + 1 is equal to the actual
demand for the period t plus the α times of the difference of
the actual and forecasting value for the period t.
Here, α tries to smoothen the variation in the previous
period actual and forecasting values of the demand.
The forecast for tth period can be given as

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Example 3.3:

Using the data shown in Table 3.3, forecast the

demand for the periods using the exponential
smoothing method (α = 0.3 and α = 0.5). Also,
compare the results graphically.

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Adjusted Exponential Smoothing
Double exponential smoothing is also called
exponential smoothing with trend. If trend exists,
single exponential smoothing may need adjustment.
There is a need to add a second smoothing constant
to account for the trend. It is similar to a single
exponential smoothing.

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Adjusted Exponential Smoothing
• β close to 1 means quicker responses to trend
changes, but may over-respond to random
fluctuations.
• α close to 1 means quicker responses to level
changes, but again may over-respond to random
fluctuations.

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where Tt is the last period trend factor and
β is a smoothing constant for trend. Value (0 to 1)
The formula for the trend factor reflects a weighted measure of the
increase or decrease between the next forecast, Ft+1, and the current
forecast, Ft.

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Example 3.4:
Using the data shown in Table 3.6, forecast the demand for
the periods with adjusted exponential smoothing method (α
= 0.5 and b = 0.3). Also, compare the result graphically with
simple exponential smoothing (α = 0.5).

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Solution:
Adjusted forecast for period 3: We have

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(E) Simple Linear Regression Method
This is a mathematical technique that relates to one
variable, that is, the independent variable, with another
variable called the dependent in the form of a linear
equation. The linear regression equation is

where y is the dependent variable,

a is the intercept, b is the slope of the line and x is the
dependent variable. The variables a and b are given by

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where a is a constant, b is a coefficient of variable x, and x is the mean
value of x, y is the mean value of y, x is time, y is the demand, and n is the
period for which data is analysed using linear regression methods.

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Coefficient of correlation (r) [1 to -1]
Coefficient of correlation shows the strength of correlation
between two variables. The linear regression model of
forecasting is only used when the value of the coefficient of
correlation (r) is high, i.e. near to 1. Coefficient of correlation
(r) in a linear regression equation is the measure of
the strength of the relationship between the independent
(time) and dependent variable (demand).

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Example 3.5
The weekly demands of a motorcycle by a retailer are shown
in Table 3.7. Find an equation of the regression line and
estimate the demand for the 14th week.

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Solution

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Seasonal adjustment
A seasonal pattern is a repetitive increase or decrease in
demand. There are several methods for reflecting seasonal
patterns in time-series forecasts.
A seasonal factor is used to adjust for seasonal patterns.
Seasonal factors are multiplied by the normal forecast to get
seasonally adjusted forecasts.

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 One method for determining seasonal factors [0-1] is :

where i shows the specific season or quarter of a year;

j shows the number of years
Si is seasonal adjustment factor;
ΣDi shows the summation of demand in ith quarter of the past years;
And ΣΣDij shows the total demand in the past years

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Example 3.6:
The quarterly demands of a raincoat from a shop for the
years 2012, 2013 and 2014 are given in Table 3.9. Forecast
the demand for the year 2015 quarterly.

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Solution: We have

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Multiplicative Seasonal Method
To deal with seasonal effects in forecasting, two
major parts of forecasting are to be completed, as
described below:
1. A forecast for the entire period (i.e. year) must be
made using whatever forecasting technique is
appropriate.
2. This forecast will be developed to reflect the
seasonal effects in each period (i.e. month or
quarter).

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example 3.7:
Solve Example 3.6 using the multiplicative method of
seasonal adjustment

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Forecasting Performance Measurement
Forecasting performance can be measured through the following
terms:
Mean absolute deviation: Mean absolute deviation (MAD) is the
average deviation of forecasting of actual demand. It can be
calculated as:

where Dt is the actual demand for the period t and

Ft is the forecast for the period t, and n is the total number of
periods.

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Forecasting Performance Measurement
Mean absolute percentage error (MAPE): It is very similar to
MAD, but it is shown in percentage. The MAPE can be
calculated as:

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Forecasting Performance Measurement
Mean square error: Mean square error (MSE) is used to
show the small deviation at larger scale by squaring the
deviation. It can be calculated as:

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Tracking Signal
Tracking signal monitors any forecasts that have been
made in comparison with actual, and warn when there are
unexpected departures of the outcomes from the
forecasts. The tracking signal is a simple indicator that
forecast bias is present in the forecast model. It is most
often used when the validity of the forecasting model
might be in doubt.

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Example 3.8:
Using Table 3.12, find MAD, MAPE and MSE

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