3-1 Forecasting

CHAPTER
3

Forecasting
3-2 Forecasting

FORECAST:
 A statement about the future value of a variable of
interest.
 Forecasts affect decisions and activities throughout
an organization
 Accounting
 Finance
 Human resources
 Marketing
 MIS
 Operations
 Product / service design
3-3 Forecasting

 Assumes causal system

past ==> future
 Forecasts are not perfect because of
randomness
 Forecasts more accurate for
groups vs. individuals I see that you will
get an A this semester.
 Forecast accuracy decreases
as time horizon increases
3-4 Forecasting

Elements of a Good Forecast

Timely

Reliable Accurate

Written
3-5 Forecasting

Steps in the Forecasting Process

“The forecast”

Step 6 Monitor the forecast

Step 5 Make the forecast
Step 4 Select a forecasting technique
Step 3 Obtain, clean and analyze data
Step 2 Establish a time horizon
Step 1 Determine purpose of forecast
3-6 Forecasting

Forecasting techniques

 Judgmental - uses subjective inputs

 Time series - uses historical data
assuming the future will be like the past
 Associative models - uses explanatory
variables to predict the future
3-7 Forecasting

Judgmental Forecasts

 Executive opinions
 Sales force opinions
 Consumer surveys
 Delphi method
 Opinions of managers and staff
 Achieves a consensus forecast
3-8 Forecasting

Time Series Forecasts

 Trend - long-term upward or downward
movement in data
 Seasonality - short-term regular variations
related to the calendar or time of the day
 Cycle – wavelike variations lasting more than
one year
 Irregular variations - caused by unusual
circumstances, not reflective of typical
behavior
 Random variations – residual variations after
all other behaviors are accounted for
3-9 Forecasting

Forecast Variations
Figure 3.1
3-10 Forecasting

Naive Forecasts

Uh, give me a minute....

We sold 250 wheels last
week.... Now, next week
we should sell....

The forecast for any period equals

the previous period’s actual value.
3-11 Forecasting

Naïve Forecasts

 Simple to use
 Virtually no cost

 Quick and easy to prepare

 Data analysis is nonexistent

 Easily understandable

 Cannot provide high accuracy

 Can be a standard for accuracy

3-12 Forecasting

Techniques for Averaging

 Moving average
 Weighted moving average
 Exponential smoothing
3-13 Forecasting

Moving Average

 Moving average – A technique that averages a

number of recent actual values, updated as new
values become available.
3-14 Forecasting

Weighted moving average

Weighted moving average – More recent values in a

series are given more weight in computing the
forecast.
3-15 Forecasting

Exponential Smoothing
• a sophisticated weighted averaging method that is
still relatively easy to use and understand.
• each new forecast is based on the previous forecast
plus a percentage of the difference between that
forecast and the actual value of the series at that
point.
3-16 Forecasting

Other Forecasting Methods

 Focus Forecasting - using the forecasting method

that demonstrates the best recent success
 Diffusion Models - based on rates of product
adoption and usage spread from other established
products, using mathematical diffusion models
3-17 Forecasting

Linear Trend Equation

Ft

Ft = a + bt

 Ft = Forecast for period t 0 1 2 3 4 5 t

 t = Specified number of time periods

 a = Value of Ft at t = 0
 b = Slope of the line
3-18 Forecasting

Calculating a and b

n  (ty) -  t  y
b =
2
n t - (  t) 2

 y - b t
a =
n
3-19 Forecasting

Linear Trend Equation Example

t y
2
Week t Sales ty
1 1 150 150
2 4 157 314
3 9 162 486
4 16 166 664
5 25 177 885

 t = 15 t = 55  y = 812  ty = 2499

2
2
(t) = 225
3-20 Forecasting

Linear Trend Calculation

5 (2499) - 15(812) 12495-12180

b = = = 6.3
5(55) - 225 275 -225

812 - 6.3(15)
a = = 143.5
5

y = 143.5 + 6.3t
3-21 Forecasting

Associative Forecasting

 Predictor variables - used to predict values of

variable interest
 Regression - technique for fitting a line to a set
of points
 Least squares line - minimizes sum of squared
deviations around the line
3-22 Forecasting

Forecast Accuracy

 Error - difference between actual value and predicted

value
 Mean Absolute Deviation (MAD)
 Average absolute error
 Mean Squared Error (MSE)
 Average of squared error
 Mean Absolute Percent Error (MAPE)
 Average absolute percent error
3-23 Forecasting

MAD, MSE, and MAPE

 Actual  forecast
MAD =
n
2
 ( Actual  forecast)
MSE =
n -1

( Actual  forecas / Actual*100)

MAPE =
t
n
3-24 Forecasting

Monitoring Forecast Error

 Control chart
 A visual tool for monitoring forecast errors
 Used to detect non-randomness in errors

 Tracking signal
 The ratio of cumulative forecast error to the
corresponding value of MAD, used to monitor
a forecast.
3-25 Forecasting

Choosing a Forecasting Technique

 No single technique works in every situation

 Two most important factors
 Cost
 Accuracy

 Other factors include the availability of:

 Historical data
 Computers

 Time needed to gather and analyze the data

 Forecast horizon
3-26 Forecasting

Thank you
