Time Series Analysis

Introduction

In modern organizations, managers believe in being proactive. This proactive approach is based on future planning. Forecasting is a technique which can aid in future planning. Time series is an important tool that can be used to predict the future.

Figure: Methods of forecasting

Time Series Analysis

Mathematically, a time series can be defined by the functional relationship

A time series may be defined as a collection of numerical values of some variable obtained over regular periods of time.

Components of Time Series

Generally in a long time series, the following four components are found to be present.

1. Secular trend or long term movements 2. Seasonal variations 3. Cyclic variations 4. Random or irregular movements

Demand Behavior
Trend

a gradual, long-term up or down movement of demand

movements in demand that do not follow a pattern an up-and-down repetitive movement in demand an up-and-down repetitive movement in demand occurring periodically
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Random variations

Cycle

Seasonal pattern

Forms of Forecast Movement

Demand Demand Random movement Time (a) Trend Time (b) Cycle Time (c) Seasonal pattern Demand Time (d) Trend with seasonal pattern

Demand

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Time Series
Assume that what has occurred in the past will continue to occur in the future Relate the forecast to only one factor - time Include

moving average etc. exponential smoothing linear trend line

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Components Of Time Series (Contd.) Secular trend or simply trend indicates the general tendency of the data to increase or decrease over a long period of time.

Seasonal Variations Seasonal variations are the variations in time series due to rhythmic forces which operate in a repetitive, predictable, and periodic manner in a time span of one year or less. Cyclical variations refer to oscillatory movements of time series with a period of oscillation of more than a year.

Cyclical variations

Random or Erratic or Irregular Variations Random or irregular variations are factors in a time series that do not repeat in a definite pattern and are random, unforeseen, unstoppable, and unpredictable.

Figure : Components of a time series

Time Series Decomposition Models

The analysis of time series includes the decomposition of the time series into trend (T), seasonal variations (S), cyclical variations, (C) and irregular or random variation (R). The main objective of time series decomposition is to isolate, study, analyse, and measure the components of time series independently and to determine the relative impact of each on the overall behaviour of the time series.

The Additive Model

The additive model is used when it is assumed that the four components of a time series are independent of one another. These components are termed independent of one another when the occurrence and the magnitude of movements in any particular component do not affect the other components.

The Multiplicative Model

In a multiplicative model, it is assumed that all the four components of a time series are not independent and the overall variation in the time series is the combined result of the interaction of all the forces operating on the time series.

Quantitative Methods of Forecasting

Quantitative methods of time series forecasting can be broadly classified into three categories: free hand methods, smoothing methods, and exponential smoothing methods.

Freehand Method
The freehand method is the simplest method of determining trend. A freehand smooth curve is obtained by plotting the values yi against time i.

Figure : Freehand graph of sales with trend line for the example on the consumer durables company

Smoothing Techniques

In this section, we will focus on three methods of smoothing: moving averages method, weighted moving averages method, and semiaverages method. The main objective of the smoothing technique is to smooth out the random variations due to the irregular fluctuations in the time-series data.

Moving Average
Naive forecast

demand in current period is used as next periods forecast

uses average demand for a fixed sequence of periods stable demand with no pronounced behavioral patterns

Simple moving average

Weighted moving average

weights are assigned to most recent data

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Moving Average: Nave Approach

MONTH Jan Feb Mar Apr May June July Aug Sept Oct Nov ORDERS PER MONTH 120 90 100 75 110 50 75 130 110 90 FORECAST 120 90 100 75 110 50 75 130 110 90
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Simple Moving Average

n

Di i=1 MAn =
where n = number of periods in the moving average Di = demand in period i

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3-month Simple Moving Average

ORDERS PER MONTH 120 90 100 75 110 50 75 130 110 90 MOVING AVERAGE 103.3 88.3 95.0 78.3 78.3 85.0 105.0 110.0

MONTH Jan Feb Mar Apr May June July Aug Sept Oct Nov

Di i=1
MA3 = 3

90 + 110 + 130 3

= 110 orders for Nov

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5-month Simple Moving Average

ORDERS PER MONTH 120 90 100 75 110 50 75 130 110 90 MOVING AVERAGE 99.0 85.0 82.0 88.0 95.0 91.0

MONTH Jan Feb Mar Apr May June July Aug Sept Oct Nov

Di i=1
MA5 =

90 + 110 + 130+75+50 5

= 91 orders for Nov

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Smoothing Effects
150 125 5-month

100
Orders 75 50 25 0 | Jan | Feb | Mar 3-month

Actual

| | Apr May

| | June July

| | Aug Sept

| Oct

| Nov

Month

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Weighted Moving Average

Adjusts moving average method to more closely reflect data fluctuations
WMAn =
where
i=1

Wi Di

Wi = the weight for period i,

between 0 and 100 percent

Wi = 1.00
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Weighted Moving Average Example

MONTH
August September October

WEIGHT
17% 33% 50%

DATA
130 110 90
3

November Forecast

WMA3 =

Wi Di i=1

= (0.50)(90) + (0.33)(110) + (0.17)(130) = 103.4 orders

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Exponential Smoothing

Averaging method Weights most recent data more strongly Reacts more to recent changes Widely used, accurate method

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Exponential Smoothing (cont.)

Ft +1 = Dt + (1 - )Ft
where: Ft +1 = forecast for next period Dt = actual demand for present period Ft = previously determined forecast for present period = weighting factor, smoothing constant

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Effect of Smoothing Constant

0.0 1.0 If = 0.20, then Ft +1 = 0.20 Dt + 0.80 Ft If = 0, then Ft +1 = 0 Dt + 1 Ft = Ft
Forecast does not reflect recent data

If = 1, then Ft +1 = 1 Dt + 0 Ft = Dt
Forecast based only on most recent data
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Exponential Smoothing (=0.30)

PERIOD
1 2 3 4 5 6 7 8 9 10 11 12

MONTH
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

DEMAND
37 40 41 37 45 50 43 47 56 52 55 54

F2 = D1 + (1 - )F1 = (0.30)(37) + (0.70)(37) = 37 F3 = D2 + (1 - )F2 = (0.30)(40) + (0.70)(37) = 37.9 F13 = D12 + (1 - )F12 = (0.30)(54) + (0.70)(50.84) = 51.79

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Exponential Smoothing (cont.)

PERIOD MONTH DEMAND FORECAST, Ft + 1 ( = 0.3) ( = 0.5)

1 2 3 4 5 6 7 8 9 10 11 12 13

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan

37 40 41 37 45 50 43 47 56 52 55 54

37.00 37.90 38.83 38.28 40.29 43.20 43.14 44.30 47.81 49.06 50.84 51.79

37.00 38.50 39.75 38.37 41.68 45.84 44.42 45.71 50.85 51.42 53.21 53.61
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Exponential Smoothing (cont.)

70 60 50 Orders 40 = 0.30 Actual = 0.50

30
20 10 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 | 11 | 12 | 13

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Adjusted Exponential Smoothing

AFt +1 = Ft +1 + Tt +1
where T = an exponentially smoothed trend factor Tt +1 = (Ft +1 - Ft) + (1 - ) Tt where Tt = the last period trend factor = a smoothing constant for trend

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Adjusted Exponential Smoothing (=0.30)

PERIOD
1 2 3 4 5 6 7 8 9 10 11 12

MONTH
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

DEMAND
37 40 41 37 45 50 43 47 56 52 55 54

T3

= (F3 - F2) + (1 - ) T2 = (0.30)(38.5 - 37.0) + (0.70)(0) = 0.45

AF3 = F3 + T3 = 38.5 + 0.45 = 38.95

T13 = (F13 - F12) + (1 - ) T12 = (0.30)(53.61 - 53.21) + (0.70)(1.77)

= 1.36
AF13 = F13 + T13 = 53.61 + 1.36 = 54.97
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Adjusted Exponential Smoothing: Example

PERIOD 1 2 3 4 5 6 7 8 9 10 11 12 13 MONTH Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan DEMAND 37 40 41 37 45 50 43 47 56 52 55 54 FORECAST Ft +1 37.00 37.00 38.50 39.75 38.37 38.37 45.84 44.42 45.71 50.85 51.42 53.21 53.61 TREND Tt +1 0.00 0.45 0.69 0.07 0.07 1.97 0.95 1.05 2.28 1.76 1.77 1.36 ADJUSTED FORECAST AFt +1 37.00 38.95 40.44 38.44 38.44 47.82 45.37 46.76 58.13 53.19 54.98 54.96
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Adjusted Exponential Smoothing Forecasts

70
60 50 Demand 40 30 Forecast ( = 0.50) Adjusted forecast ( = 0.30) Actual

20
10 0

| 1

| 2

| 3

| 4

| 5

| | 6 7 Period

| 8

| 9

| 10

| 11

| 12

| 13 12-34

Linear Trend Line

y = a + bx
where a = intercept b = slope of the line x = time period y = forecast for demand for period x xy - nxy b = x2 - nx2 a = y-bx

where n = number of periods x x = = mean of the x values n y y = n = mean of the y values

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Least Squares Example

x(PERIOD)
1 2 3 4 5 6 7 8 9 10 11 12 78

y(DEMAND)
73 40 41 37 45 50 43 47 56 52 55 54 557

xy
37 80 123 148 225 300 301 376 504 520 605 648 3867

x2
1 4 9 16 25 36 49 64 81 100 121 144 650
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Least Squares Example (cont.)

78 x = = 6.5 12 557 y = = 46.42 12 xy - nxy b = = 2 2 x - nx

3867 - (12)(6.5)(46.42) =1.72 2 650 - 12(6.5)

a = y - bx = 46.42 - (1.72)(6.5) = 35.2

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Linear trend line y = 35.2 + 1.72x Forecast for period 13 y = 35.2 + 1.72(13) = 57.56 units
70 60 50 Demand 40 Linear trend line 30 20

Actual

10
0

| 1

| 2

| 3

| 4

| 5

| | 6 7 Period

| 8

| 9

| 10

| 11

| 12

| 13

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Seasonal Adjustments
Repetitive increase/ decrease in demand Use seasonal factor to adjust forecast Di D

Seasonal factor = Si =

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Seasonal Adjustment (cont.)

YEAR 2002 2003 2004 Total DEMAND (1000S PER QUARTER) 1 2 3 4 Total 12.6 14.1 15.3 42.0 8.6 10.3 10.6 29.5 6.3 7.5 8.1 21.9 17.5 18.2 19.6 55.3 45.0 50.1 53.6 148.7

D1 42.0 S1 = = = 0.28 D 148.7 D2 29.5 S2 = = = 0.20 D 148.7

D3 21.9 S3 = = = 0.15 D 148.7 D4 55.3 S4 = = = 0.37 D 148.7

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Seasonal Adjustment (cont.)

For 2005

y = 40.97 + 4.30x = 40.97 + 4.30(4) = 58.17

SF1 = (S1) (F5) = (0.28)(58.17) = 16.28 SF2 = (S2) (F5) = (0.20)(58.17) = 11.63 SF3 = (S3) (F5) = (0.15)(58.17) = 8.73 SF4 = (S4) (F5) = (0.37)(58.17) = 21.53

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Forecast Accuracy
Forecast error

difference between forecast and actual demand MAD

mean absolute deviation

mean absolute percent deviation

MAPD

Cumulative error Average error or bias

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Mean Absolute Deviation (MAD)

Dt - Ft MAD = n
where t = period number Dt = demand in period t Ft = forecast for period t n = total number of periods = absolute value
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MAD Example
PERIOD 1 2 3 4 5 6 7 8 9 10 11 12 DEMAND, Dt 37 40 41 37 MAD 45 50 43 47 56 52 55 54 557 Ft ( =0.3) (Dt - Ft) |Dt - Ft| 3.00 3.10 1.83 6.72 9.69 0.20 3.86 11.70 4.19 5.94 3.15 53.39 37.00 37.00 3.00 37.90 3.10 D t - Ft -1.83 38.83 n 38.28 6.72 40.29 9.69 53.39 43.20 -0.20 43.14 3.86 11 44.30 11.70 4.19 4.8547.81 49.06 5.94 50.84 3.15 49.31

= = =

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Other Accuracy Measures

Mean absolute percent deviation (MAPD)

|Dt - Ft| MAPD = Dt

Cumulative error E = et = (Dt - Ft)

Average error
E= n

et
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Comparison of Forecasts

FORECAST Exponential smoothing ( = 0.30) Exponential smoothing ( = 0.50) Adjusted exponential smoothing ( = 0.50, = 0.30) Linear trend line

MAD 4.85 4.04 3.81 2.29

MAPD 9.6% 8.5% 7.5% 4.9%

E 49.31 33.21 21.14

(E) 4.48 3.02 1.92

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Time Series Forecasting using Excel

Excel can be used to develop forecasts:

Moving average Exponential smoothing Adjusted exponential smoothing Linear trend line

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Exponentially Smoothed and Adjusted Exponentially Smoothed Forecasts

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Demand and exponentially smoothed forecast

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Data Analysis option

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Computing a Forecast with Seasonal Adjustment

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Using Excel

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Regression Methods
Linear regression

a mathematical technique that relates a dependent variable to an independent variable in the form of a linear equation a measure of the strength of the relationship between independent and dependent variables

Correlation

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Linear Regression
y = a + bx
where

a = y-bx xy - nxy b = x2 - nx2 a = intercept b = slope of the line

x = mean of the x data n y y = n = mean of the y data x =
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Linear Regression Example

x (WINS) 4 6 6 8 6 7 5 7 49 y (ATTENDANCE) 36.3 40.1 41.2 53.0 44.0 45.6 39.0 47.5 346.7

xy
145.2 240.6 247.2 424.0 264.0 319.2 195.0 332.5 2167.7

x2
16 36 36 64 36 49 25 49 311

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Linear Regression Example (cont.)

49 = 6.125 8 346.9 y= = 43.36 8 x=

xy - nxy2 b= x2 - nx2
(2,167.7) - (8)(6.125)(43.36) = (311) - (8)(6.125)2 = 4.06 a = y - bx = 43.36 - (4.06)(6.125) = 18.46
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Linear Regression Example (cont.)

Regression equation y = 18.46 + 4.06x
60,000 50,000 40,000 30,000 20,000 10,000 | 0 | 1 | 2 | 3 | 4 | 5 Wins, x | 6 | 7 | 8 | 9 | 10

Attendance forecast for 7 wins y = 18.46 + 4.06(7) = 46.88, or 46,880

Attendance, y

Linear regression line, y = 18.46 + 4.06x

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Correlation and Coefficient of Determination

Correlation, r
Measure of strength of relationship Varies between -1.00 and +1.00

Coefficient of determination, r2
Percentage of variation in dependent variable resulting from changes in the independent variable
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Computing Correlation
r= n xy - x y
[n x2 - ( x)2] [n y2 - ( y)2] (8)(2,167.7) - (49)(346.9) r=

[(8)(311) - (49)2] [(8)(15,224.7) - (346.9)2] r = 0.947

Coefficient of determination r2 = (0.947)2 = 0.897
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Regression Analysis with Excel

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Regression Analysis with Excel (cont.)

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Regression Analysis with Excel (cont.)

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Multiple Regression
Study the relationship of demand to two or more independent variables
y = 0 + 1x1 + 2x2 + kxk where 0 = the intercept 1, , k = parameters for the independent variables x1, , xk = independent variables
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Multiple Regression with Excel

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Thank You

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