National Institute of Technology Calicut

Department of Mechanical Engineering

Forecasting

Forecasting is the projection or estimation of the occurrence of uncertain future events or

level of activity.

Used for predicting

Demand, Revenues, Costs, Profits, Prices, Technological changes, Environment
problems, Rainfall, etc.

Forecast is one input to many types of planning and control

Policy decisions (economic, social, political,
technological conditions)
Product design (product lines, services and market)

Forecasting

Process decision (process and methods)

Plant decision (facility location and layout)

Operations decisions (output scheduling and

control)

Fig. 1 Master forecasting

Financial planning (financial aggregate, cash flow,
balance sheets, income statement)

Forecasting

Market planning (product lines, pricing, and

promotion
Production planning (aggregate output levels)

Master scheduling (product output levels)

Fig. 2 Functional forecasting

Forecasting usually involves the following considerations

Item to be forecasted (products, product groups, assemblies, etc)

Top down or bottom up forecasting

Forecasting techniques (quantitative or qualitative model)

Demand Forecasting

March 2012

National Institute of Technology Calicut

Department of Mechanical Engineering

Units of measure (Rs, units, weights, etc)

Time interval (weeks, months, quarters, etc)

Forecast horizons (how many time intervals to include)

Forecasting components (levels, trends, seasonal, cycles and random variations)

Forecast accuracy (error measurement)

Exception reporting and special situations

Revision of forecasting model parameters

Sales Forecasting

Sales forecasts are used to establish product levels, facilitate scheduling, set inventory
levels, determine manpower loading, make purchasing decisions, establish sales
conditions pricing and advertising, and financial planning cash budgeting and capital
budgeting

Generally, sales forecast is used to estimate the demand of independent items

Many environmental factors influence the demand for products and services of an
organisation.

Some major environmental factors are

1. General business conditions and state of the economy.
2. Competitor actions and reactions
3. Governmental legislative actions
4. Marketplace trend
a) Product life cycle
b) Style and fashion
c) Changing consumer demands
5. Technological innovations

Presence of randomness preclude a perfect forecast

Forecast for groups of items tend to be more accurate than forecast for individual items

Error potential increases as time horizon of a forecast increases

We are interested in estimating the level of future demand. Statistical techniques are used
to forecast.

Statistical methods use historical (past) data

All statistical forecasting techniques assume to some extent that forces that have existed
in the past will persist in the future.

New product demand (with little or no history of past demand) rely more on subjective
phenomenon and solicitation of opinions

Direct survey approach asking prospective customers of their buying interest

Indirect survey approach information from salesmen, wholesalers, area managers,
etc

Demand Forecasting

March 2012

National Institute of Technology Calicut

Department of Mechanical Engineering

Comparison with substitute or comparable products

Limited market test of the new product
Basic demand forecasting models

Time series analysis, soliciting opinions, economic indicators and econometric models

These are short range forecasting models

Generally, these forecasts give starting point for making the final forecast

Final forecast usually requires an additional input in the form of judgment, intuition, and
experience and requires periodic review

Note on economic indicators and econometric models

Economic Indicators

Knowledge of one variable is used to predict the value of another (prediction by

association)

Certain economic indicators are

Gross domestic product (GDP), Personal income, Bank deposits, Freight car
loadings, etc

One or more of these indicators have relationship with the forecast variable

Econometric Models

Involves a set of simultaneous equations that explains the interactions of variables

involved in a business situation

Attempt to show the relationships between relevant variables such as supply, demand,
prices and purchasing power of the consumer

Time Series Analysis

Time series analysis predict future demand from past interval data.

A time series is a set of time ordered observations on a variable during successive and
equal time periods
Period

Jan Feb Mar Apr May Jun

Demand (in units) 75

70

82

76

87

90

The above table shows a time series. This table shows the past demand in successive and
equal interval of time
Period

Jan Mar Apr May Jul Sep

Demand (in units) 75

70

82

76

87

90

This table is not representing a time series as it is not showing demand in equal interval of
time.

Interactive components: levels, trends, seasonal variations, cyclical variations, and

random variations

Fig. 3 illustrates the various components of time series

Levels indicates the scale or magnitude of a time series

Demand Forecasting

March 2012

National Institute of Technology Calicut

Department of Mechanical Engineering

Trend identify the rate of growth or decline of a series over time (Long-term historical
pattern of demand over time)

Seasonal variations consists of annually recurring movements above and below the trend
line
o Demand fluctuates in a repetitive pattern from year to year
o Seasonal periodic peaks and valleys should occur at the same time every year
o Seasonal variations should be of larger magnitude than the random variations

Cyclical variations are long term oscillations or swings about a trend line

The cycles may or may not be periodic, but they often are the result of business cycles of
expansion and contraction of economic activity over a number of years

Business cycles may be due to one or more of the following: prosperity, recession,
depression and recovery

The cycles may vary with respect to the time of occurrence, the length of the phases, and
the amplitude of the fluctuations

Raw Data

Trend Component

Seasonal Component

Cyclic Component

Random Component

Time (years)
Fig. 3 Various components of a time series

Demand Forecasting

March 2012

National Institute of Technology Calicut

Department of Mechanical Engineering

Random variations have no particular pattern and usually are without specific assignable
cause

They represent all influences not included in trend, seasonal, and cyclical variations

Erratic occurrence may be isolated and removed from the data, but there are no general
techniques for doing so

Averaging process will help to eliminate its influence

Random variations are often referred to as noise, residuals, or irregular variations

Various techniques in time series analysis



Last period demand

Arithmetic average

Simple moving average

Weighted moving average

Exponentially weighted moving average (EWMA)

Simple exponentially weighted moving average

Trend adjusted exponentially weighted moving average

Seasonally adjusted exponentially weighted moving average

Trend and Seasonally adjusted exponentially weighted moving average

Regression analysis (Linear forecasting technique)

The time series contains interactive components. The models representing interactive
components of demand are classified as
o Multiplicative model
o Additive model
o Mixed model (partially additive, partially multiplicative)

The demand in period (t) for a multiplicative model is represented as

Demand = (Trend) (seasonal) (cycle) (random)
Dt = b F c t

The demand in period (t) for a additive model is represented as

Demand = level + trend + seasonal + cyclic + random
Dt = a + b t + Ft + Ct + t

Generally, demand process can be modelled as

Dt = a + t (level model additive type)
Dt = a + b t + t (trend model additive type)
Dt = (a + b t) Ft + t (mixed model type- trend part is additive and seasonal
part is in multiplicative in form)

Demand Forecasting

March 2012

National Institute of Technology Calicut

Department of Mechanical Engineering

Some Notations
Dt Actual demand for the period t
ft - forecast for the period t

Simple Moving Average

This method is used to represent a demand process of type

Dt = a + t
That is, the demand is represented as a level with random noise.

Parameter a is not really known and is subjected to random changes from time to time.

Using the simple moving average procedure we can get an estimate for a and it can be get
updated as time progresses.

Estimating procedure (updating procedure)

The procedure involves the determination of average of demand of last N periods.

As new period demand observation is available, the old period demand data is removed
from average calculation.

Number of periods considered for average calculation is same but, demand data
considered for the calculation is different at different time periods.

This way of estimation is actually an updating procedure also.

MAt,N = (Dt + Dt-1 + Dt-2 + . Dt-N+1)/N
Where, N is the period of moving average, Dt is the actual demand at period t and
MAt,N is the moving average at period t based on demand of N periods.

The estimate of a, as of the end of the period t is represented as

a t

= MAt,N

This estimate of a results from minimizing the sum of squares of error over the preceding
N period.

A slightly simple updating procedure for this method is

MAt,N = MAt-1,N +

a t

Forecast equations are

Dt Dt N
N

minimizes the standard error, s =

2
t
x j a j

t = j N +1

ft+1 = MAt,N
ft+n = MAt,N (forecast for n period ahead)

Simple EWMA

Underlying demand model is

Dt = at + t

Demand Forecasting

March 2012

National Institute of Technology Calicut

Department of Mechanical Engineering

where, t is normally distributed with mean zero

A best estimates for at is the exponentially weighted smoothing average.

The equation for simple exponential smoothing uses only two pieces of information: (1)
actual demand for the most recent period and (2) the most recent average
Let Xt = exponentially weighted moving average for the period t
X t = Dt + (1 ) X t 1

Forecast equation is
ft+1 = Xt

The above equation for Xt can be written as X t = X t 1 + ( Dt X t 1 )

That is, X t = f t + ( Dt f t )

This equation indicates that using exponential average in one period as a forecast for the
next period; it is possible to revise the average upward or downward, depending on the
forecast error.
Weights for the past data and for the initial average can be easily identified from the
equation given below.
Xt =

t 1

(1 ) D

+ (1 ) t X 0

t k

k =0

The weight for demand in a period k from now (t) is (1 ) k

Expansion of exponentially weighted moving average equation

Xt = Dt + (1 )[Dt 1 + (1 ) X t 2 ]
= Dt + (1 ) Dt 1 + (1 ) 2 X t 2
= Dt + (1 ) Dt 1 + (1 ) 2 [ Dt 2 + (1 ) X t 3 ]
= Dt + (1 ) Dt 1 + (1 ) 2 Dt 2 + (1 ) 3 X t 3

If exponential average is determined for third period, the weight for the demand of
various periods and the initial average can be clearly seen from the equation below
X 3 = D3 + (1 ) D2 + (1 ) 2 D1 + (1 ) 3 X 0

For the demand process, the best estimate of at which minimize the following the sum of
discounted squares of residuals

S= d
j =0

j +1

(D

t j

a t ) where, d = a distant factor (0 < d < 1)

The resulting estimate of at satisfies the following updating formation

a t = Dt + (1 )a t 1

Average age of data in a simple EWMA is 1/ period. In a N month moving average the
average age of data is (N+1)/2
1/ = (N+1)/2
2
Relationship between N (period of moving average) and is =
N +1

Demand Forecasting

March 2012

National Institute of Technology Calicut

Department of Mechanical Engineering

Initialization
When significant historical data exists, simply use the average demand in the first several
periods as the initial estimate of Xt.
Forecast for future periods
ft+1 = Xt
ft+n = Xt (forecast for n period ahead)

Trend Adjusted EWMA

Dt = at + bt t + t is the demand process

Estimation procedure

Estimate for bt is Tt = (Xt - Xt-1) + (1- )Tt-1

Estimate for at is Xt = Dt + (1-)ft

The above equation is written in terms of forecast.

A trend adjusted forecast is the sum of the best average and trend available at the current
time

Hence, the average Xt can be written as

Xt = Dt + (1-)(Xt-1+Tt-1)

Forecast equations are

ft+1 = Xt + Tt
ft+n= Xt + (n-1) Tt

Seasonally adjusted EWMA

Dt = at t + t is a multiplicative demand process

Where, t = seasonal factor

Simple EWMA provides an estimate for at

An estimate for t be calculated by an index, It

It =

Dt
Xt

Seasonal factors allow us to connect back and forth between periods of sales and the
exponential average.

Estimate for at is
Xt =

Dt
It m

+ (1 ) X t 1

where, m is the number of periods in seasonal pattern (m = 12 for monthly data and m = 4
for quarterly data with an annual seasonal pattern)

Demand Forecasting

March 2012

National Institute of Technology Calicut

Department of Mechanical Engineering

Dt
+ (1 )I t m
Xt

Estimate for t is It=

Forecast equation is ft+1 = Xt It+1-m

Trend & seasonally adjusted EWMA

Demand process is Dt = (at + bt t ) t + t

Estimate for at is

Xt =

Dt
It m

+ (1 )( X t 1 + Tt 1 )

Estimate for bt is
Tt = ( X t X t 1 ) + (1 )Tt 1

Estimate for I t is

It =

Dt
+ (1 )I t m
Xt

Forecast equation is
f t +1 = ( X t + Tt )I t +1 m

Forecast Error Measurement

The forecast error measurement belongs to any one of the following

Error estimate to know the magnitude of error
to get an idea on biasness of forecast
to get an idea on revision of parameters

Magnitude of Error (extent of error)

Mean Absolute Deviation (MAD)

n | Dt f t |
n
t =1

MAD =

where, n is the number deviations available

n ( Dt f t ) 2
n
t =1

Mean Square Error, MSE =

MSE penalise deviations with large magnitude

Standard deviation, S r2 =

t =1

(Dt f t )2
n2

The 2 in the denominator represents the number of degree of freedom.

Sr =1.25MAD for error normally distributed.

Demand Forecasting

March 2012

National Institute of Technology Calicut

Department of Mechanical Engineering

Bias measurement Direction

Running Average Forecast Error (RAFE)

n ( Dt f t )
n
t =1

RAFE =
Revision

Tracking Signal (TS)

TS =

RAFE
MAD

1 TS 1

The limiting conditions are achieved if all errors are positive or all errors are negative.

Error updating procedure

= smoothing constant

MADt = ( Dt f t ) + (1 ) MADt 1

MSEt = ( Dt f t ) 2 + (1 ) MSEt 1

Forecasting Problems
Moving Average Methods

Twelve-month demand data of a product is given below. Use this data to develop forecasts
using three- and six-month moving averages, and three-month weighted moving average
(weights for data: 0.25, 0.25 and 0.5 for most recent) method.
TABLE 1 Demand data
Month
Jan. Feb. Mar. Apr. May June July Aug. Sep. Oct. Nov. Dec.
Demand 450 440 460 510 520 495 475 560 510 520 540 550

TABLE 2 Three and Six-Month Moving Averages Used as Forecasts

Month
January
February
March
April
May
June
July
August
September
October
November
December

Demand
(Dt)
450
440
460
510
520
495
475
560
510
520
540
550

Three-Month
Moving
Average
(MA t )
450
470
497
508
497
510
515
530
523
537

Three-Month
Moving Average
Forecast*
(ft)
450
470
497
508
497
510
515
530
523

Six-Month
Moving
Average
(MA t )
479
483
503
512
513
517
526

Six-Month
Moving
Average
Forecast (ft)
479
483
503
512
513
517

Note: The average at time t becomes a forecast for time t+1

*Using ft as the forecast for period t, ft is set equal to the most recently calculated moving
average, ft =MA t 1
Demand Forecasting
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March 2012

National Institute of Technology Calicut

Department of Mechanical Engineering

TABLE 3 Forecast Using Moving Average and Weighted Moving Average

Month
January
February
March
April
May
June
July
August
September
October
November
December

Demand
(Dt)
450
440
460
510
520
495
475
560
510
520
540
550

Three-Month
Moving
Average
(MA t )
450
470
497
508
497
510
515
530
523
537

Three-Month
Moving
Average
Forecast (ft)
450
470
497
508
497
510
515
530
523

Three -Month
Weighted Moving
Average
(0.25,0.25.0.50)
Most Recent (MA t )
453
480
503
505
491
523
514
528
528
540

Three-Month
Weighted
Moving
Average
Forecast (ft)
453
480
503
505
491
523
514
528
528

Simple Exponential Smoothing Method

Determine the forecast from March to December for the demand data given in Table 1. Given
= 0.2 and initial average for March = 480. The last column of the Table 4 is the weights
given to various months when exponentially weighted average of December month is
calculated. The weight for a month can be calculated as (1 )k where, k varies from 0 to
(10-1) for December to March with December having a value of zero. That is, the value of k
is zero for the current month, 1 for just previous month and so on. Hence, the smoothing
expression can be written as
t 1

X t = (1 )k Dt k + (1 )t X 0
k =0

where, t is the current month; here for December t = 10.

TABLE 4 Simple Exponential Smoothing Forecast

Month
March
April
May
June
July
August
September
October
November
December
a

Demand
(D t )
460
510
520
495
475
560
510
520
540
550

Smoothed Average
( Xt )
476.00
482.80
490.24
491.19
487.95
502.36
503.89
507.11
513.69
520.95

Forecast
(ft)
480
476
483
490
491
488
502
504
507
514

Weightsa
0.027
0.034
0.042
0.052
0.066
0.082
0.102
0.128
0.160
0.200

At the end of December, X DEC implicitly applies these weights to the sales from March through

December. To see this, calculate X DEC = 0.2(550)+0.16(540)+0.128(520)++0.027(460) = 520.95

Demand Forecasting

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National Institute of Technology Calicut

Department of Mechanical Engineering

Trend adjusted exponential smoothing method

Twelve-month demand from March to February is given in Table 5. Determine the forecast
for these months using trend adjusted exponential smoothing method.
Given =0.2; =0.2; T0=9; X0= 480
TABLE 5 Trend adjusted exponential smoothed forecast
Month

March
April
May
June
July
August
September
October
November
December
January
February

Demand
(Dt)

460
510
520
495
475
560
510
520
540
550
555
569

Simple
exponential
averagea (Xt)
476.00
482.80
490.24
491.19
487.95
502.36
503.89
507.11
513.69
520.95
527.76
536.01

Trend adjusted
exponential
average (Xt)
480.00
483.20
494.83
506.74
511.80
511.18
526.23
529.62
533.55
540.16
547.43
554.35
562.72

Trend
(Tt)

Forecast
(ft)

9.00
7.84
8.60
9.26
8.42
6.61
8.30
7.32
6.64
6.63
6.76
6.79
7.11

489.00
491.04
503.43
516.00
520.22
517.79
534.53
536.94
540.20
546.79
554.19
561.15

Given for comparison purposes. Note how the simple exponential average lags the upward
trend.
Seasonally Adjusted Exponential Smoothing Method
Monthly demand data for three years is given in Table 6. Use the first two years data to
determine monthly seasonal index and determine monthly forecast of third year.
TABLE 6 Demand data for a seasonal product

Month
January
February
March
April
May
June
July
August
September
October
November
December

2006

Demand
2007

2008

80
75
80
90
115
110
100
90
85
75
75
80

100
85
90
110
131
120
110
110
95
85
85
80

95
75
90
105
120
117
102
98
95
75
85
75

Consider the average demand of years 2006 and 2007 as initial average (X0) to start
exponential smoothing forecast. Given =0.2, = 0.05
Seasonal index calculation
Calculate the average demand for each month (eg:- Average demand of January = January
month demands in 2006 + 2007)
Average these to get average monthly demand
Demand Forecasting

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National Institute of Technology Calicut

Department of Mechanical Engineering

Seasonal index of January = Average demand of January divided by average monthly

demand
Similarly calculate seasonal index of all other month.
TABLE 7 Sample Seasonal Index Computation
Demand
2006
2007
Month
January
80
100
February
75
85
March
80
90
April
90
110
May
115
131
June
110
120
July
100
110
August
90
110
September
85
95
October
75
85
November
75
85
December
80
80
a
Average monthly demand: 1128/12=94

Average
Demanda
90
80
85
100
123
115
105
100
90
80
80
80

Seasonal
Index
(It)
0.957
0.851
0.904
1.064
1.309
1.223
1.117
1.064
0.957
0.851
0.851
0.851

TABLE 8 Computation of Seasonalized Forecast

Month
January
February
March
April
May
June
July
August
September
October
November
December

Demand
(Dt) 2008
95
75
90
105
120
117
102
98
95
75
85
75

Deseasonalized
Demand
(Dt/(It-12))
99.27
88.13
99.56
98.68
91.67
95.67
91.32
92.11
99.27
88.13
99.88
88.13

Average
(Xt)
X 0 =94
95.05
93.67
94.85
95.62
94.83
95.00
94.26
93.83
94.92
93.56
94.82
93.48

Forecast
(ft)
89.96
80.88
84.68
100.92
125.17
115.98
106.11
100.29
89.80
80.78
79.62
80.69

Old
New
Seasonal Seasonal
Factor
Factor
(It-12)
(It)
0.957
0.959
0.851
0.848
0.904
0.906
1.064
1.066
1.309
1.307
1.223
1.223
1.117
1.115
1.064
1.063
0.957
0.959
0.851
0.849
0.851
0.853
0.851
0.849

Problem from Economic Indicators

The General Manager of a building materials production plant feels the demand for plaster
board shipments may be related to the number of construction permits issued in the district
during the previous quarter. The manager has collected the data shown in the accompanying
table. Derive a regression forecasting equation and determine a point estimate for plaster
board shipments when the number of construction permits is 30

Demand Forecasting

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National Institute of Technology Calicut

Department of Mechanical Engineering

Construction permits
15 9 40 20 25 25 15 35
Plaster board shipments 6 4 16 6 13 9 10 16
Solution
Consider construction permit as independent variable (X) and plaster board shipments as
dependent variable (Y) and establish a linear relationship.
Let the linear relationship be Y = aX + b
Normal equations to find a and b are

Y = a X + nb

XY = a X

+ b x

Forecasting equation is

Y = 0.395 X = 0.915

The point estimate for the plaster board shipments is 12.765 13

Demand Forecasting

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March 2012