RAFAEL IRENEO, MBA,

CSSBB

FORECASTING FAR EASTERN UNIVERSITY

IABF
 LECTURE OUTLINE
❖ Elements of a good forecast
❖ Outline the steps in the foreacsting process
❖ Describe at least three qualitative forecasting techniques and the
advantages and disadvantages of each
❖ Compare and contrast qualitative and quantitative approaches to
forecasting
❖ Averaging techniques, regression analysis and solve typical problems
❖ Describe two measures of forecast accuracy
❖ Describe two ways of evaluating and controlling forecasts
FORECASTING SUMMARY
 FORECAST
❖ A statement about the future
value of a variable of interest
❖ Critical to make an informed
decision
TWO IMPORTANT ASPECTS OF FORECASTS

❖ EXPECTED LEVEL OF
DEMAND
❖ The level of demand may be
a function of some structural
variation such as trend or
seasonal variation
❖ ACCURACY
❖ potential size of forecast
error
 FORECAST USES
1. PLAN THE SYSTEM
2. PLAN THE USE OF THE
SYSTEM
 FORECAST FEATURES
❖ If it happened in the past, it
will happen in the future
❖ Not perfect
❖ Random Variation = residual
error
❖ Group forecast is more
accurate than individual
forecast
❖ Accuracy decreases overtime
ELEMENTS OF A GOOD FORECAST
❖ TIMELY
❖ ACCURATE
❖ RELIABLE
❖ EXPRESSED IN
MEANINGFUL UNITS
❖ IN WRITING
❖ SIMPLE TO UNDERSTAND
❖ COST-EFFECTIVE
STEPS IN THE FORECASTING PROCESS

1. DETERMINE THE PURPOSE

2. ESTABLISH A TIME
HORIZON
3. OBTAIN, CLEAN, ANALYZE
APPROPRIATE DATA
4. SELECT FORECASTING
TECHNIQUE
5. MAKE THE FORECAST
6. MONITOR FORECAST
ERRORS
FORECAST ACCURACY AND CONTROL

❖ ALLOWANCES SHOULD BE
MADE FOR FORECAST
ERRORS
❖ EX. MARGIN OF ERROR
❖ FORECAST ERRORS
SHOULD BE MONITORED
❖ ERROR/RESIDUAL =
ACTUAL DATA -
FORECASTED DATA
FORECASTING ACCURACY METRICS
❖ MEAN ABSOLUTE
DEVIATION (MAD)
❖ MEAN SQUARED ERROR
(MSE)
❖ MEAN ABSOLUTE
PERECENT ERROR (MAPE)
FORECAST ACCURACY METRICS
∑ Actual t − Forecast t MAD weights all errors
MAD =
n evenly

2
∑ (Actual t − Forecast t ) MSE weights errors according
MSE = to their squared values
n −1

Actualt − Forecast t
∑ × 100
Actualt MAPE weights errors
MAPE = according to relative error
n

LO 3.5
FORECAST ERROR CALUCLATION
Actual Forecast (A-F)
Period
(A) (F) Error |Error| Error2 [|Error|/Actual]x100
1 107 110 -3 3 9 2.80%

2 125 121 4 4 16 3.20%

3 115 112 3 3 9 2.61%

4 118 120 -2 2 4 1.69%

5 108 109 1 1 1 0.93%

Sum 13 39 11.23%

n=5 n-1 = 4 n=5

MAD MSE MAPE

= 2.6 = 9.75 = 2.25%

 FORECASTING APPROACHES
❖ QUALITATIVE FORECASTING
❖ soft information
❖ ex. human factors, personal
opinnions, hunches
❖ QUANTITATIVE
FORECASTING
❖ hard data
❖ ex. earnings per share,
productivity per year, capital
turnover
 QUALITATIVE FORECASTING
❖ Forecasts that use subjective
inputs eg. opinions, surveys
❖ Executive opinions
❖ Sales force opinions
❖ Consumer surveys
❖ Other methods (Delphi
Method)
QUANTITATIVE FORECASTING
❖ TIME-SERIES FORECAST
❖ Forecasts that project pattern
over a period of time
❖ Assume that future values of
the time-series can be
estimated from past values
of the time series
QUANTITATIVE FORECASTING
❖ TIME-SERIES BEHAVIORS
❖ TREND
❖ long-term upward or downward
movement
❖ SEASONALITY
❖ short-term, fairly regular variations
related to calendar or time of day
❖ CYCLES
❖ wavelike variations lasting for more than
a year
❖ IRREGULAR VARIATIONS
❖ variations to due unusual circumstances
❖ Random Variation
❖ residual variations
QUANTITATIVE FORECASTING
❖ NAIVE FORECASTING
❖ Uses a single previous value
of a time series as the basis
for the forecast
❖ Applicable only if:
❖ stable time series
❖ seasonal variations
❖ trend
QUANTITATIVE FORECASTING
❖ AVERAGING TECHNIQUES
❖ MOVING AVERAGE
❖ WEIGHTED MOVING
AVERAGE
❖ EXPONENTIAL
SMOOTHING
QUANTITATIVE FORECASTING
❖ MOVING AVERAGE
❖ Technique that averages a number of the most recent actual
values in generating a forecast
n

∑A
i =1
t −i
At − n + ... + At − 2 + At −1
Ft = MA n = =
n n
where
Ft = Forecast for time period t
MA n = n period moving average
At −i = Actual value in period t − i
n = Number of periods in the moving average
QUANTITATIVE FORECASTING
❖ Using a three-point moving PERIOD DEMAND
average, whats the forecasted
demand for period 6? 1 42
❖ F6 = 43 + 40 + 31 / 3 = 41.33
2 40

❖ If the actual demand in period 3 43

6 turns out to be 38, the
moving average for period 7 4 40
would be
❖ F7 = 40 + 41 + 38 /3 = 39.67 5 41
QUANTITATIVE FORECASTING
❖ WEIGHTED MOVING AVERAGE
❖ The most recent values in a time series are given more weight in
computing a forecast
❖ The choice of weights, w, is somewhat arbitrary

Ft = wt ( At ) + wt −1 ( At −1 ) + ... + wt − n ( At −n )
where
wt = weight for period t , wt −1 = weight for period t − 1, etc.
At = the actual value for period t , At −1 = the actual value for period t − 1, etc.
QUANTITATIVE FORECASTING
❖ Compute a weighted forecasting
PERIOD DEMAND
using a weight of 40% for the most
recent and 30% for the next most
recent, 20% for the next and 10% for 1 42
the next
❖ F6 = .10(40) + .20(43) + .30(40) + . 2 40
40(41) = 41.0

3 43
❖ If the actual demand for period 6 is
39, forecast demand for period 7 using
4 40
the same weights
❖ F7 = .10(43) + .20(40) + .30(41) + .
40(39) = 40.2 5 41
QUANTITATIVE FORECASTING
❖ EXPONENTIAL SMOOTHING
❖ A weighted averaging method that is based on the previous
forecast plus a percentage of the forecast error.

Ft = Ft −1 + α ( At −1 − Ft −1 )
where
Ft = Forecast for period t
Ft −1 = Forecast for the previous period
α = Smoothing constant
At −1 = Actual demand or sales from the previous period
QUANTITATIVE FORECASTING
Actual
❖ The symbol alpha represents a Period (t)
Demand
Forecast 1 Error Forecast 2 Error

percentage of the forecast error. 1 42 - - - -

❖ Ex. Forecast 1 has 10% forecast 2 40 42 -2 42 -2

error and forecast 2 has 40% 3 43 41.8 1.2 41.2 1.8

forecast error
4 40 41.92 -1.92 41.92 -1.92

❖ Ft = 42 + .10(40 - 42) = 41.8

5 41 41.73 -0.73 41.15 -0.15

❖ Actual demand in period 3 6 39 41.66 -2.66 41.09 -2.09

is 43, so:
7 46 41.39 4.61 40.25 5.75

❖ Ft = 41.8 + .10(43 - 41.8) =

8 44 41.85 2.15 42.55 1.45
41.92 is the forecasted
demand for period 4 9 45 42.07 2.93 43.13 1.87
 TECHNIQUES FOR TRENDS
❖ LINEAR TREND
❖ A simple data plot that
reveals the existence and
nature of a trend

Ft = a + bt
where
Ft = Forecast for period t
a = Value of Ft at t = 0
b = Slope of the line
t = Specified number of time periods from t = 0
 TECHNIQUES FOR TREND
❖ Plot the data Week (x) Unit Sales (y) xy
1 700 700
❖ Does the plot suggests that
2 724 1448
a linear trend line would be
3 720 2160
appropriate?
4 728 2912
❖ If yes, compute the 5 740 3700
coefficients of the trend line 6 742 4452
7 758 5306
8 750 6000
9 770 6930
10 775 7750
TOTAL 7407 41358
TECHNIQUES FOR SEASONALITY
❖ TWO MODELS OF
SEASONALITY:
❖ MULTIPLICATIVE
❖ SEASONAL RELATIVES
TECHNIQUES FOR SEASONALITY
❖ ADDITIVE
❖ Seasonality is expressed as a
quantity that gets added to or
subtracted from the time-series
average in order to incorporate
seasonality
❖ MULTIPLICATIVE
❖ Seasonality is expressed as a
percentage of the average
amount which is then used to
multiply the value of a series in
order to incorporate seasonality
TECHNIQUES FOR SEASONALITY
A furniture manufacturer Period Quarter Sales Quarter Deseasonalized
wants to predict Rela0ve Sales
quarterly demand for a 1 1 132 1.20 110
certain furniture for 2 2 140 1.10 127.27
periods 15 and 16 3 3 146 0.75 194.67
which happens to be 4 4 153 0.95 161.05
the second and third
quarters of a particular 5 1 160 1.20 133.33
y e a r. T h e s e r i e s 6 2 168 1.10 152.73
composed of both trend 7 3 176 0.75 234.67
and seasonality.
8 4 185 0.95 194.74
The trend portion of
demand is projected
using the equation Ft =
124 + 7.5t.
Quarter relatives are
Q1= 1.20 Q2=1.10
Q3=0.75 and Q4 = 0.95
TECHNIQUES FOR SEASONALITY
Use the information to predict demand for periods
15 and 16.

The trend values at t=15 and t= 16 are:

F15 = 124 + 7.5(15) = 236.5

F16= 124 + 7.5(16) = 244.0

Multiplying the trend value by the appropriate

quarter relative yields a
Forecast that includes both trend and seasonality.
Given that t= 15 is a
second quarter and t= 16 is a third quarter, the
forecasts are:

Period 15: 236.5 (1.10) = 260.15

Period 16: 244.0 (0.75) = 183.00
TECHNIQUES FOR SEASONALITY
❖ COMPUTING FOR
SEASONAL RELATIVES
❖ Centered Moving Average Period Demand Three Period
Centered
a commonly used method for
representing the portions of a
Average
time series
1 40
Computation and resulting values 42.67
2 46
are the same as those for a
moving average forecast, but the 3 42
values are not projected in the
forecast . Instead, they are
positioned in the middle of the
periods used to compute the
moving average.

Implies that the average is most

representative of that point in the
series.
TECHNIQUES FOR SEASONALITY
Three-period average is 42.67
As centered average, it is positioned at period 2; the
average is most
representative of the series at that point.

The ratio of demand at period 2 to this centered

average at period 2 is an
estimate of the seasonal relative at that point.

The ratio is 46/42.67= 1.08

The series is about 8% above average at that point.

To achieve a reasonable estimate of seasonality for

any season , it is usually
necessary to compute seasonal ratios for a number of
seasons and hen average
these ratios

e.g Friday attendance at theater, ratios of five for the

Friday relative, average six
for Saturday relative and so on..
 TECHNIQUES FOR CYCLES
❖ Cycles are up-and-down
movements similar to seasonal
variations but of longer
duration.
❖ Explanatory Approach
❖ e.g. When classes starts, sales
of ballpens and pencils tends
to rise up. The higher the
correlation between August
to pencil sales, the better the
chances the
 SIMPLE LINEAR REGRESSION
❖ REGRESSION
❖ a technique for fitting a line to a
set of data points
❖ LINEAR REGRESSION
❖ represents the relationship
between two or more variables
❖ THE GOAL IS TO OBTAIN AN
EQUATION OF A STRAIGHT
LINE THAT MINIMIZES THE
SUM OF SQUARED VERTICAL
DEVIATIONS FROM THE LINE
e.g. least squares method
 SIMPLE LINEAR REGRESSION
❖ Linear Regression Equation

y = a + bx

where:
y = predicted (dependent) variable
x = predicted (independent)
variable
b = slope of the line
a = intercept
 SIMPLE LINEAR REGRESSION
❖ The coefficient a and b of the
line are boased on the
following two equations:
 SIMPLE LINEAR REGRESSION
❖ Plot the data and decide if a UNIT SALES, x PROFITS, y
linear model is reasonable 7 $0.15
2 0.10
❖ Using excel, obtain regression 6 0.13
equation 4 0.15
14 0.25
❖ y = 0.0506 + 0.0159x
15 0.27
❖ If predicted sales is 10, then 16 0.24
profits would be .2099 or 12 0.20
$209,900. 14 0.27
20 0.44
15 0.34
7 0.17
 CORRELATION
❖ Measure the strenght the
direction of relationship
between two variables.
❖ can rage from -1.00 to +1.00
❖ +1.00 indicates a positive
correlation, -1.00 indicates a
negative correlation
 CORRELATION
❖ Correlation is measured by R

❖ where n = total data points, x = independent variable and y =

dependent variable
❖ r2, square of the correlation coefficient measures the percentage of
variability in the values of y that is “explained” by the
independent variable x
SIMPLE LINEAR REGRESSION ASSUMPTIONS

1. Variations around the line are random

2. Deviations around the average value
(the line) should be normally
distributed
3. Predictions are made only within the
range of observed values
4. Always plot the line to verify that a
linear relationship is appropriate
5. Data may be time-dependent, if so use
analysis of time series and use time as
an independent variable in a multiple
regression analysis
6. A small correlation may indicate that
other variables are important.
 MONITORING A FORECAST
❖ Tracking forecast errors and
analyzing them can provide
useful insight into whether
forecasts are performing
satisfactorily.
❖ Sources of forecast errors:
❖ Model may be inadequate
❖ Irregular variations may
have occured
❖ Random variation
 MONITORING A FORECAST
❖ Control charts are useful for identifying the presence of non-
random errors in forecasts

1. Compute the MSE.

2. Estimate of standard deviation of the distribution of errors
s = MSE
3. UCL : 0 + z MSE
4. LCL : 0 − z MSE
where z = Number of standard deviations from the mean
CHOOSING A FORECAST TECHNIQUE

• COST
• ACCURACY
• AVAILABILITY OF
HISTORICAL DATA
• AVAILABILITY OF
FORECASTING SOFTWARE
• TIME NEEDED TO GATHER
AND ANALYZE DATA AND
PREPARE FORECAST
• FORECAST HORIZON
 SEATWORK
❖ GET A ONE WHOLE SHEET OF YELLOW PAD PAPER
❖ ANSWER THE CASE STUDY IN EDMODO