GROUP 1

“FORECASTING”

ACOGIDO, TROY
ALANG, BABY NURLAIKA
ALESNA, CHARLIE A.
ALINTON. JESSA MAE

Forecasting
  Is a projection of future sales, revenues, earnings, costs, and other possible variables that are
help in the firm’s operation (Brigham & Houston, 2011).

 Is the starting point of business planning, making it as one of the most important functions to be
applied to business

 The primary objective of forecasting is to reduce the risk or uncertainty that the firm will face in
making a decision. Before a firm starts with the production, it has to determine its sales
forecast.

 With the available figures on hand, a strategic plan is laid out by the top management with the
alternative courses of action. Production plan, Inventory plan, and variable and factory overhead
plan are also put in place to avoid possible miscalculations that may result in unnecessary losses.

Users of Forecast
Forecast, with its wide array of application, is used by people within and outside the company for
various reasons. Some of the users of forecast and their purposes are listed below;

1. Top Management- makes use of the forecast as a tool for long-range planning, particularly in
providing a basis for performance targets, implementing long-range strategic objectives, and making
capital budgeting decisions.

2. Production Manager- utilizes the forecast to determine the amount of raw materials that will be
needed in the production, the budget, schedule of production activities, inventory levels to maintain
so as not to disrupt the production, labor hours, and the schedule of shipments.

3. Purchasing Manager- uses the forecast to ascertain the volume or bulk of materials that should
be purchased for a particular period. This avoids overstocking or understocking of inventories.

4. Marketing Manager- makes use of the forecast to estimate how much sales should be made in a
particular period, and to plan promotional and advertising activities for the products.

5. Finance Manager- uses the forecast to anticipate the funding needed by the firm. The finance
manager must establish the firm’s cash inflows and outflows, and indicate the exact moments when
the firm will need additional funding.

6. Human Resource Manager- utilizes the forecast to supply the human resource needed in
achieving the firm’s objectives. He or she must specify when to hire additional people to support the
firm’s operations.

7. Colleges and Universities- makes use of forecast to identify possible enrollees in a school year.
The figures on hand help determine the revenues to be obtained from the tuition fees, the faculty to
be hired, the planning of room assignments, and building facilities.

Forecasting Approaches
ln general, there are two forecasting; qualitative and quantitative ( Shim et al, 2006)

1. Qualitative (or judgmental) forecasts- these forecasts incorporate factors such as the decision-
maker’s intuition, emotion, personal experiences, and value system.

The qualitative forecasting methods are as follows:

a. Expert opinions

b. Delphi method

c. Sales force polling

d. Consumer market surveys

e. PERT-forecasts

Expert Opinion

Under this method, the views of the managers or a group with a high level of expertise, often in
combination with statistical models, are synthesized to generate a consensual forecast. A leading
business magazine, for instance, gathers a certain number of well-known practitioners who usually
meet as a group or as a jury of executive opinion predicting economic trends.

Delphi Method

This method is similar to the similar opinion, is also done by a group of experts. The difference is
that members are asked individually through a questionnaire about their forecast of future events.
In this way, peer pressure or group consensus is avoided.

Sales Force Polling

The sales force is used by companies to arrive their sales forecast. The sales people, having direct
contact with the consumers, envision the condition of the future markets. In the approach, every
sales person estimates the sales in his or her region. These forecasts are then reviewed to ensure
that they are realistic. Then they are combined at the district and national levels to arrive at a
general forecast

Survey Market Survey

Firms, at times, conduct their own customer or potential customers surveys to accumulate
information regarding future purchasing plan. Surveys are conducted through telephone inquires,
questionnaires, and interviews. Surveys can help not only in in preparing a forecast but also in
improving product design, planning for new product, and determining consumer behavior
2. Quantitative forecasts- use a variety of mathematical models that rely on historical data and/or
causal variables to forecast demand.

The two types of quantitative forecasting are:

A. Time series forecasting

i. Naïve model

ii. Moving average

iii. Weighted moving average

iv. Exponential smoothing

v. Trend projections

B. Associative or causal models

i. Regression analysis

Time series forecasting

assumes that the future is a function of the past. Thus, historical data are used to predict the future
using sequences with equal periods. The sequence may be daily, weekly, monthly, quarterly,
annually, or any equal periods the firm may think of.

Decomposition of a Time Series Forecast

1. Trend is the gradual upward or downward movement of the data over time. Changes in income,
population, age distribution, or cultural views may account for movement in trends.

2. Seasonality is a data pattern that repeats itself after a period of days, weeks, months, or quarters.

Period of Pattern “Season” length Number of “Seasons” in pattern

Week Day 7

Month Week 4-4 ½

Month Day 28-31

Year Quarter 4

Year Month 12

Year Week 52

3. Cycle is a pattern of the data occurs every several years. It is usually associated with the business
cycle and is very important in short-term business analysis and planning. A business cycle is difficult
to predict because of armed conflicts, political upheavals, economic development, and social
changes in the global scene.
4. Random variations are “ blips” in the data caused by chance and unusual situations. They follow
no discernable pattern, so they cannot be predicted.

Naive Model

The simplest way to forecast is to assume that the demand in the next period will be equal to the
demand in the most recent period. The naïve model is considered as the benchmark model. Other
models which cannot beat it should be disregard.

The common advantages of using the naïve model are as follows:

1. It is cheap to develop.

2. It does not require any software or machine

3. Storing of data is simple because all one has to do is to keep the previous records.

4.It is very east to operate because it does require or use complex mathematical applications.

Its common disadvantages are as follows:

1. It does not attempt to explain casual relationships with the forecasted variable.

2. A drastic change in the variable for forecasting is not captured

Using the symbol Y’ t+1 as the forecasted value for the next period and symbol Yt as the observed
value for this period, then
Y’ t+1 =Yt
Example.
Consider the following sales data XYZ Corporation for 2013. The corporation would like to
forecast the sales for the month of January 2014.
013 2
Month Monthly Sales of Product
January 4,150
February 4,250
March 3,950
April 4,230
May 4,050
June 3,950
July 4,175
August 4,785
September 4,875
October 5,250
November 5,550
December 5, 750
Answer: Y’t+1=Yt= Php 5,750
If the actual sales for January 2014 was Php 6,250 and the sales for February 2014 is forecasted , the
answer would be

Y’t+1= Yt = 6,250
Moving Average

~ is the simplest among the series model. In this model, the number of period n, in which a series of
average will be created and computed , should be decided.

The common advantages of the moving average are:

1. It is simple to use.

2. It is easy to understand

The common disadvantages of moving average are as follows:

1. It requires numerous records and data.

2. It is inconvenient needed to conduct a forecast.

The following formula is used in finding the moving average of orders n, MA (n) for a period t+l,

MAt+1= [Dt+Dt-1+…+Dt-n+1]
Where:

n= the number of observations used in the calculation

The forecast for time period t+1 is the forecast for all future time periods. However, this forecast is
revised when new data becomes available.

Example

The table sales of Tableu Company are shown in the middle column of the table below. A three-
month moving average appears on the right.

Month Actual Sales 3-Month Moving Average

January 15

February 12

March 15

April 18 15+12+15= 14.00

May 21 18+15+12= 15.00

June 25 21+18+15= 18.00

July 28 25+21+18= 21.33

August 32 28+25+21= 24.67

September 30 32+28+25= 28.33

October 20 30+32+28= 30.00

November 18 20+30+32= 27.33

December 16 18+20+30= 22.67

3
Weighted Moving Average

~ is more powerful and economical compared with moving average. It is widely used where
repeated forecast require the application of methods like sum-of-the-digits and trend adjustment
methods. WMA may be expressed mathematically as:

WMA t+1= ∑  Wt Dt

Where

wt = weight assigned in a particular period

Dt = demand for period

Example

Tableu Company (see previous example) decides to forecast table sales by assigning the past 3
months with the following weight.

Weight Applied Period

0.20 Three months ago

0.30 Two months ago

0.50 Last month

1.00 Sum of weights

Forecast this month = (0.20 x sales 3 months ago) + (0.30 x sales 2 months ago)

+ (0.50 x sales last month)

The results of this weighted average forecast are as follows:

Month Actual sales Three month weighted moving average

January 15

February 12

March 15

April 18 (15x0.20) + (12x0.30) + (15x0.50)= 14.1

May 21 (12x0.20) + (15x0.30) + (18x0.50)= 15.9

June 25 (15x0.20) + (18x0.30) + (21x0.50)= 18.9

July 28 (18x0.20) + (21x0.3) + (25x0.50)= 22.4

August 32 (21x0.20) + (25x0.03) + (28x0.50)= 25.7

September 30 (25x0.20) + (28x0.03) + (32x0.50)= 29.4

October 20 (28x0.20) + (32x0.03) + (30x0.50)= 30.2

November 18 (32x0.20) + (30x0.03) + (20x0.50)= 25.4

December 16 (30x0.20) + (20x0.03) + (18x0.50)= 21.00

Exponential Smoothing

~This method uses the weighted moving average technique where more weight is given to the
recent data. It is supported by the beliefs that the future is more dependent on the recent past than
on the distance past,. Exponential smoothing is a popular technique that does not involve
voluminous records to forecast, and is easy to use and effective for short-run forecasting. The
method is known to be useful on random historical data with no seasonal fluctuations.

~ Exponential smoothing is a continuous adjudgment process. The alpha a is used as the smoothing
parameter to minimize the error and has value of 0 to 1. The a is adjusted until the minimized mean
squared error (MSE) is solved. If the difference between the actual value and the forecasted value is
a positive, it means that the forecasted value is slow in reacting to the changes in sales increase and
a higher a must be assigned . On other hand, if the difference between the actual value and
forecasted value is a negative, a lower a must be assigned. A higher a means that a greater weight is
given to the most recent data and less weight to the distant past.

The formula for exponential smoothing is:

Y’ t+1= a Yt + (1-a) Y’t or, in words Y’ new =aYold + (1-a) Y’ old

Where Y’new = exponentially smoothed average to be used as the forecast

Yold = most recent actual data

Y’old = most recent smoothed forecast

a = smoothing constant

The formula for MSE is:

MSE= ∑ (Yt-Y’)2

t+1 n-i
i = the number of observations used to determine the initial forecast

Example:

The following are data on sales.

Time period (t) Actual Sales(Yt) Time period(t) Actual sales (Yt)

(000s) (000s)

1 100 7 120

2 114 8 124

3 108 9 112

4 116 10 124

5 120 11 118

6 110 12 116

The initial forecast is necessary for the exponential smoothing process. The first smoothed forecast
to be used can be:

1. First actual observations

2. An average of the actual data for a few periods

For illustrative purposes, a five-period average is used as the initial forecast Y’6 with a smoothing
constant of a=0.70.

Y6 = ( Y1 + Y2 + Y3 + Y4 + Y5 )

= ( 110 + 114 + 108 + 116 + 120 )

= 113.60

Note that Y6 =110. Then Y’7 is computed as follows:

Y’7 = a Y6 + (1-a) Y’ 6

= (0.70) (110) + (1 – 0.70) (113.60)

= 77.0 + 34.08

= 111.08
 Similarly,

Y’8 = a Y7 + ‘(1-a) Y’7

= (0.70) (120) (1-0.70) (111.08)

= 84.00 + 33.32

= 117.32

And Y’ 9 = a Y8 + (1-a ) Y’8

= (0.70) (124) + (1-0.70) (117.32)

= 86.80 + 35.20

= 122.00

The same procedure is followed in computing for the values of Y’10, Y’11, and Y’12. The table below
shows a comparison between the actual sales and the predicted sales using the exponential
smoothing method.
Time period Actual Sales Predicted Sales Difference Difference

(t) (Yt) Y’t Yt – Y’t (Yt – Y’t )2

1. 110

2. 114

3. 108

4. 116

5. 120

6. 110 113.60 (3.60) 12.96

7. 120 111.08 8.92 79.57

8. 124 117.32 6.68 44.62

9. 112 122.00 (10.00) 100.00

10. 124 115.00 9.00 81.00

11. 118 121.30 (3.30) 10.89

12. 116 118.99 (2.99) 8.94

337.98

The formula presented in exponential smoothing is expected to give either positive or negative results
between the actual sales and the predicted sales. Since the objective is to bring the differences or error
to zero, the forecaster may use a higher or lower smoothing constant (a) to adjust the prediction to
large fluctuations in the data series.
 n
MSE= ∑  (Yt-Y’t)²
t+1 n–I
Based on the example, the value of i is 5.
Therefore, MSE is computed as:
= 337.98
12 – 5
= 48.28
The idea is to select the a that minimizes the MSE which is the average sum of the variations
between the historical sales data and forecast values for the corresponding periods.
Trend projection
~ technique fits a trend line to a series of historical data points and then projects the line into the
future for medium-to-long range forecasts. The problem with this kind of technique is that is only
visualizes the relationship of the given variables. Through this visualized relationship, a best fitting
line is drawn through the observed data.
Associative Models
~ Such as linear regression, incorporate the variables of factors that might be influence the quality
being forecasted.
Linear Regression
~ shows the relationship between two variables: the dependent and the independent
~ The dependent variables to be forecasted will still be Y. But now, the independent variable (x) no
longer represents the time.
A least squares line is described in terms of its y-intercept (the height at which it intercepts the y-
axis) and its slope (the angle of the line).
If the y-intercept and slope can be computed, the line can be expressed with the following equation.
Y = a + bx
Where Y = computed value of the variable to be predicted

a = y-axis intercept

b = slope of the regression (or the rate of change in y for a given change in x)

x = independent variable (in this case, time)

Statisticians have developed equations that can be used to find the values of a and b for any
regression line. The slope b is found with the formula:

b = ∑ xy – nxy

∑  x² – nx²

Where:

b = slope of the regression line

∑  = summation sign

x = known values of the independent variable

y = known values of the dependent variable

x̄ = average of the value of the x’s

y = average of the value of y’s

n = number of data points or observations

Example

Nodel Construction Company renovates old homes in Quezon City. Over time, the company has
found that its peso volume of renovation work is dependent on the Quezon City area payroll.
The following table list Nodel’s revenues and the amount of money earned by wage earners in
Quezon City during the past six years.

Nodel’s Sales Local Payroll Nodel’s Sales Local Payroll

(₱000,000), y (₱000,000,000), x (₱000,000), y (₱000,000,000), x

2.0 1 2.0 2

3.0 3 2.0 1

2.5 4 3.5 7
Nodel management wants to establish a mathematical relationship to help predict sales. First, it
needs to determine whether there is a straight-line (linear) relationship between the area
payroll and sales, so it plots the known data on a scatter diagram.

Sales (y) Payroll (x) x² xy y²

2.0 1.0 1.0 2.0 4.0

3.0 3.0 9.0 9.0 9.0

2.5 4.0 16.0 10.0 6.25

2.0 2.0 4.0 4.0 4.0

2.0 1.0 1.0 2.0 4.0

2.5 7.0 49.0 24.5 12.25

∑y = 15.0 ∑x = 18.0 ∑x² = 80.0 ∑xy = 51.5 ∑ y² = 39.5

x = ∑ x = 18 = 3.0

6 6

y = ∑ y = 15 = 2.5

6 6

b = ∑x – nxy = 51.5 – (6)(3)(2.5) = 0.25

∑x² - nx² 80 – (6)(3²)

a = ȳ - b x̄  = 2.5 – (0.25) (3) = 1.75

The estimated regression equation, therefore, is:

Y = 1.75 + 0.25x or Sales = 1.75 + 0.25 (payroll)

If the local chamber of commerce predicts that the Quezon City area payroll will be ₱600 million
years, the sales of Nodel may be estimated with the regression equation:

Sales (in hundred thousands of Php) = 1.75 + 0.25 (6)

= 1.75 + 1.50

= 3.25

Standard Error of the Estimate

~ The forecast of ₱325,000 for Nodel’s sales in the example is called a point estimate of y. The
estimate is really the mean, or expected value, of a distribution or possible values of sales.

~ To measure the accuracy of the regression estimates, the standard error of the estimates, Syx,
must be solved. This computation is called the standard deviation of the regression: it measures
the error from the dependent variable, y , to the regression line, rather than to the mean.

Syx = ∑y²- a∑y - b∑xy

n–2

= 39.5 - 1.75 (15.0) – 0.25(51.5)

6-2

= 0.09375 = 0.306 (in hundred thousand thousands of Php)

Thus, the standard error of the estimate is ₱30,600 in sales

Correlation Coefficients for Regression Lines

~ The regression equation is one way of expressing the nature of the relationship between two
variables. It shows how one variable relates to the values and changes in another variable.

~ Another way to evaluate the relationship between two variables is to compute the coefficient
of correlation. This measure expresses the degree or strengths of the linear relationship. Usually
identified as f3 the coefficient of correlation can be any number between +1 and -1.

~To compute for r, the same needed earlier will be used to calculate a and b for the for the
regression line. The rather lengthy equation for r is:

r = n ∑xy - ∑x ∑y

[n ∑x² - (∑x)² ] [n ∑y² - (∑y)²]

To compute for the coefficient of correlation for the data shown, an additional column is needed
to calculate for y2. The equation is then applied for r:

y x x² xy y²

2.0 1.0 1.0 2.0 4.0

3.0 3.0 9.0 9.0 9.0

2.5 4.0 16.0 10.0 6.25

2.0 2.0 4.0 4.0 4.0

2.0 1.0 1.0 4.0 4.0

3.5 7.0 49.0 24.5 12.25

∑y = 15.0 ∑x = 18.0 ∑ x² = 80.0 ∑xy = 51.5 ∑ y² = 39.5

r= (6) (51.5) - (18) (15.0)

[(6) (80) – (18)2 ] [(6) (39.5) - (15.0)2]

= 309 - 270 = 39

(156) (12) 1,872

= 39 = 0.901

43.3