Keith Henrich M.

Chua FEASTUD
FORECASTING
I. What is Forecasting?
- Forecasting is the art and science of predicting future events. In business, it applies to
the future of a business, product, or industry. It's extremely important for a business
to do proper forecasting before developing new products or product lines, lest you
spend a lot of time and money developing a product that fails in the marketplace. In
the view of systems analysts, forecasting involves taking historical data and
projecting them into the future using a mathematical model. It may be subjective or
intuitive predictions or it may involve a combination of these.

II. Forecasting Time Horizons
- Short-range forecast This type of forecast have a time span of up to 1 year but is
generally less than 3 months.
- Medium-range forecasts This type of forecast generally spans from 3 months to 3
years.
- Long-range forecasts This type of forecast generally spans for 3 or more years.

III. Types of Forecasts
- Economic Forecasts address the business cycle by predicting inflation rates, money
supplies, housing starts, and other planning invitation.
- Technological Forecasts are concerned with rates of technological progress, which
can result in the birth of exciting new products, requiring new plants, and equipment.
- Demand Forecasts projections of demand for a companys products and services.

IV. Qualitative Models
- Jury of executive opinion Under this method, the opinions of a group of high-level
experts and managers, often in combination with statistical models, are pooled to
arrive at a group estimate of demand
- Delphi method - is a structured communication technique, originally developed as a
systematic, interactive forecasting method which relies on a panel of experts. There
are three types of participants in the Delphi Method: decision makers, staff personnel,
and respondents.
- Sales force composite In this approach, each salesperson estimates what sales will
be in his or her region. These forecasts are then reviewed to ensure that they are
realistic.
- Consumer Market Survey This method solicits inputs from customers or potential
customers regarding future purchasing plans.

V. Quantitative Models
- Naive Approach This approach assumes that demand in the next period is the same
as demand in most recent period and demand pattern may not always be that stable. It
is used only for comparison with the forecasts generated by the better (sophisticated)
techniques. An example of this would be: If June sales were 50 units, then July sales
will also be 50 units. In some product lines, the nave approach is seen to be the most
cost-effective and efficient objective forecasting model because it does at the very
least provide a starting point against which more sophisticated models that follow can
be compared.
- Moving Averages This approach is one of the most popular and easy to use tools
available to the technical analyst. It is basically a series of arithmetic means and is
used if little or no trend is present in the data. It is an approach useful if one can
assume the market demands will stay fairly steady over time. The Moving average is
commonly used with time series data to smooth out short-term fluctuations and
highlight longer-term trends or cycles. The threshold between short-term and long-
term depends on the application, and the parameters of the moving average will be set
accordingly. This approach provides an overall impression of data over time. This
type of forecast helps in quickly responding to changes since no trend can be found in
the behaviour of the system.
A simple moving average uses average demand for a fixed sequence of periods
and is good for stable demand with no pronounced behavioural patterns. For example:
a 5-day moving average would be calculated by adding the closing prices for the last
5 days and dividing the total by 5.
Equation 1: Sample Moving Average Equation # 1

A moving average moves because as the newest period is added, the oldest period
is dropped. If the next closing price in the average is 15, then this new period would
be added and the oldest day, which is 10, would be dropped. The new 5-day moving
average would be calculated as follows:
Equation 2: Sample Moving Average Equation # 2

On the other hand, there is also what we call weighted moving averages. A
weighted average is any average that has multiplying factors to give different weights
to data at different positions in the sample window. Mathematically, the moving
average is the convolution of the data points with a fixed weighting function. The
computation for weighted moving average is basically the same with the computation
of simple moving averages but the denominator for the WMA is the sum of the
weights.
Equation 3: Weighted Moving Average Base Formula and Parameters

- Exponential Smoothing - This is a very popular scheme to produce a smoothed time
series. The criterion for choosing the exponential smoothing approach involves
having very little record keeping of past data. In exponential smoothing (as opposed
to in moving averages smoothing) older data is given progressively-less relative
weight (importance) whereas newer data is given progressively-greater weight.
Furthermore, in exponential smoothing, there are one or more smoothing parameters
to be determined and these choices determine the weights assigned to the
observations. The equation for the exponential smoothing approach is given as
follows:
Equation 4: Exponential Smoothing Base Formula

Exponential Smoothing is a time-series averaging technique that requires three
pieces of information to generate a forecast: 1) The previous estimated forecast (Ft-
1), 2) the previous actual demand (A t-1 ), and alpha (), a factor that indicates how
much of the most recent miss we want to incorporate into the next forecast to bring it
in line with reality. In other words, alpha is the proportion of the most recent error
which we want to include in the next forecast.
The exponential smoothing approach is easy to use and it has been applied in
virtually every type of business. However, the appropriate value of the smoothing
constant alpha can make the difference between an accurate forecast and an
inaccurate forecast.
This simple model is only good for non-seasonal patterns with zero trend. To
deal with a non-zero trend, simple exponential smoothing can be modified by adding
a multiplier () that increases or decreases the exponential smoothing estimate by the
amount indicated by the trend (the slope of the regression line). This is called,
appropriately, trend-adjusted exponential smoothing.Trend projection is used when a
trend exists, the forecasting technique must consider the trend as well as the series
average ignoring the trend will cause the forecast to always be below (with an
increasing trend) or above (with a decreasing trend) actual demand.
Ft = Ft-1 + (A t-1 - Ft-1)
Equation 5: Exponential Smoothing Equation with Trend Projection

- Linear Regression Linear regression is the study of relationships among variables,
a principal purpose of which is to predict, or estimate the value of one variable from
known or assumed values of other variables related to it. To make predictions or
estimates we must identify the effective predictors of the variable of interest: which
variables are important indicators and can be measured at the least cost, which carry
only a little information, and which are redundant. Predicting a change over time or
extrapolating from present conditions to future conditions is not the function of
regression analysis. To make estimates of the future, use time series analysis.

The linear regression equation formula can be seen as follows:

Equation 6: Regression Equation




Forecast for period t+1: Ft+1 = At + Tt
Average: At = aDt + (1 - a) (At-1 + Tt-1) = aDt + (1 - a) Ft
Average trend: Tt = B CTt + (1 - B) Tt-1
Current trend: CTt = At - At-1
Forecast for p periods into the future: Ft+p = At + p Tt

where:
At = exponentially smoothed average of the series in period t
Tt = exponentially smoothed average of the trend in period t
CTt = current estimate of the trend in period t
a = smoothing parameter between 0 and 1 for smoothing the averages
B = smoothing parameter between 0 and 1 for smoothing the trend
Regression Equation(y) = a + b*x
Slope (b) = (NXY - (X)(Y)) / (NX2 - (X)2)
Intercept (a) = (Y - b(X)) / N

Where:
x and y are the variables.
b = the slope of the regression line
a = the intercept point of the regression line and the y axis.
N = Number of values or elements
X = First Score
Y = Second Score
XY = Sum of the product of first and Second Scores
X = Sum of First Scores
Y = Sum of Second Scores
X2 = Sum of square First Scores
VI. Measuring Forecast Errors
The overall accuracy of any forecasting model - may it be moving average,
exponential smoothing or other - can be determined by comparing the forecasted values
with the actual or observed values. Several measures are used to calculate the overall
forecast errors. These measures can be used to compare different forecasting models, as
well as to monitor forecasts to ensure they are performing well. Four of the most popular
measures are mean error (ME), mean square error (MSE), mean absolute deviation
(MAD), and mean absolute percentage error (MAPE). The equations and parameters of
the different measure can be seen as follows:


VII. Criteria for Selecting a Forecasting Method
In forecasting, it is evidently important to look for the appropriate forecasting
technique for a case/system since most of the cases in reality consider factors such as
inventory, products and even money. It is also important to understand that each
forecasting technique requires in-depth research before it can truly be applied into the
Mean Error
Where :
FE : Forecast Error
Ai : The actual value in time period i
Fi : The forecast value in time period i
Mean Square Error
Where :
MSE : Mean Square Error
Ai : The actual value in time period i
Fi : The forecast value in time period i
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Mean Absolute Deviation
Where :
MAD : Mean Absolute Deviation
Ai : The actual value in time period i
Fi : The forecast value in time period i
Mean Absolute Percentage Error
Where :
MAPE : Mean Square Error
Ai : The actual value in time period i
Fi : The forecast value in time period i

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system. As for the accuracy of ones forecasts, it is important to use forecast error
measuring methods such as MAD, MSE, and MAPE. The objectives and criteria in
selecting a forecasting method can be seen as follows:
Objectives:
1. Maximize Accuracy
2. Minimize Bias

Potential Rules for selecting a time series forecasting method. Select the method
that:
1. gives the smallest bias, as measured by cumulative forecast error (CFE)
2. gives the smallest mean absolute deviation (MAD)
3. supports management's beliefs about the underlying pattern of demand or others.

VIII. References
Heizer, J., & Render, B. (2007). An Introduction to Operations Management. Prentice
Hall.