Forecasting is the art and science of predicting future events.

It may involve taking historical data and projecting them into the future with some sort of mathematical model. It may be subjective or intuitive prediction. Or it may involve a combination of these that is, a mathematical model adjusted by a managers good judgment.
Common features of forecasting: 1. All forecasting techniques assume that there is some degree of stability in the system, and what happened in the past will continue to happen in the future. 2. Forecasting is rarely perfect (deviation is expected). 3. Forecasting for a group of items is more accurate than the forecast for individuals. 4. Forecasting accuracy increases as time horizon increases. Elements of good forecast: 1. Timely: Forecasting horizon must cover the time necessary to implement possible changes. 2. Accurate: Degree of accuracy should be stated. 3. Reliable: It should work consistently. 4. Meaningful: Should be expressed in meaningful units. Financial planners should know how many dollars needed, production should know how many units to be produced, and schedulers need to know what machines and skills will be required. 5. Written: to guarantee use of the same information and to make easier comparison to actual results. 6. Easy to use: users should be comfortable working with forecast. Types of forecast by time: Short-range (days weeks months): Job scheduling, work assignments Time spans ranging from a few days to a few weeks. Cycles, seasonality, and trend may have little effect. Random fluctuation is main data component. Medium term (1-2 years): Sales, production Long range forecast (> 2years): change location Time spans usually greater than one year. Necessary to support strategic decisions about planning products, processes, and facilities. Types of Forecast Organizations use three major types of forecasts in planning future operations:

1. Economic Forecasts 2. Technological Forecasts 3. Demand Forecasts The Strategic Importance of Forecasting Human Resources Capacity Supply-Chain Management
Steps in forecast development: 1. Determine purpose of forecast. 2. Establish a time horizon: time limit, accuracy decreases with shorter durations. 3. Select forecasting technique. 4. Gather and analyze data. 5. Prepare the forecast 6. Monitor forecast.

Methods of Forecasting Qualitative methods: (based on judgment and opinion) -often called judgmental methods, are methods in which the forecast is made subjectively by the forecaster. 1. Jury of executives: opinions of high level executives 2. Sales force composite: estimates from sales individuals are reviewed for reasonableness (may tend to make under estimates), then aggregated. 3. Consumer market survey: Asking the customers may give best forecasts but it is higher in cost, difficult to apply. 4. Delphi method: (a) Panel of experts queried. (b) Chosen experts to participate should be of a variety of knowledgeable people in different areas (finance, marketing, production etc). They are unknown to any one, except for the coordinator. (c) Through questionnaire the coordinator obtains estimates from all participants. (d) Coordinator summarizes results and redistributes them to participants along with appropriate new questions. (e) Summarize again and refine forecasts and develop new question. Quantitative (based on time series data): - Time series data: a time ordered sequence of observation taken at regular intervals over time. -based on mathematics Five quantitative forecasting methods. They fall in two categories 1. 2. 3. 4. 5. Nave Approach Moving Averages Exponential Smoothing Trend Projection Linear Regression

time-series models associative/casual models

Time-Series Models predict on the assumption that the future is a function of the past. Associative Models incorporate the variables or factors that might influence the quantity being forecast. Decomposition of a Time-Series a. Trend: A long-term upward or downward movement in data. b. Seasonality: Short-term regular variations related to calendar or time of day. c. Cycle: Wavelike variation lasting more than one year. d. Random variations: residual variations after all other behaviors are accounted for. e. Irregular variations: caused by irregular circumstances, not reflective of typical behavior.

Naive forecast: The forecast for any period equals the previous periods actual value. Simple to use. Virtually no cost. Quick and easy to prepare (no data analysis required). Easily understandable. Cannot provide high accuracy. Mathematically, we can put this in the following form:

Ft+1 = Ai

where: Ft+1 = forecast of demand for the next period Ai = actual value of the current period t = current time period
Can be applied in stable demand (moving around average), seasonal, and trend Examples: 1. Sales of air conditioning units next July, will be the same as the sales in last July. (Seasonal) 2. Highway traffic next Tuesday will be the same as last Tuesday (stable, moving around average). 3. If the last 2 actual values were 50 and 53, the next will be 56 (trend).

Techniques for Averaging Simple Mean or Average One of the simplest averaging models Here the forecast is made by simply taking an average of all data.

where: Ft+1 = forecast of demand for the next period Ai = actual value of the current period n = no. of periods or data points to be averaged Moving Average Technique that averages a number of recent actual values, updated as new values become available. It can be calculated using the following equation:

Ft+1 = Ai/ n

Ft+1 = Ai/ n

where: Ft+1 = forecast of demand for the next period Ai = actual value of the current period n = no. of periods or data points to be averaged Example: MA2 refers to a three-period moving average forecast, and MA0 would refer to a five period moving average forecast. Calculate three period moving average for: Period 1 2 3 4 5 Demand 42 40 43 40 41

F6 = (43+40+41)/3 = 41.33 If actual demand in period 6 turns out to be 39, so F7 = (40+41+39)/3 =40 (Note that: the forecast is updated by adding the newest actual value and dropping the oldest) Advantage of moving average: Easy to use and to compute. Disadvantage: values in the average are weighted equally. For example, in a ten- period moving average each the same weight of -/-., the oldest has an equal value to the most recent. Weighted moving average: More recent values in a series are given more weight in computing a forecast.

where: Ft+1 = forecast of demand for the next period Ci = weight placed on the actual value in period Ai = actual value of the current period Example: The weight of most recent value = 0.40, next most recent weight = 0.30, next = 0.20, and next= 0.10 Total weights always = 1 In the last example: forecast of period 6 will be: F6 = 0.40(41) + 0.30(40) + 0.20(43) + 0.10(40) = 41 If actual demand of period 6 is 39. Forecast of period 7 will be: F7 = 0.40(39) + 0.30(41) + 0.20(40) + 0.10(43) = 40.2

Ft+1 = CiAi

Advantage: more reflective of the most recent occurrences. Exponential Smoothing: Weighted averaging method based on previous forecast plus a percentage () of the forecast error. Next forecast = Previous forecast + ( Actual Previous forecast) Where (Actual Previous forecast) = forecast error, is a percentage of the error.

Ft = Ft-1 + (At-1 Ft-1)

where: Ft = Forecast for period t Ft-1 = Forecast for previous period = Smoothing constant At-1 = Actual demand or sales for the previous period. Or

Ft+1 = A1 + (1- ) F1 where: Ft = Forecast for period t F1 = Forecast for previous period = Smoothing constant A1 = Actual demand or sales for the previous period.
Example: If the previous forecast was 42 units, actual demand was 40 units, and = 0.10. The new forecast would be: Ft = 42 +0.10 (40-42) = 41.8 Then if the actual demand turns out to be 43, the next forecast would be: Ft = 41.8 + 0.10 (43-41.8) = 41.92 Period 1 2 3 4 5 6 7 8 9 Annual Demand 42 40 43 40 41 39 46 44 45 = 0.10 Forecast Error 42 -2 41.8 1.2 41.92 -1.92 41.73 -0.73 41.66 -2.66 41.39 4.61 41.85 2.15 42.07 2.93 = 0.40 Forecast Error 42 -2 41.2 1.8 41.92 -1.92 41.15 -0.15 41.09 -2.09 40.25 5.75 42.55 1.45 43.13 1.87

Relation between the smoothing constant and response to error: Exponential smoothing is one of the most widely used techniques in forecasting. The quickness of the forecast adjustment to error is determined by the smoothing constant . The closer the value of to zero, the slower the forecast will respond to error more smoothing

The closer the value of to -..., the greater the forecast will respond to error less smoothing Smoothing means that values are less variable smooth curve