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FORECASTING
2.1 Definition
What is forecast?
Forecasts are estimates of the occurrence of uncertain future events or levels of activity.
The purpose of forecasting activities is to make use of the best available present information to guide
future activities toward system goals.
Forecast = Estimate about the future,
Forecasting is the art and science of predicating future event
Successful forecasting requires blending art and science. Experience, judgment, and technical
expertise will all play a role in successful forecasting
Elements of a Good Forecast
The forecast should be timely
The forecast should be accurate and the degree of accuracy should be stated
The forecast should be reliable (consistent)
The forecast should be expressed in meaningful terms. Different users may need different
terms (Financial in dollars, marketing in units by products, operations by units, human
resources by skills, etc)
The forecast should be in writing
The forecasting technique should be simple to understand and use.
Steps in the Forecasting Process
Determine the purpose of the forecast
Establish a time horizon
Select a forecasting technique
Gather and analyze the appropriate data
Prepare a forecast
Monitor the forecast
Advantages of good forecasts
Improved employee relations
Improved materials management
Better use of capital and facilities
Improved customer service
Forecasting, which is projection into the future based on the analysis of past data, is the principal
technique for analyzing demand.
It is apparent that an analysis of the demand situation is a necessary prerequisite to the
establishment of any inventory system.
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Types of Forecasts
Economic forecasts -address the business cycle by predicting inflation rates, money supplies,
housing starts, and other planning indicators.
Technological Forecasts-are concerned with rates of technological progress which can result
in the birth of exciting of new products requiring new plants and equipment.
Demand forecasts are projections of demand for a company’s products or services.
Forecasts are often classified according to time period.
Short range-up to 1 year
Medium 1 to 3 years
Long range-5 years or more
Data base- Most forecasting models rely up on quantitative Data-It is the basis for scientific
decision making.
Quantification enhances the objectivity of the model and forces precisions.
Problems arise when either the data or the model is inadequate Qualitative methods are
applied.
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3. Summarize the results and redistribute them to the participants along with appropriate
new questions
4. Summarize again, refining forecasts and conditions, and again develop new questions
5. Repeat Step 4 as necessary and distribute the final results to all participants
c) Market research/ surveys)- set out data in a variety of ways (surveys, interviews etc) to test
hypothesis about the market. These are typically used to forecast long range and new product sales.
d) Historical Analogy- comparison with stages in life cycle of comparable product (that is
introduction, growth, maturity, decline).
Assumes similar patterns.
Forecast may be derived by using the history of a similar product.
II. Time series Analysis
statistical techniques that use historical demand data to predict future demand
-Time series forecasting models try to predict the future based on past data.
Used for inventory and near term scheduling decisions
Based on the idea that the history of occurrences over time can be used
to predict the future.
Time series analysis is a set of observation of some variable over time.
Time series analysis will have a variable which is dependent and another
Variable time. The time is independent variable because it doesn’t dependent on the other
variable. The other variable becomes a dependent variable when it depends on time.
• The simple moving average model assumes an average is a good estimator of future behavior
• The formula for the simple moving average is:
* Decomposition of a time series Analysis based on Demand Behavior
(1) Trend-is the gradual up ward or down ward movement of the data over time.
(2) Seasonality -is a data pattern that repeats itself for a period of days, weeks or quarters. E.g.
shops, restaurants
(3) cycles-are patterns in the data that occur every several years.
(4) Random variations-are “blips” in the data caused by chance and unusual situations.
a. Irregular variables
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Demand
Demand
Random
movement
Time
Time
(b)
(a) Trend
Cycle
Demand
Demand
Time
Time
(c) Seasonal
(d) Trend with seasonal pattern
pattern
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Year x(time) y (dd for aluminum) xy x2
1994
-5 13 -65 25
1995 -4 17 -68 16
1996 -3 16 -48 9
1997 -2 16 -32 4
1998 -1 21 -21 1
1999 0 20 0 0
2000 1 20 20 1
2001 2 23 46 4
2002 3 25 75 9
2003 4 24 96 16
2004 5 25 125 25
Sum 0 220 128 110
n = 11 x= ∑x = 0 = 0, y = ∑y = 220 = 20
n 11 n 11
b= åxy - nxy
åx2 - nx2
=
128-11xox20
(110)- 11 (0)2
b = 128 = 1.163
110
a = y - bx
= 20-1.163(0)
= 20
Y= a+ 1.163x
Forecast for year 2005.
20 + 1.163 (6)
= 26.98 tones of aluminum
Exercise. Forecast the demand for aluminum for year 2007taking 1994
as a base year.
x(PERIOD) y (DEMAND)xy x2
1 73 37 1
2 40 80 4
3 41 123 9
4 37 148 16
5 45 225 25
6 50 300 36
7 43 301 49
8 47 376 64
9 56 504 81
10 52 520 100
11 55 605 121
12 54 648 144
5
78
x = = 6.5
12
55
y =7 = 46.42
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b = xy - nxy = 3867 - (12)(6.5)(46.42) =1.72
x2 - nx2
a = y - bx 650 - 12(6.5)2
= 46.42 - (1.72)(6.5) = 35.2
y = 35.2 + 1.72x
Linear trend line
1.72x
Forecast for period 13 y = 35.2 + 1.72(13) = 57.56 units
Actual
70 –
Demand
60 –
50 –
40 – Linear trend line
30 –
20 –
10 –
0–
| | | | | | | | | | |
| |
1 2 3 4 5 6 7 8 9 10
11 12 13 Period
B) Simple Moving Average: A moving average is obtained by summing and averaging the values
from a given number of periods repetitively each time deleting the oldest value and adding a new
value.
MA = ∑x
Number of periods
Where x value is exchanged each period. Or
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A t -1 + A t - 2 + A t -3 + ... + A t - n
Ft =
n
Compute a three year moving for the aluminum tube shipments for the following
1997 2 - -
1998 3 11÷3 3.7 2000
1999 6 19 6.3 2001
2000 10 24 8 2002
2001 8 25 8.3 2003
2002 7 27 9 2004
2003 12 33 11 2005
2004 14 40 13.3 2006
2005 14 46 15.3 2007
2006 18 51 17 2008
2007 19 - -
Eg3. Storage shade sales at Donna’s Garden supply are shown in the middle column of the table
below.
Month Actual sales of shed 3 month moving average
January 10
February 12
March 13
April 16 (10+12+13) /3=11 2/3
May 19 (12 +13+16) /3 = 13 2/3
June 23 16
July 26 19 1/3
August 30 22 2/3
September 28 26 1/3
October 18 28
November 16 15 1/3
December 14 20 2/3
January (forecast) (18 + 16 + 14 )/3 =16
C) Weighted moving Average – weights assigned to components of moving average, in this way
the most recent values are emphasized. It is simply a moving average but with differential weights
applied to particular time period.
MAWt = £ (Wtx)= F =w A +w A t + w A + ... + w A
1 t -1 2 t -2 3 t -3 n t -n
£Wt
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wt = weight given to time period “t” occurrence (weights must add to one)
While the moving average formula implies an equal weight being placed on each value that is being
averaged, the weighted moving average permits an unequal weighting on prior time periods
If a weight of 3 is assigned to the 2007 shipments 2, 2006and 1 to 2005, the weighted moving
average is
MAWT = £wtx=3x19 + 2x 18 + 1x 14 = 17.8
£wt 3+2+1
Is a sophisticated weighted moving average forecasting method that is still fairly easy to use. It
involves very little record keeping of past data.
The basic exponential smoothing formula can be shown as follows.
New forecast=last periods forecast +ά (last periods actual dd-last period forecast)
Where ά is a weight or smoothing constant chosen by the forecaster that has a value between 0 and
1.
Mathematically
Ft+1=Ft-1+ ά (At-1-Ft-1)
Or Ft+1= ά(last periods Demand)+1- ά(forecast calculated last period)
= άAt-1+(1- ά)Ft-1
Where Ft+1=new forecast for period t+1
Ft-1= pervious forecast
ά = smoothing constant (or weighting ) (0<ά<1)
At-1= previous periods actual demand.
• Premise: The most recent observations might have the highest predictive value
• Therefore, we should give more weight to the more recent time periods when forecasting
Eg. In January, a car dealer predicted February demand for 142 Ford.
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Actual February demand was 153 autos. Using a smoothing constant chosen by management of ά
=0.2. Forecast March demand using exponential smoothing model.
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=0.2(27)+0.8(28+3)
=30.2
T1=0.2(30.2-28)+0.8(3)=2.8
F2=Al+Tl=30.2+2.8=33
If the actual number of syringes used in week 2 proved to be 44, the updated forecast for week 3
would be:
A2=0.2(44) +0.8(30.2+2.8)=35.2
T2=0.2(35.2-30.2) +0.8(2.8) =3.2
F3=35.2+3.2=38.4
G) Seasonal patterns
Seasonal patterns are regularly repeating upward or downward movements in demand measured in
periods of less than one year
-Multiplicative seasonal Method-A method where by seasonal factors are multiplied by an estimate
of average demand to arrive at seasonal forecast.
Steps:
1. For each year, calculate the average demand per season by dividing annual demand by
number of season per year.
2. For each year, divide the actual demand for a season by the average demand per season.
The result is a seasonal index for each season in year, which indicates the level of demand relative
to the average demand.
3. Calculate each average seasonal index for each season. Add the seasonal indicates for a
season and divide by the number of years of data.
4. Calculate each seasons forecast for next year. Begin by estimating the average demand
per season for next year using different estimating methods. Then obtain the seasonal factors by
multiplying the seasonal index by the average demand per season.
Example .The manager of Stanley steamer carpet cleaning company needs a quarterly forecast of
the number of materials needed by customers next year. The carpet cleaning business is seasonal
with a peak in third quarter.
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2.(1.34+1.23+1.3+1.32)/4=1.3
3..(2.08+1.97+1.84+2.11)/4=2
4.(0.4+0.57+0.63+0.39)/4=0.5
Step4. Average demand per quarter for year 5,is=2600/4=650
Quarter Forecast
1 650 (0.2) =130
2 650(1.3)=845
3 650(2)=1300
4 650(0.5)=325
III. Causal Methods: Liner Regression
Attempt to develop a mathematical relationship between demand and factors that cause its
behavior
The simple linear regression model seeks to fit a line through various data over time
causal methods are used when historical data are available and the relationship between the factor
to be forecasted.
Linear regression is a causal method in which one variable (the dependent variable) is related to
one or more independent variables by a linear equation.
Y=a+bx
Where; Yt is the regressed forecast value or dependent variable in the model, a is the intercept
value of the regression line, and b is similar to the slope of the regression line. However, since it is
calculated with the variability of the data in mind, its formulation is not as straight forward as our
usual notion of slope.
a = y - bx
b=
xy - n( y)( x )
x - n( x )
2 2
E.g.1 The person in charge of production scheduling for a company must prepare forecasts of
product demand in order to plan for appropriate production quantities. The marketing manager
gives her information about the advertising budget for a product.
The following are sales and advertising data for five months.
Month sales (‘000s of units) Advertising (‘000s of $)
1 264 2.5
2 116 1.3
3 165 1.4
4 101 1
5 209 2
The marketing manager says that the next month the company will spend$ 1750 on advertising for
the product
Required. Use linear regression and forecast for this product.
Solution: a =-8.137
b= 109.230
Y = -8.137+109.230x Regression equation
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Therefore, the forecast for six months is y = -8.137+ 109.230 (1.75)
Y = 183.016 or 18, 016 units.
500
400
300 Y=-8.137+109.230x
x (‘000)
1 1.5 2 2.5 3 3.5
Advertising
E.g.2 The general manager of a building materials production plant feels that the demand for his
building materials depends on the construction permit issued by the municipality in the previous
years.
The manager has collected the following data.
Construction permit(x) Demand for materials(y) xy x2
15 6 90 225
9 4 36 81
40 16 640 1600
20 6 120 400
25 13 325 625
25 9 225 625
15 10 150 225
35 16 560 1225
184 80 2146 5006
If the construction permit for a next year is 30, what is the demand for the construction material?
X=Σ x= 184/8=23 y= Σy=80/8=10
n n
b = 2146-{8(23*10)}= 0.395
5006-8(23)2
a = 10-0.395(23) = 0.91
y = a+bx=0.91+0.395x
= 0.91+0.395(30)= 12.76=13
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(2) Average forecast error (E)= CFE/n
(3) Mean squared error(MSE), standard Deviation( ),and Mean
Absolute deviation (MAD) measure the dispersion of forecast errors
MSE=∑Et2/n
• The ideal MAD is zero which would mean there is no forecasting error
The larger the MAD, the less the accurate the resulting model
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(4)
(Dt - Ft)2
= n-1
= 27.4
(5)MAD= 195/8=24.4
(6)MAPE=81.3%=10.2%
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=å(Dt - Ft) = E
MAD MAD
Demand forecast, error åe =
Period dt ft dt - ft å(dt - ft) MAD tracking signal
e.g1 37 37.00 – – – -
2 40 37.00 3.00 3.00 3.00 1
*3 41 37.90 3.10 6.10 3.05 2
4 37 38.83 -1.83 4.27 2.64 1.62
5 45 38.28 6.72 10.99 3.66 3
6 50 40.29 9.69 20.68 4.87 4.25
7 43 43.20 -0.20 20.48 4.09 5.01
8 47 43.14 3.86 24.34 4.06 6
9 56 44.30 11.70 36.04 5.01 7.19
10 52 47.81 4.19 40.23 4.92 8.18
11 55 49.06 5.94 46.17 5.02 9.2
12 54 50.84 3.15 49.32 4.85 10.17
* tracking signal for period 3 is
TS3=6.1/3.05=2.00
2.3 Materials Budgeting
2.3.1Introduction
Budgets is quantitative model, or summary of expected convergences of the Organization short term
operating activities
-Budgeting is the process of preparing budget
Master budget is a summary of all phases of company’s plans and goal for the future.
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-It is a set of budgets prepared collectively for all activities of a company.
-Budgets can be grouped in to two depending up on the longevity of time they cover. These are:
(a)short term budgets are shorter plans formally expressed in quantitative terms. (Quarterly monthly
or weekly)
-Long-term budgets are prepared to quantify the long-term planning-strategic planning which is a
process of setting long term goals and determining to achieve them (5-10 years)
e.g. Capital budget is an impotent part of long term budget
2.3.2 Budget classification
a) Sales budget (demand forecast)
Sales budget is basis for all other budgets. It is from sales budget that budgets for purchases,
manufacturing costs, selling & administrative expenses, are prepared
Sales budget is developed based on the sales forecast.
A sales forecast is formal prediction of the quantities expected to be sold in the budget period and
the price at which the expected volume of sales is to be sold.
-The accuracy of estimated production schedules and of costs to be incurred depends on the detail
ness and accuracy of the treated sales in monetary unit and quantity. Besides costly mistakes can be
made by purchasing un necessary materials and hiring employees.
-The major factors affecting sales forecast are price, general economic out look, conditions with the
industry, government policies, etc
b) Production Budget
The sales budget is the foundation for the production budget in manufacturing companies
-It is from the sales budget that plans for manufacturing products that will be needed-
-The manufacturing and will schedule production so as to deliver products plans will have to be
synchronized with the sales budget.
-The production budget stems from the sales budget. Once the sales forecast and the sales budget
are completed, the next phase in developing the master budget to fore pare the production badger.
The production budget stems from the sales budget is a formal bean quant sing in units, the
required production. Carrying very little inventory of finished goods may result in lower sales and
production rush which leads to higher costs.
-If sales volume is irregular, it will not be possible to schedule production evenly
Through out the budget period and maintain the constant level of inventory at the same time.
-moderate inventory level is kept as a minimum stocks level in most firms as a policy.
-production budget is governed by the firm’s inventory policy.
Inventories may be built up or liquidated depending up on the policy adopted by management & the
out look for future sales.
-The sales budget, on a unit basis related to the desired inventory level, can be converted in to a
budget of units to be produced.
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When direct materials budget is developed it is important to consider the inventory policy of the
organization. It may be possible to purchase materials in advance for favorable price. It may also
possible to save by purchasing in large quantities
-saving obtained by purchasing under favorable conditions can be offset by more cost of carrying
excessive quantities of materials inventory.
The materials inventory should be balanced so as to avoid excessive inventory and shortage of
inventory during the production cycle with the help of economic order quantity model
-The materials usage budget is the total materials reframed for production during the period. The
materials purchase budget is derived from the usage budget and the minimum and maximum invert
limits. Purchase budget is prepared in monetary terms. The monetary figures help for developing
cash plan for disbursements.
MRO Budgets
This a purchase plan typically for twelve months period, for all the maintenance, repairment, and
operating supplies which will be needed thus purchased.
e) Capital Budget
Based on the production needs, obsolescence of present equipment, equipment replacement needs
and expansion plans, decisions can be made on projected capital purchases for a several year
horizon.
f) Purchasing Administrative budget
This annual budget is based on the anticipated workloads, should be prepared for all of the
administrative expenses incurred in the operation of the purchasing function such as salaries and
wages ,space costs including electricity, heat equipment, costs for desks office machines files and
typewriters data processing costs including computer usage or time sharing charges travel and
entertainment expenses education expenditure for personnel who attend seminars and professional
meetings postage telegraph charges office supplies subscription tom trade publications and
additions to the purchasing library.
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