knowledge skills technology innoventures

Session 8
Quantitative Methods 1

 Topics to be covered in this session:

 Time Series Forecasting

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 Why do we need to forecast
 It is important in business to know the possible
values of the key decision variables
 To order inventory, we need to know the future
sales
 To make investment, have an idea of future profits
 Forecasting is used to
 Create plans of action
 Monitor the continuing progress of action plans
 Providing a warning system of critical factors
to be monitored regularly

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 Timing of Forecasts
 Short-Range Forecasts:
 Time Span ≤ 1 Year; Typically less than 3 months
 E.g.: Used in job scheduling, workforce levels,
job assignments
 Medium Range Forecasts:
 >1 Year, ≤ 3 Years; Typically 3 months to 1 Year
 E.g.: Sales Planning, Production Planning, Cash
Budgeting
 Long Range Forecasts:
 ≥ 3 Years
 Design and installation of new plants, Facility
Location, Capital Expenditure, Research and
Development
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 Timing of Forecasts: Note
 Medium and Long Range Forecasts support
management decisions regarding macro issues like
development of new products, plants and
processes
 Mathematical Techniques such as Moving
Averages, Exponential Smoothing and Trend
Extrapolation are used for Short Range Forecasts
 Short Range Forecasts tend to be more accurate
than Medium and Long Range Forecasts

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 Quantitative Forecasting Methods
 Quantitative Forecasting Methods are used when
 Past data about criterion variable is available
 Data is quantifiable
 Assumption: Pattern of the past will continue
 Time Series Forecasting Methods: Data wrt the
variable is gathered over a period of time; Works by
examining patterns, cycles, trends
 Causal Forecasting Methods: Based on the
assumption that the variable being forecasted has a
cause effect relationship with one or more variables

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 Steps of Forecasting
 Define objectives and policies to be achieved
 Select the variable(s) of interest
 Determine the time horizon: Short, Medium, Long
Term
 Select an Appropriate Forecasting Model
 Collect relevant primary data
 Make the forecast
 Implement the results

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Time Series Analysis

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 Assumptions & Objectives of Time Series Analysis
 Assumption:
 There is an underlying pattern in the historical
data
 This pattern continues with time
 Objective:
 Understand the said pattern
 Isolate the influencing factors
 E.g.: Progress of 5 Year Plan is judged by annual
growth rates in the Gross National Product (GNP)
 Actual Value of Variable at time t = Mean Value of
Variable at time t + Random Deviation of the
variable from the Mean Value of the Variable at
time t
 y = Pattern + e
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Component of Time Series

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COMPONENTS OF TIME SERIES

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 Time Series Decomposition Models
 To analyze a Time Series
 Identify the various factors that produce variation
 Isolate, analyze and measure the effect of these factors
 Decomposition is breaking the Time Series into 4
components
 Trend (T)
 Cyclical (C)
 Seasonal (S)
 Irregularity (I)

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Example (1): Fit a Trend Line to the Following

Method using the Freehand Method
Year 1997 1998 1999 2000 2001 2002 2003 2004
Sales
Turnover 80 90 92 83 94 99 92 104
(Rs Lakh)

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 Smoothing Methods
 They smoothen out the random variations due to
irregular component
 And provide an overall impression of the pattern
of data
 Important smoothing methods are:
 Moving averages
 Exponential Smoothing

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 Moving Averages

 Enables us to focus on long term trends and cyclic

movements without obscuring the effect of short term
noise
 Accuracy of this method is directly proportionally to n
 It is difficult to choose the optimal length of time for
which the moving average is to be found

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Example (2): Shown is the production volume (in ‘000 tonnes) for a
product. Compute a 3 year moving average and thus, determine trend
and short term error

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Example (2): Shown is the production volume (in ‘000 tonnes) for a product.
Compute a 3 year moving average and thus, determine trend and short term
error

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 Weighted Moving Averages

= Weighted Moving Average

 A moving average where each time period is

weighted differently
 There is a possibility of loss of information
 Choice of weights: Mostly judgmental; there is no set
of rules to determine them
 Mostly, weights are increased for current time and
decreased for earlier times
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Example (3): A food processor uses a moving average to forecast next

month’s demand. Past actual demand (in units is shown below. (a)
Compute a simple 5 month moving average to forecast demand for
month 52 (b) Compute a weighted 3 month moving average where the
weights are highest for the latest months and descend in order of 3, 2, 1

Month Actual Demand

43 105
44 106
45 110
46 110
47 114
48 121
49 130
50 128
51 137
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(a) Compute a simple 5 month moving average to forecast demand for

month 52

Thus, projected demand for month 52 is 126 units

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(b) Compute a weighted 3 month moving average where the weights are
highest for the latest months and descend in order of 3, 2, 1

Actual
Weighted 3 Thus, projected
Month
Demand
month demand for
average month 52 is 133
43 105 units
44 106
45 110 107.83
46 110 109.33
47 114 112.00
48 121 116.83
49 130 124.33
50 128 127.50
51 137 132.83
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 Semi Averages
 Gives us an estimate of the slope and intercept of the
Trend Line
 Divide data into 2 parts and compute arithmetic
means
 Plot the points and join
 Trend Line: ŷ = a + bx
 Arithmetic Mean of the 1st Part is the intercept value
 Slope = Ratio (Difference of Arithmetic Means,
Number of Years between them)

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Example (4): Fit a trend line to the data by the method of

semi averages and forecast for the year 2002
Sales of Division
Firm (in of Data (# Semi
Year (x)
thousand of years is Averages
units) odd)
1993 102
1994 105 A 107
1995 114
1996 110
1997 108
1998 116 B 112
1999 112

Intercept = a = 107 at 1994; Slope = b = change in sales/

change in year = (112-107)/ (1998-1994) = 5/4 = 1.25
→ Trend Line is ŷ = 107 + 1.25 x
Thus forecastes sales (in thousand units) = 107 + (1.25x(2002-
1994)) = 117

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 Simple Exponential Smoothing
 Ft+1 = α Xt + (1-α) Ft
 Ft+1 = Forecast for the next time period t+1
 Ft is the forecast for the present time period t
 α is a weight called the Exponential Smoothing
Constant
 Xt is the Actual Value for the present time period t
 0≤α≤1

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Example 5: A firm uses simple exponential

smoothing with α = 0.1 to forecast demand
(weekly). The forecast of February 1 was 500 units
whereas actual demand turned out to be 450
units. Forecast the demand for the week of Feb 8

Ft = Ft-1 + α(Dt-1 – Ft-1)

= 500 + 0.1(450-500)
= 495

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 Concept of Seasonal Index
Year Quarter
I II III IV Total
1 122 108 83 90 401
2 130 100 73 96 399
3 132 98 71 99 400
Average 128 102 75 95 400

Seasonal Index = period average demand / average demand for all

periods
Average Quartly Demand = 100

Seasonal Index = 128/100 = 1.28 ( Quarter – I)

= 102/100 = 1.02 ( Quarter – II)
= 75/100 = 0.75( Quarter –III)
= 95/100 = 0.95 ( Quarter – IV)

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 Seasonal Forecasts
Seasonal demand = Seasonal Index x Average Demand

Suppose in earlier problem the company forecasts the annual demand next
Year to be 420. Then average quarter demand will be 105

1st Quarter Forecast = 105 x 1.28 = 134.4

2nd Quarter Forecast = 1.02 x 105 = 107.1
3rd Quarter Forecast = 0.75 x 105 = 78.75
4th Quarter Forecast = 0.95 x 105 = 99.75
Total Forecast Demand = 420 units

Deseasonalized demand = actual seasonal demand/ seasonal index

A company selling tennis raquets has a Jan demand of 5200 units and a
June demand of 24000 . If the seasonal index for Jan is 0.5 and Jun is 2.5 , find
Out how they compare ?
Deseasonalised Jan demand = 5200/0.5 = 10400
Deseasonalised Jun demand = 24000/2.5 = 9600

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 Example

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 Example -2

b= ∑ Xy/ ∑x2
𝑌 = 𝑎 + 𝑏𝑋
= 1266/168 = 7.536 𝑌 = 139.25 + 7.536 𝑋
𝑌 1984 = 139.25 + 7.536 𝑋9
and a = 𝑦 = 139.25
= 207

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 Example

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 Finding Seasonal Index
Year I II III IV
1979 - - 56.7 115.2
1980 96 127.0 62.5 107.5
1981 96.5 129.7 68.4 115.0
1982 89.5 134.2 59.1 111.3
1983 92.9 128.4 - -
Modified Means I = 186.9/2 = 94.45
II = 258.1/2 = 129.05
III = 121.6/2 = 60.80
IV = 226.3/2 = 113.15
= 397.45
Adjusting Factor = 400/397.45 = 1.0064
I 94.45 X 1.0064 = 95.1
II 129.05 X 1.0064 = 129.9
III 60.80 X 1.0064 = 61.20
IV 113.15 X 1.0064 = 113.9

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 Example (Con’td)

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 Example

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 Example (Con’td)
𝑌 = 𝑎 + 𝑏𝑋 = 18 + 0.16 𝑥

Forecasted value of 1984 –III

It is 3 quarters past 1984 IV having coded value of

19. Thus adding 2 to every quarter we get the
value 25

From equation – 18 + 0.16 x 25 = 22

Seasonalizing the value = 22 x 61.20/100 = 13.5

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 Example

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 Sec A

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 Sec B

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 Sec C

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Time Series Decomposition Model: Multiplicative Model

 Used when the effect of C, S, I is measured in the
relative sense and not in the absolute sense
 Also, the Geometric Mean of C, S, I ≤ 1
 E.g.: Actual Sales in 20 months = 423.36
 T = Mean Sales = 400
 Effect of current cycle, which decreases sales by
10% is C = 0.9
 Seasonality of the Series, that increases sales by
20% is S = 1.2
 A random Factor decreases sales by 2% → I =
0.98
 Thus, 400x0.9x1.2x0.98 = 423.36
 Model is Y = T x C x S x I
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Time Series Decomposition Model: Additive

 Used when the effect of C, S, I are absolute quantities
 T, C, S, I are independent of each other
 Model is Y = T + C + S + I

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THANK YOU…

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