FORECASTING

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Group Members..
Muhammad Sarfaraz UW-10-ME-BE-82
Hassan Zahid UW-10-ME-BE-84
Muhammad Adnan UW-10-ME-BE-86
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What is forecasting..
Forecasting is the art of science of predicting future
events.
It may involve taking historical data and projecting them
into the future with some sort of mathematical model.
It is the estimating the future demand for products and
services.
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Forecasting Time Horizons
Short-range forecast
Up to 1 year (usually less than 3 months)
Job scheduling, worker assignments, plan for purchasing
Medium-range forecast
3 months to 3 years
Sales & production planning, budgeting
Long-range forecast
3 years, or more
New product planning, facility location

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Types of Forecasts
Economic forecasts
Address the future business conditions (e.g., inflation rate,
money supply, etc.)
Technological forecasts
Predict the rate of technological progress
Predict acceptance of new products
Demand forecasts
Predict sales of existing products

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The Strategic Importance of Forecasting
Forecast of demand therefore drive decisions in many
areas. Lets look at he impact of product forecast on three
activities i-e
Human Resources Hiring, training, laying off workers
Capacity Capacity shortages can result in
undependable delivery, loss of customers, loss of market
share
Supply Chain Management Good supplier relations and
price advantages

6
Seven Steps in Forecasting
Determine the purpose of the forecast
Select the items to be forecasted
Determine the time horizon of the forecast
Select the forecasting model(s)
Gather the data
Make the forecast
Validate and implement results

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Forecasting Approaches

Qualitative Methods

Used when situation
is vague & little data
exist
New products
New technology
Involves intuition,
experience
e.g., forecasting sales on
Internet

Quantitative Methods

Used when situation
is stable & historical
data exist
Existing products
Current technology
Involves mathematical
techniques
e.g., forecasting sales of
color televisions

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Overview of Qualitative Methods
Jury of executive opinion
Pool opinions of high-level executives, sometimes
augment by statistical models
Delphi method or judge mental method
Panel of experts, queried iteratively
Sales force composite
Estimates from individual salespersons are reviewed
for reasonableness, then aggregated
Consumer (Market research) Survey
Ask the customer

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Overview of Quantitative Methods
Time Series Models:
Assumes information needed to generate a forecast is
contained in a time series of data
Assumes the future will follow same patterns as the
past
Causal Models or Associative Models
Explores cause-and-effect relationships
Uses leading indicators to predict the future
Housing starts and appliance sales

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Decomposition of Time series
Naive approach
Moving average
Exponential smoothing
Trend projection
Linear regression analysis

Time-
Series
Models
Associative
Model
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1.Naive Approach
Assumes demand in next period is equal to the
actual demand in most recent period
e.g., If May sales were 48, then June sales will
be 48
Sometimes cost effective & efficient

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2.Moving Average Method
Moving average uses a number of most recent
historical actual data values to generate a forecast.
MA is a series of arithmetic means
Used if little or no trend
Used often for smoothing
Provides overall impression of data over time
Equation:
MA
n
n


Demand in Previous Periods
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January 10
February 12
March 13
April 16
May 19
June 23
July 26

Actual 3-Month
Month Shed Sales Moving Average




(12 + 13 + 16)/3 = 13
2
/
3

(13 + 16 + 19)/3 = 16
(16 + 19 + 23)/3 = 19
1
/
3
10
12
13
(10 + 12 + 13)/3 = 11
2
/
3
Moving Average Example
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| | | | | | | | | | | |
J F M A M J J A S O N D
S
h
e
d

S
a
l
e
s

30
28
26
24
22
20
18
16
14
12
10
Actual
Sales
Moving
Average
Forecast
Graph of Moving Average
Used when trend is present
Older data usually less important
Weights based on experience and intuition
Weighted
moving average
=
(weight for period n)
x (demand in period n)
weights
Weighted Moving Average
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January 10
February 12
March 13
April 16
May 19
June 23
July 26

Actual 3-Month Weighted
Month Shed Sales Moving Average




[(3 x 16) + (2 x 13) + (12)]/6 = 14
1
/
3

[(3 x 19) + (2 x 16) + (13)]/6 = 17
[(3 x 23) + (2 x 19) + (16)]/6 = 20
1
/
2
10
12
13
[(3 x 13) + (2 x 12) + (10)]/6 = 12
1
/
6



Weighted Moving Average
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30
25
20
15
10
5
S
a
l
e
s

d
e
m
a
n
d

| | | | | | | | | | | |
J F M A M J J A S O N D
Actual
sales
Moving
average
Weighted
moving
average
Figure 4.2
Moving Average And
Weighted Moving Average
3.Exponential Smoothing Method
It requires only three items of data this periods forecast,
the actual demand for this period and which is referred
to as a smoothing constant and having value between 0
and 1
New forecast = Last periods forecast + {Last periods actual
demand Last periods forecast}

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New forecast = Last periods forecast
+ a (Last periods actual demand
Last periods forecast)
F
t
= F
t 1
+ a(A
t 1
- F
t 1
)
where F
t
= new forecast
F
t 1
= previous forecast
a = smoothing (or weighting)
constant (0 a 1)
Exponential Smoothing
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Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant a = .20
New forecast = 142 + .2(153 142)
= 142 + 2.2
= 144.2 144 cars
Exponential Smoothing Example
225
200
175
150
| | | | | | | | |
1 2 3 4 5 6 7 8 9
Quarter
D
e
m
a
n
d

a = .1
Actual
demand
a = .5
Impact of Different a
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Chose high values of a
when underlying average
is likely to change
Choose low values of a
when underlying average
is stable
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Measuring Forecast Error
Forecasts are never perfect
Need to know how much we should rely on our chosen
forecasting method
Measuring forecast error:


Note that over-forecasts = negative errors and under-
forecasts = positive errors

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Mean Absolute Deviation (MAD)
MAD =
|Actual - Forecast|
n
Mean Squared Error (MSE)
MSE =
(Forecast Errors)
2

n
Common Measures of Error
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Mean Absolute Percent Error (MAPE)
MAPE =
100|Actual
i
- Forecast
i
|/Actual
i

n
n
i = 1
Common Measures of Error
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When a trend is present, exponential
smoothing must be modified
Forecast
including (FIT
t
) =
trend
Exponentially Exponentially
smoothed (F
t
) + (T
t
) smoothed
forecast trend
Exponential Smoothing with Trend
Adjustment
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F
t
= a(A
t - 1
) + (1 - a)(F
t - 1
+ T
t - 1
)
T
t
= b(F
t
- F
t - 1
) + (1 - b)T
t - 1

Step 1: Compute F
t

Step 2: Compute T
t

Step 3: Calculate the forecast FIT
t
= F
t
+ T
t

Exponential Smoothing with Trend
Adjustment
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Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (A
t
) Forecast, F
t
Trend, T
t
Trend, FIT
t

1 12 11 2 13.00
2 17
3 20
4 19
5 24
6 21
7 31
8 28
9 36
10
Table 4.1
Exponential Smoothing with Trend
Adjustment
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Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (A
t
) Forecast, F
t
Trend, T
t
Trend, FIT
t

1 12 11 2 13.00
2 17
3 20
4 19
5 24
6 21
7 31
8 28
9 36
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Table 4.1
F
2
= aA
1
+ (1 - a)(F
1
+ T
1
)
F
2
= (.2)(12) + (1 - .2)(11 + 2)
= 2.4 + 10.4 = 12.8 units
Step 1: Forecast for Month 2
Exponential Smoothing with Trend
Adjustment
30
Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (A
t
) Forecast, F
t
Trend, T
t
Trend, FIT
t

1 12 11 2 13.00
2 17 12.80
3 20
4 19
5 24
6 21
7 31
8 28
9 36
10
Table 4.1
T
2
= b(F
2
- F
1
) + (1 - b)T
1

T
2
= (.4)(12.8 - 11) + (1 - .4)(2)
= .72 + 1.2 = 1.92 units
Step 2: Trend for Month 2
Exponential Smoothing with Trend
Adjustment
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Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (A
t
) Forecast, F
t
Trend, T
t
Trend, FIT
t

1 12 11 2 13.00
2 17 12.80 1.92
3 20
4 19
5 24
6 21
7 31
8 28
9 36
10
Table 4.1
FIT
2
= F
2
+ T
1

FIT
2
= 12.8 + 1.92
= 14.72 units
Step 3: Calculate FIT for Month 2
Exponential Smoothing with Trend
Adjustment
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Forecast
Actual Smoothed Smoothed Including
Month(t) Demand (A
t
) Forecast, F
t
Trend, T
t
Trend, FIT
t

1 12 11 2 13.00
2 17 12.80 1.92 14.72
3 20
4 19
5 24
6 21
7 31
8 28
9 36
10
Table 4.1

15.18 2.10 17.28
17.82 2.32 20.14
19.91 2.23 22.14
22.51 2.38 24.89
24.11 2.07 26.18
27.14 2.45 29.59
29.28 2.32 31.60
32.48 2.68 35.16
Exponential Smoothing with Trend
Adjustment
33
Figure 4.3
| | | | | | | | |
1 2 3 4 5 6 7 8 9
Time (month)
P
r
o
d
u
c
t

d
e
m
a
n
d

35
30
25
20
15
10
5
0
Actual demand (A
t
)
Forecast including trend (FIT
t
)
with a = .2 and b = .4
Exponential Smoothing with Trend
Adjustment
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Fitting a trend line to historical data points to
project into the medium to long-range
Linear trends can be found using the least
squares technique
y = a + bx
^
where y = computed value of the variable to be predicted
(dependent variable)
a = y-axis intercept
b = slope of the regression line
x = the independent variable
^
Trend Projections
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Time period
V
a
l
u
e
s

o
f

D
e
p
e
n
d
e
n
t

V
a
r
i
a
b
l
e

Figure 4.4
Deviation
1

(error)
Deviation
5

Deviation
7

Deviation
2

Deviation
6

Deviation
4

Deviation
3

Actual observation
(y value)
Trend line, y = a + bx
^
Least Squares Method
Equations to calculate the regression variables
b =
Sxy - nxy
Sx
2
- nx
2

y = a + bx
^
a = y - bx
Least Squares Method
b = = = 10.54
xy - nxy
x
2
- nx
2

3,063 - (7)(4)(98.86)
140 - (7)(4
2
)
a = y - bx = 98.86 - 10.54(4) = 56.70
Time Electrical Power
Year Period (x) Demand x
2
xy
2001 1 74 1 74
2002 2 79 4 158
2003 3 80 9 240
2004 4 90 16 360
2005 5 105 25 525
2005 6 142 36 852
2007 7 122 49 854
x = 28 y = 692 x
2
= 140 xy = 3,063
x = 4 y = 98.86
Least Squares Example
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b = = = 10.54
Sxy - nxy
Sx
2
- nx
2

3,063 - (7)(4)(98.86)
140 - (7)(4
2
)
a = y - bx = 98.86 - 10.54(4) = 56.70
Time Electrical Power
Year Period (x) Demand x
2
xy
1999 1 74 1 74
2000 2 79 4 158
2001 3 80 9 240
2002 4 90 16 360
2003 5 105 25 525
2004 6 142 36 852
2005 7 122 49 854
Sx = 28 Sy = 692 Sx
2
= 140 Sxy = 3,063
x = 4 y = 98.86
The trend line is
y = 56.70 + 10.54x
^
Least Squares Example
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Time Series Components
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D
e
m
a
n
d

f
o
r

p
r
o
d
u
c
t

o
r

s
e
r
v
i
c
e

| | | |
1 2 3 4
Year
Average
demand over
four years
Seasonal peaks
Trend
component
Actual
demand
Random
variation
Figure 4.1
Components of Demand
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Trend Component
Persistent, overall upward or downward pattern
Due to population, technology etc.
Several years duration

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Seasonal Component
Regular pattern of up & down fluctuations
Due to weather, customs, etc.
Occurs within 1 year

Number of
Period Length Seasons
Week Day 7
Month Week 4-4.5
Month Day 28-31
Year Quarter 4
Year Month 12
Year Week 52
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Cyclical Component
Repeating up & down movements
Due to interactions of factors influencing economy
Can be anywhere between 2-30+ years duration

0 5 10 15 20
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Random Component
Erratic, unsystematic, residual fluctuations
Due to random variation or unforeseen events
Union strike
Tornado
Short duration & non-repeating

M T W T F
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Factors to be considered in the selection
of forecasting method
1. The amount & type of available data
Some methods require more data than others
2. Degree of accuracy required
Increasing accuracy means more data
3. Length of forecast horizon
Different models for 3 month vs. 10 years
4. Presence of data patterns
Lagging will occur when a forecasting model meant
for a level pattern is applied with a trend

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Forecasting Software
Spreadsheets
Microsoft Excel, Quattro Pro, Lotus 1-2-3
Limited statistical analysis of forecast data
Statistical packages
SPSS, SAS, NCSS, Minitab
Forecasting plus statistical and graphics
Specialty forecasting packages
Forecast Master, Forecast Pro, Autobox, SCA
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Summary
Three basic principles of forecasting are: forecasts are rarely perfect,
are more accurate for groups than individual items, and are more
accurate in the shorter term than longer time horizons.
The forecasting process involves five steps: decide what to forecast,
evaluate and analyze appropriate data, select and test model,
generate forecast, and monitor accuracy.
Forecasting methods can be classified into two groups: qualitative
and quantitative. Qualitative methods are based on the subjective
opinion of the forecaster and quantitative methods are based on
mathematical modeling.
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Continue...
There are four basic patterns of data: level or
horizontal, trend, seasonality, and cycles. In addition,
data usually contain random variation. Some forecast
models used to forecast the level of a time series are:
nave, simple mean, simple moving average, weighted
moving average, and exponential smoothing. Separate
models are used to forecast trends and seasonality.
A simple causal model is linear regression in which a
straight-line relationship is modeled between the
variable we are forecasting and another variable in the
environment. The correlation is used to measure the
strength of the linear relationship between these two
variables.
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continue
Three useful measures of forecast error are mean
absolute deviation (MAD), mean square error (MSE) and
tracking signal.
There are four factors to consider when selecting a
model: amount and type of data available, degree of
accuracy required, length of forecast horizon, and
patterns present in the data.

THANX
Any question???
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