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**Eight Steps to Forecasting
**

**Determine the use of the forecast
**

What objective are we trying to obtain?

**Select the items or quantities that are to be forecasted. Determine the time horizon of the forecast.
**

Short time horizon – 1 to 30 days Medium time horizon – 1 to 12 months Long time horizon – more than 1 year

Select the forecasting model or models Gather the data to make the forecast. Validate the forecasting model Make the forecast Implement the results

Forecasting Models

Forecasting Techniques

Qualitative Models Delphi Method Jury of Executive Opinion Sales Force Composite Consumer Market Survey Causal Methods Simple Regression Analysis Multiple Regression Analysis Time Series Methods Naive Moving Average Weighted Moving Average Exponential Smoothing Trend Analysis Seasonality Analysis Multiplicative Decomposition

Time-Series – attempts to predict the future by using historical data.Model Differences Qualitative – incorporates judgmental & subjective factors into forecast. Causal – incorporates factors that may influence the quantity being forecasted into the model .

distributing.Qualitative Forecasting Models Delphi method Iterative group process allows experts to make forecasts Participants: decision makers: 5 -10 experts who make the forecast staff personnel: assist by preparing. and summarizing a series of questionnaires and survey results respondents: group with valued judgments who provide input to decision makers . collecting.

Forecasts are reviewed to ensure realistic. Result is a group estimate. . Each salesperson estimates sales in his region.Qualitative Forecasting Models (cont) Jury of executive opinion Opinions of a small group of high level managers. Used for forecasts and product design & planning Sales force composite Consumer market survey. often in combination with statistical models. Solicits input from customers and potential customers regarding future purchases. Combined at higher levels to reach an overall forecast.

Similar to T simple sample variance = ∑ (At − Ft ) 2 / T Variance .Standard deviation of the sampling distribution T T MAD .Forecast Error Forecast Error = At − Ft T Bias .Mean Absolute MAD = ∑ | forecast error | /T = ∑ |At − Ft | / T Deviation t =1 t =1 MAPE – Mean Absolute T Percentage Error MAPE = 100∑ [|At − Ft | / At ] / T t =1 .The arithmetic sum of MSE = ∑ | forecast error | 2 /T the errors t =1 Mean Square Error .Sample variance t =1 (adjusted for degrees of freedom) Standard Error .

Quantitative Forecasting Models Time Series Method Naïve Whatever happened recently will happen again this time (same time period) The model is simple and flexible Provides a baseline to measure other models Attempts to capture seasonal factors at the expense of ignoring trend Ft = Yt −1 Ft = Yt − 4 : Quarterly data Ft = Yt −12 : Monthly data .

0 16.08% 23.Naïve Forecast W allace Garden Supply Forecas ting Storage Shed Sales Period January February March April May June July August September October Nov ember December Actual Value 10 12 16 13 17 19 15 20 22 19 21 19 Naïv e Forecast N /A 10 12 16 13 17 19 15 20 22 19 21 Error 2 4 -3 4 2 -4 5 2 -3 2 -2 0.0 9.0 25.09% 15.0 16.76% MAPE Squared Error 4.53% 10.53% 17.00% 9.176619 Standard E rror (Square Root of MSE = ) .0 16.52% 10.0 4.00% 23.0 4.0 10.0 9.53% 26.818 BIAS Absolute Error 2 4 3 4 2 4 5 2 3 2 2 3 MAD Percent Error 16.79% 9.67% 25.091 MSE 3.67% 25.0 4.0 4.

N a iv e Fo r e c a s t 25 20 15 Sheds A c tu a l V a lu e N a ïv e Fo r e c a s t 10 5 0 February Ma r c h A p r il Ma y Ju n e Ju ly P e r io d A ugus t S e p te mb e r O c to b e r No v e m b e r De c e m b e r .Naïve Forecast Graph W a lla c e G a r d e n .

k k . Technique will smooth out short-term irregularities in the time series.Quantitative Forecasting Models Time Series Method Moving Averages Assumes item forecasted will stay steady over time.period moving average = ∑ (Actual value in previous k periods) /k k =1 .

Moving Averages Wallace Garden Supply Forecasting Storage Shed Sales Period January February March April May June July August September October November December Actual Value 10 12 16 13 17 19 15 20 22 19 21 19 Three-Month Moving Averages 10 12 16 13 17 19 15 20 22 + + + + + + + + + 12 16 13 17 19 15 20 22 19 + + + + + + + + + 16 13 17 19 15 20 22 19 21 / / / / / / / / / 3 3 3 3 3 3 3 3 3 = = = = = = = = = 12.67 15.67 .00 20.33 20.67 13.33 16.33 17.00 18.00 19.

000 0.000 BIAS 0.778 9.333 3.Forecast Input Data Period Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Month 7 Month 8 Month 9 Month 10 Month 11 Month 12 Next period Actual Value 10 12 16 13 17 19 15 20 22 19 21 19 19.667 12.667 -1.17% 8.000 0.111 13.333 3.000 20.61% 19.00% 3.333 3.77% 10.333 17.89% 15.000 4.000 0.444 2.000 MAD 0.000 19.333 3.000 18.667 1.000 0.000 0.333 3.Moving Averages Forecast Wallace Garden Supply Forecasting 3 period moving average Actual Value .667 Average 0.667 1.000 16.667 15.074 MSE 2.333 3.30% 8.667 Forecast Error Analysis Forecast Error Absolute error Squared error Absolute % error 12.333 16.667 2.000 0.667 13.61% MAPE .778 6.56% 19.333 20.111 11.00% 18.444 1.18% 0.000 4.667 -1.

Moving Averages Graph T h re e P e rio d M o vin g A ve ra g e 25 20 15 Value A c tu a l V a lu e For ec as t 10 5 0 1 2 3 4 5 6 T im e 7 8 9 10 11 12 .

period weighted moving average = ∑ (Weight for each period i)(Actual value in previous k periods) / ∑ (weights) i =1 i =1 k k . Use weights to place more emphasis on some periods and less on others. earlier periods).Quantitative Forecasting Models Time Series Method Weighted Moving Averages Assumes data from some periods are more important than data from other periods (e.g. k .

185 1.5 / 1 = 15 2.9 + 10 + 2.407 16.815 19.298 14.262 21.4 + 13 + 3.7 + 4.185 / 1 = 13 2.5 + 2.1 + 3 / 1 = 17 2.5 / 1 = 21 4.484 17.814 16.000 20.000 .9 / 1 = 19 4.5 + 7.2 + 7.3 + 12 + 3.8 + 11 / 1 = 22 4.9 + 11 12.8 / 1 = 20 3.7 + 3.2 + 8.036 20.9 + 3.Weighted Moving Average W allace Garden Supply Storage Shed Sales Forecasting Period January February March April May June July August September October November December Next period Sum of weights = Actual Value Weights Three-Month Weighted Moving Averages 10 0.556 14.4 / 1 = 19 3.7 + 9.593 16 0.1 / 1 = 19 3.2 + 3.222 12 0.

776 26.484 2.444 4.186 5.89% 10.185 -0.036 1.889 0.298 14.556 14.952 MAD 0.000 1.814 16.036 6.971 21.484 2.988 BIAS 0.57% 1.484 17.185 0.000 Weights 0.000 1.069 0.702 2.45% 10.00% 5.952 MSE 5.000 -1.185 1.185 Forecast Error Analysis Forecast Error Absolute error Squared error Absolute % error 12.93% 23.593 -1.Weighted Moving Average Wallace Garden Supply Forecasting 3 period weighted moving average Input Data Period Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Month 7 Month 8 Month 9 Month 10 Month 11 Month 12 Next period Sum of weights = Actual value 10 12 16 13 17 19 15 20 22 19 21 19 20.37% 24.262 0.036 Average 0.40% 14.093 2.186 5.38% 0.702 2.444 4.593 0.202 4.492 5.000 20.593 1.57% MAPE .407 16.17% 9.262 21.262 0.815 19.074 6.222 0.

1 + α (actual value in period t . Uses a smoothing constant α with a value between 0 and 1.forecast for period t .Quantitative Forecasting Models Time Series Method Exponential Smoothing Moving average technique that requires little record keeping of past data.1 to 0.1 .1) .3) Forecast for period t = forecast for period t . (Usual range 0.

002 11.1 0.1 0.342 12.1 0.1 0.691 15.347 14.Exponential Smoothing Data Wallace Garden Supply Forecasting Storage Shed Sales Exponential Smoothing Period January February March April May June July August September October November December Actual Value 10 12 16 13 17 19 15 20 22 19 21 19 Ft 10 10 10 10 11 11 12 12 13 13 14 15 + + + + + + + + + + + α 0.1 0.1 0.780 11.200 10.607 13.212 14.602 12.1 0.1 0.000 10.1 0.1 0.1 At *( *( *( *( *( *( *( *( *( *( *( 10 12 16 13 17 19 15 20 22 19 21 Ft 10 10 10 11 11 12 12 13 13 14 15 )= )= )= )= )= )= )= )= )= )= )= Ft+1 10.322 .1 0.

136 4.106 19.211 17.26% 0.53% 22.19% 14.987 Absolute error 2.256 19.67% 32.608 MAD Squared error 4.487 4.404 -0.30% 5.000 4.02% 2.000 13.441 19.000 18.596 19.000 5.404 0.419 19.000 26.842 MSE Absolute % error 16.702 2.487 4.Exponential Smoothing Wallace Garden Supply Forecasting Exponential smoothing Input Data Period Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Month 7 Month 8 Month 9 Month 10 Month 11 Month 12 Alpha Next period Actual value 10 12 16 13 17 19 15 20 22 19 21 19 0.744 0.68% 20.973 9.162 0.573 Forecast Error Analysis Forecast 10.487 15.70% MAPE .000 14.162 0.000 10.000 4.391 0.91% 20.864 17.32% 8.041 0.838 13.649 0.325 -1.675 16.000 5.987 2.000 10.441 1.00% 23.000 16.194 3.000 4.000 4.744 -0.441 1.136 4.987 Average Error 2.76% 9.325 1.

Sheds 10 15 20 25 0 5 Ja nu ar y F eb ru ar y M ar c h A pr i l M ay Ju ne Ju ly E xponential Smoothing A ug us t S ep te m be r O Exponential Smoothing ct ob e r N ov em be r D ec em be r Forecast Actual value .

example: demand for coal & fuel oil in winter months. Seasonality analysis . projects the curve into the future for medium and long term forecasts. adjustment to time series data due to variations at certain periods.Trend & Seasonality Trend analysis technique that fits a trend equation (or curve) to a series of historical data points. adjust with seasonal index – ratio of average value of the item in a season to the overall annual average value.

Linear Trend Analysis Midwestern Manufacturing Sales Sales(in units) vs. Time Scatter Diagram Actual value (or) Y 74 79 80 90 105 142 122 Period number (or) X 1995 1996 1997 1998 1999 2000 2001 160 140 120 100 80 60 40 20 0 1994 1996 1998 2000 2002 Period number (or) X .

Least Squares for Linear Regression Midwestern Manufacturing Least Squares Method Values of Dependent Variables Time .

n X2 ∑ _ _ .n X Y ] _ 2 X .Least Squares Method Y = a + bX Where ^ ^ Y = predicted value of the dependent variable (demand) X = value of the independent variable (time) a = Y-axis intercept b = slope of the regression line b= [∑ XY .

250 77.12% 1.18% 22.393 22.464 71.464 Absolute Squared A bsolute error error % error 6.071 -8.321 98.464 Average E rror 6.786 88.750 1.857 78.246 10.54% 8.750 45.582 110.214 1.393 19.54% 8.857 109.94% 8.84% 4.536 141.449 9.857 -4.071 487.22% M AD MSE M AP E .321 69.563 9.393 119.929 130.644 6.Linear Trend Data & Error Analysis M idw estern M anufacturing C om pany F o recasting Linear trend analysis In p ut D ata Period Y ear 1 Y ear 2 Y ear 3 Y ear 4 Y ear 5 Y ear 6 Y ear 7 Intercept S lope N ext perio d Actual v alue eriod num ber P (or) Y (or) X 74 1 79 2 80 3 90 4 105 5 142 6 122 7 56.474 1.148 15.714 10.403 8.321 -8.40% 8.214 -8.297 4.000 8 F o recast Erro r An alysis Forecast 67.

714 120 100 Value 80 60 40 20 0 1 2 3 4 Tim e A ctual values Linear (A ctual values) 5 6 7 .536x + 56.Least Squares Graph Tre nd Analysis 160 140 y = 10.

064)/2 = 0.170 1. (0.309 1.Seasonality Analysis Eichler Supplies Year 1 Month January February March April May June July August September October November December January February March April May June July August September October November December Demand 80 75 80 90 115 110 100 90 85 75 75 80 100 85 90 110 131 120 110 110 95 85 85 80 Ratio = demand / average demand Average Demand 94 94 94 94 94 94 94 94 94 94 94 94 94 94 94 94 94 94 94 94 94 94 94 94 Ratio 0.904 0.851 0.170 1.851 0.851 + 1.957 1.223 1.957 0.223 1.064 0.957 = 96 units Forecast demand Year 3 May: 100 X 1.170 1.904 0.957 0.064 0.957 1.851 0.170 1.851 0.957 0. Example: average of year 1 January ratio to year 2 January ratio.851 1.117 1.957 If Year 3 average monthly demand is expected to be 100 units.798 0.011 0.064 1.798 0.904 0.798 0.277 1.394 1.904 1.309 = 131 units 2 . Forecast demand Year 3 January: 100 X 0.904 0.064 0.851 Seasonal Index – ratio of the average value of the item in a season to the overall average annual value.851 Seasonal Index 0.851 0.

957 = 100.Deseasonalized Data Going back to the conceptual model.31) This eliminates seasonal variation and isolates the trend Now use the Least Squares method to compute the Trend . solve for trend: Trend = Y / Season (96 units/ 0.

we can reseasonalize the data and generate the forecast Y = Trend x Seasonal Index .Forecast Now that we have the Seasonal Indices and Trend.

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