II.

Forecasting

A forecast is a statement about the future. It serves as a basis for planning.

In business, forecasts are the basis for capacity planning, budgeting, sales planning, production
and inventory planning, manpower planning, purchasing planning, and more. Forecasts play
such an important role in the planning process because they enable managers to aniticipate the
future and to plan accordingly.

Two uses of Forecasts:

1.) To help managers plan the system;

2.) To help them plan the use of the system.

Features Common to All Forecasts

1. Forecasting techniques generally assume that the same underlying causal system that
existed in the past will continue to exist in the future.
2. Forecasts are rarely perfect; actual results usually differ from predicted values.
3. Forecasts for groups of items tend to be more accurate than forecasts for individual items
because forecasting errors among items in a group usually having a canceling effect.
4. Forecasts accuracy decreases as the time period covered by the forecast (i.e., the time
horizon) increases.

Steps in the Forecasting Process

1. Determine the purpose of the forecast and when it will be needed.

2. Establish a time horizon that the forecast must cover, keeping in mind that accuracy
decreases as the length of the forecast period increases.
3. Select a forecasting technique.
4. Gather and analyze that appropriate data, and then prepare the forecast. Identify any
assumptions that are made in conjunction with preparing and using the forecast.
5. Monitor the forecast to see if it is a performing in a satisfactory manner.
Approaches to Forecasting

There are two general approaches to forecasting: qualitative and quantitative.

Qualitative methods consist mainly of subjective inputs, which often defy precise numerical
description. Quantitative methods involve either the extension of historical data or
development of associative models that attempt to utilize causal variables to make a forecast.

Forecasts Based on Judgment and Opinion

Judgmental forecasts rely on analysis of subjective inputs obtained from various

sources, such as consumer surveys, the sales staff, managers and executives, and panels of
experts.

Forecasts Based on Historical Data

The theme of the approach is that the future will be like the past. In effect, approaches
based on historical data treat the data as a mirror that reflects the combination of all forces
influencing the variable of interest (e.g., demand), without trying to identify or measure those
forces directly.

Associative Forecasts

Associative models involve identification of one or more variables that can be used to
predict future demand. The analysis in such cases yields a mathematical equation that enables
the manager to predict volume of sales, for example, on the basis of given values of the
“explaining” variable(s).

Accuracy and Control of Forecasts

Accuracy and control of forecasts is a vital aspect of forecasting. To begin with, the
complex nature of most real-world variables makes it almost impossible to correctly predict
future values of those variables on a regular basis. Consequently, it is essential to include an
indication of the extent to which the forecast might deviate from the value of the variable that
actually occurs. This will provide the forecast user with a better perspective on how far off a
forecast might be.

Moreover, because some techniques will provide more accuracy than others in a given
situation, in choosing among different techniques, the decision maker needs a measure of
accuracy that can be used as a basis for comparison.

Finally, some forecasting applications involve a series of forecasts (e.g., weekly

revenues), whereas others involve a single forecast that will be used for a one-time decision
(e.g., deciding on size of a power plant). When periodic forecasts are made, it is important to
monitor forecast errors to determine if the errors are within reasonable bounds. If they are not,
it is necessary to take corrective action. This involves controlling the forecast.

Choosing A Forecasting Technique

There are many different kinds of forecasting techniques available, and no one technique works
best in every situation. In selecting a technique for a given situation, the manager or analyst
must take a number of factors into consideration.

Two most important factors: Cost and Accuracy (How much money is budgeted for generating
the forecast? What are the possible costs of error, and what are the possible benefits that might
accrue from an accurate forecast?)

Other factors: availability of historical data; availability of computers; the ability of decision-
makers to utilize certain techniques; the time needed to gather data; analyze them and prepare
the forecast; and any prior experience with a technique.

Elements of a Good Forecast

A properly prepared forecast must fulfill certain requirements:

1. The forecast should be timely;

2. The forecast should be accurate, and the degree of accuracy should be stated;
3. The forecast should be reliable, it should work;
4. The forecast should be in meaningful units;
5. The forecast should be in writing;
6. The forecasting techniques should be simple to understand and use.

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