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forcasting

© All Rights Reserved

- Sales & Distribution Management
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planning capacity, sales, production

and inventory, personnel, purchasing

and more.

planning process because they enable

a manager to anticipate the future so

he can plan accordingly.

profit projections, cash management etc.

recruitment, training etc.

inventory planning etc.

underlying casual system that existed in the past will

continue to exist in the future.

from predicted values.

than forecasts for individual items. Because forecasting

errors among items in a group usually has a cancelling

effect.

increases. Short term forecasts have lower uncertainties

than the long-term forecasts.

requirements. The forecasts should be:

necessary to implement possible changes.

possible errors and provides a basis for

comparing alternatives

good forecasts and sometimes poor one leaves

users with the uneasy feelings.

to know how many dollars will be needed?

Schedulers should know what machines and

skills will be required?

objective basis for evaluating the forecast once

actual results are in.

techniques enjoy wide spread popularity because

users are more comfortable working with them.

How will it be used and when will it be needed?

It will provide an indication of the level of detail

required in the forecast and the level of the

accuracy necessary.

indicate a time interval, keeping in mind that

accuracy decreases as the time horizon

increases.

identifying any assumptions that are made in

conjunction with preparing and using forecast.

performed in a satisfactory manner. If it is not,

reexamine the method.

develop forecasts.

inputs, numerical description. It includes soft

information (human factor, personal opinion

etc) in the forecasting process.

projection of historical data or the development

of associative methods which utilize

explanatory variables to make forecasts. This

method mainly analyzes data.

Judgmental

Time series

Associative

subjective inputs obtained from various

sources such as opinion from consumer

surveys, sales staff, managers and

executives and experts

recent time series observations. It project

past experience into the future

variables to predict future demand. For

example, demand for paint might be related

to variables such as the price per gallon and

the amount spent on advertising and drying

time, ease of cleanup etc.

judgment and opinion. For instances,

If the management must have a forecast quickly,

there may not be enough time to gather and

analyze quantitative data.

At another time, especially when political and

economic conditions are changing, available data

may be out of date and more up-to-date information

might not yet be available.

In such instances forecasts are based on executive

opinions, sales force opinions, consumer surveys, etc.

operations manager may meet and

collectively develop a forecast. This

approach is used for long-term planning and

new product development.

is often a good source of information

because of their direct contact with

customers. They are often aware of any

plans the customers may be considering for

the future. One of the drawbacks of this

approach is that they may be unable to

distinguish between what customers would

like to do and what they actually will do.

better to collect information from them. If

possible every customer or potential

customer can be contacted. However, it is

not all time possible to identify all the

customer or potential customers. So,

managers often rely on sample consumer

opinions.

observations taken at regular intervals

(hourly, weekly, daily, etc). The data may

be measurements of demand, earnings,

profits etc. These techniques are based on

the assumption that future values of the

series can be estimated from the past

values.

accomplished by plotting the data in any of

the following patterns:

i.

ii.

iii.

iv.

v.

Trend

Seasonality

Cycles

Irregular variations

Random variations

Trends

downward movement in the data.

Example: Population shifts, changing incomes

etc.

Seasonality

variations related to calendar or time of a day.

Example: Restaurants, supermarkets

experiences weekly or daily seasonality.

Cycles

lasting more than one year.

Example: Economic, political and

agricultural conditions.

Irregular Trends

circumstances, not relative of typical

behavior. These need to be identified and

remove from the data.

residual variations that remains after all other

behaviors have been accounted for. The small

bumps in the figures are random variation.

method. This is the forecast for any period

equals the previous periods actual value. For

example, if the demand for a product last

week was 50 KGs, the forecast for this week

is 50 KGs. This method has several

advantages: it has no cost, it is quick and

easy, and it is easily understandable.

Averaging techniques smooth fluctuations in

a time series because the individual highs

and lows in the data offset each other when

they are combined into an average. A

forecast based on an average thus tends to

exhibit less variability than the original

data. The minor variations are treated as

random variation and larger variations are

viewed as real changes.

for averaging.

i. Moving average

ii. Weighted moving average

iii. Exponential smoothing

number of recent actual data values, updated as

new values become available is known as moving

average forecast. The moving average forecast

can be computed using the following formula:

n

Ft MAn

i 1

At i

n

n = No. of period in the moving average

At= Actual value in period t-i

MA = Moving average

Ft= Forecast for time period t

moving average forecast,and MA5 implies a

fiveperiod moving average forecast.

Example: Compute a 3-period moving

average forecast given demand for

shopping carts for the last five periods.

Period

Demand

42

40

43

40

41

n =3= No. of period in the moving average

Ai= Actual value in period t-i

MA = Moving average

Ft= Forecast for time period t

t i

i 1

43 40 41

41.33

3

the actual demand in period 6 turns out to be 38, the moving average

forecast for period 7 would be :

F7 MA3

t i

i 1

40 41 38

39.67

3

demand for 10 periods.

forecast will lag changes in the data.

* This technique is easy to compute and easy to understand.

* A possible disadvantage is that all values in the average are

weighted equally. For example, in a 10-period moving average,

each value has weight of 1/10. Hence, the oldest value has the

same weight as the most recent value. Decreasing the number of

values in the average increases in weight of more recent values.

Period No. of

complaints

1

60

2

65

55

58

64

next period.

(ii)Compute a 3-period moving average forecast.

A weighted average is similar to

the moving average, except that it

assigns more weight to the most

recent values in a time series. For

example, the most recent value

might be assigned a value of 0.4,

the next most recent value a

weight of 0.3, the next after that a

weight of 0.2, and the next after

that a weight of 0.1. Note that the

sum of the weights is 1.0.

formula:

Ft wn At n wn 1 At ( n 1) wn 2 At ( n 2) ......w2 At 2 w1 At 1

The advantage of a weighted average over a simple

moving average is that the weighted average is more

reflective of the most recent occurrences. However, the

choice of the weight is somewhat arbitrary and

generally involves the use of trial and error to find a

suitable weighting scheme.

shopping carts for the last five periods.

Period

Demand

42

40

43

40

41

weight of 0.4 for the most recent period, 0.3 for the next

most recent, 0.2 for the next, and the next after that a

weight of 0.1.

(b) If the actual demand for period 6 is 39, forecast

demand for period 7 using the same weights as in part (a).

Solution: (a)

Ft wn At n wn 1 At ( n 1) wn 2 At ( n 2) ......w2 At 2 w1 At 1

F6 w4 At 4 w3 At 3 w2 At 2 w1 At 1

0.1 * 40 0.2 * 43 0.3 * 40 0.4 * 41 41.0

Solution: (b)

F7 w4 At 4 w3 At 3 w2 At 2 w1 At 1

0.1 * 43 0.2 * 40 0.3 * 41 0.4 * 39 40.2

Period

No. of complaints

60

65

55

58

64

weight of 0.4 for the most recent period, 0.3 for the next

most recent, 0.2 for the next, and the next after that a

weight of 0.1.

(b) If the actual demand for period 6 is 59, forecast demand

for period 7 using the same weights as in part (a).

Exponential smoothing:

Weighted averaging method based on previous forecast plus a

percentage of the forecast error.

It is sophisticated weighted average method that is still relatively easy

to use and understand.

Next forecast = Previous forecast +

That is,

Ft Ft 1 At 1 Ft 1

= The smoothing constant = % of the error

Ft = Forecast for time period t

Ft 1 = Forecast for the previous time period

Commonly used value of ranges from 0.05 to 0.5. Low values are used when the average tends to be stable. Higher values of

Period

No. of complaints

60

65

55

58

64

Use exponential smoothing approach with a smoothing constant of 0.4 to make the forecast for the next period.

Solution:

Period

No. of complaints

60

65

60

60 + 0.4(65-60) = 62

55

62

62 + 0.4(55-62) = 59.2

58

59.2

64

58.72

Forecast

Calculations

60 is the initial forecast

60.83

carts for the last five periods.

Period

Demand

42

40

43

40

41

smoothing constant of 0.3 to make the forecast

for the next period.

Example: Cell phone for a firm over the last 10 weeks are shown as follows. Would a linear

trend line be appropriate? Determine the equation of the trend line and predict sales for

weeks 11 and 12.

Week

10

Unit Sales

700

724

720

728

740

742

758

750

770

775

ty

700

700

724

1448

720

2160

728

2912

740

3700

742

4452

758

5306

750

6000

770

6930

10

775

7750

7407

41358

Given

n 10,

55,

n ty t y

n t t

2

385

10 41,358 55 7,407

7.51

10 385 55 55

y b t 7,407 7.51 55

699.4

n

10

Ft a b t 699.4 7.51t

where t = 0 for period 0.

that a linear trend line is appropriate. Develop a line trend

equation. Then use the equation to predict the next two values of

the series.

Period

Demand

44

52

50

54

55

55

60

56

62

The essence of associative techniques is the

development of an equation that summarizes the effects

of predictor variables (which is used to predict values of

the variable of interest). Linear regression method is used

for this analysis.

Technique for fitting a line to a set of points. The objective

in linear regression is to obtain an equation of a straight

y c a bx

line that minimizes

the sum of squared vertical deviations

of data points from the line. The least squares line has

the equation

a= Value of at x = 0

b= Slope of the line

yc= Predicted or dependent variable

The line intersect the y axis where y =

a. The slope of the line is b.

The coefficients of the line a and b can

be computed from the formulas:

y

y c a bx

y

x

a

y

x

n xy

n x 2

x y

x

2

and

y b x

a

y bx

n

time series.

Example: Healthy hamburger has a chain of 12 stores in California. Sales figures and profits for the

stores given below. Obtain a regression line for the data and predict for a store assuming sales of

$10 million.

Unit sales x $

million

14

15

16

12

14

20

15

Profit y

$ million

0.15

0.10

0.13

.15

.25

0.27

0.24

0.2

0.27

0.44

0.34

0.17

Solution:

Step1: Plot the data and decide if a linear model is

reasonable.

x

y

Forecasts

7

.15

0.1621124

0.10

0.0824612

0.13

0.1461822

0.15

0.1143217

14

0.25

0.273624

15

0.27

0.2895543

16

0.24

0.3054845

12

0.20

0.2417636

14

0.27

0.273624

20

0.44

0.3692054

15

0.34

0.2895543

0.17

0.1621124

Step2:

n xy x y

n x 2 x

0.0159

12 1796 132 132

0.0506

n

12

For example, for sale of x = 7, estimated profit is

or $162,1124

Example: The owner of a hardware store has noted a sales pattern for window locks that

seems to be parallel the number of break-ins reported each week in the newspaper. The

data are:

sales

46

18

20

22

27

34

14

37

30

Break-ins

c.

b. Obtain a regression equation for the data.

Estimate sales when the number of break-ins is 5.

linear regression:

narrowly distributed.

observed values.

Forecast accuracy:

Forecasting accuracy is a significant factor when deciding among forecasting

alternatives. Accuracy is based on the historical error performance of a forecast.

Three common methods for measuring historical errors are:

(i) Mean absolute deviation (MAD): Average absolute error. MAD =

At Ft

n

t

n 1

(iii) Mean absolute percent error (MAPE): Average absolute percent error.

MAPE =

Ft

At

n

100%

Ft

data.

Error 2

Error

Period

Actual

Forecast

Error (A-F)

217

215

0.92%

213

216

-3

1.41

216

215

0.46

210

214

-4

16

1.9

213

211

0.94

219

214

25

2.28

216

217

-1

0.46

212

216

-4

16

1.89

-2

22

76

10.26%

Ft

Ft

n 1

76

10.86

8 1

22

2.75

8

Ft

At

n

100%

10.26%

1.28%

8

Example 2: Calculate MAD, MSE and MAPE for the following data and

compare them

Month

Demand

Forecast

Technique 1

Technique 2

492

488

495

470

484

482

485

480

478

493

490

488

498

497

492

492

493

493

forecast:

Tracking signal method is used to monitor a

forecast. This method is an older method which is

the ratio of the cumulative forecast error to the

corresponding value of MAD.

Tracking signalt =

Ft

MADt

A F

t

MADt

2

0.7

2.75

The End

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