FORECASTING TECHNIQUES

Chapter 16
Qualitative Approaches to Forecasting
Quantitative Approaches to Forecasting
The Components of a Time Series
Using Smoothing Methods in Forecasting
Measures of Forecast Accuracy
Using Trend Projection in Forecasting
Using Regression Analysis in Forecasting

Dr. C. Lightner
Fayetteville State University

Forecasting Introduction
An essential aspect of managing any organization is
planning for the future.
Organizations employ forecasting techniques to
determine future inventory, costs, capacities, and
interest rate changes.
There are two basic approaches to forecasting:
-Qualitative
-Quantitative

Dr. C. Lightner
Fayetteville State University

Qualitative Approaches to Forecasting

Delphi Approach
A panel of experts, each of whom is physically separated from
the others and is anonymous, is asked to respond to a
sequential series of questionnaires.
After each questionnaire, the responses are tabulated and the
information and opinions of the entire group are made known to
each of the other panel members so that they may revise their
previous forecast response.
The process continues until some degree of consensus is
achieved.

Dr. C. Lightner
Fayetteville State University

Qualitative Approaches (continued)

Scenario Writing
Scenario writing consists of developing a conceptual scenario
of the future based on a well defined set of assumptions.
After several different scenarios have been developed, the
decision maker determines which is most likely to occur in the
future and makes decisions accordingly.

Dr. C. Lightner
Fayetteville State University

Qualitative Approaches (continued)

Subjective or Interactive Approaches
These techniques are often used by committees or panels
seeking to develop new ideas or solve complex problems.
They often involve "brainstorming sessions".
It is important in such sessions that any ideas or opinions be
permitted to be presented without regard to its relevancy and
without fear of criticism.

Dr. C. Lightner
Fayetteville State University

Quantitative Approaches to Forecasting

Quantitative methods are based on an analysis of historical data
concerning one or more time series.
A time series is a set of observations measured at successive
points in time or over successive periods of time.
If the historical data used are restricted to past values of the series
that we are trying to forecast, the procedure is called a time series
method.
If the historical data used involve other time series that are believed
to be related to the time series that we are trying to forecast, the
procedure is called a causal method.
Quantitative approaches are generally preferred. In this chapter we
will focus on quantitative approaches to forecasting.
Dr. C. Lightner
Fayetteville State University

Time Series Data

Time Series Data is usually plotted on a graph to
determine the various characteristics or components of
the time series data.
There are 4 Major Components: Trend, Cyclical,
Seasonal, and Irregular Components.

Dr. C. Lightner
Fayetteville State University

Components of a Time Series

The trend component accounts for the gradual shifting
of the time series over a long period of time.
Any regular pattern of sequences of values above and
below the trend line is attributable to the cyclical
component of the series.
The seasonal component of the series accounts for
regular patterns of variability within certain time periods,
such as over a year.
The irregular component of the series is caused by
short-term, unanticipated and non-recurring factors that
affect the values of the time series. One cannot attempt
to predict its impact on the time series in advance.
Dr. C. Lightner
Fayetteville State University

Time Series Data

We will learn the following Forecasting Approaches:
Smoothing
Trend Projections

Dr. C. Lightner
Fayetteville State University

Excel Instructions for Drawing a Scatter Plot

1. Enter data in the Excel spreadsheet.
2. Click on Insert on the toolbar and then click on the Chart tab. The
Chart Wizard will appear. In step 1 on select the XY (scatter) chart
type and then click next.
3. In step 2 specify the cells where your data is located in the data
range box.
4. In step 3 you can give your chart a title and label your axes. In
step 4 specify where you want the chart to be placed.

Dr. C. Lightner
Fayetteville State University

10

Example: Roberts Drugs

During the past ten weeks, sales of cases of Comfort brand
headache medicine at Robert's Drugs have been as follows:
Week Sales
1
110
2
115
3
125
4
120
5
125

Week
6
7
8
9
10

Sales
120
130
115
110
130

Plot this data.

Dr. C. Lightner
Fayetteville State University

11

Plot Roberts Drugs Example

Excel Spreadsheet Showing Input Data. Specify cells A4:B13 as the Data
Range.
A
B
1
2
3
4
5
6
7
8
9
10
11
12
13
14

Robert's Drugs
Week (t )
1
2
3
4
5
6
7
8
9
10
11

Dr. C. Lightner
Fayetteville State University

Salest
110
115
125
120
125
120
130
115
110
130
12

Plot Roberts Drugs Example

I labeled
Roberts Drug
Example as
The Chart title

Robert's Drug Example

135

Sales

130
125
120
115

I labeled
Sales as
My Value (y)
axis

110
105
0

10
Week, t

Dr. C. Lightner
Fayetteville State University

15

I labeled
Week, t as
My Value (x)
axis
13

Smoothing Methods
In cases in which the time series is fairly stable and
has no significant trend, seasonal, or cyclical effects,
one can use smoothing methods to average out the
irregular components of the time series.
Three common smoothing methods are:
Moving average
Weighted moving average
Exponential smoothing

Dr. C. Lightner
Fayetteville State University

14

Smoothing Methods: Moving Average

Moving Average Method
The moving average method consists of computing
an average of the most recent n data values for the
series and using this average for forecasting the value
of the time series for the next period.

Dr. C. Lightner
Fayetteville State University

15

Robert Drugs Example: Moving Average

Our scatter plot for Roberts Drug Sales has no
significant trend, seasonal, or cyclical effects. Thus we
should employ a smoothing technique for forecasting
sales.

Forecast the sales for period 11 using a three period

moving average (MA3).

Dr. C. Lightner
Fayetteville State University

16

Example: Roberts Drugs: Moving Average

Steps to Moving Average Using Excel
Step 1: Select the Tools pull-down menu.
Step 2: Select the Data Analysis option.
Step 3: When the Data Analysis Tools dialog
appears, choose Moving Average.
Step 4: When the Moving Average dialog box
appears:
Enter B4:B13 in the Input Range box.
This specifies
the value of n
Enter 3 in the Interval box.
Enter C5 in the Output Range box.
This is the column
following our data,
and one row below where Select OK.
our data begins.
Dr. C. Lightner
Fayetteville State University

17

Roberts Drugs: Moving Average

MA3 (Three period Moving average) for Roberts Drug Example
Ft is the forecast for week t.

Robert's Drug
Week (t )
1
2
3
4
5
6
7
8
9
10
11

Yt
110
115
125
120
125
120
130
115
110
130

n=3
Ft
#N/A
#N/A
116.6667
120
123.3333
121.6667
125
121.6667
118.3333
118.3333

F4 (forecast for week 4)=116.7

F11 (forecast for week 11)=118.3

Thus we would forecast the sales

for Week 11 to be 118.3

Dr. C. Lightner
Fayetteville State University

18

Smoothing Methods: Weighted Moving Average

Weighted Moving Average Method
The weighted moving average method consists of computing a
weighted average of the most recent n data values for the series
and using this weighted average for forecasting the value of the
time series for the next period. The more recent observations are
typically given more weight than older observations. For
convenience, the weights usually sum to 1.
The regular moving average gives equal weight to past data values
when computing a forecast for the next period. The weighted
moving average allows different weights to be allocated to past
data values.
There is no Excel command for computing this so you must do this
manually. You can either manually enter the formulas into excel
and apply to all periods or compute value by hand.
Dr. C. Lightner
Fayetteville State University

19

Smoothing Methods: Weighted Moving Average

Use a 3 period weighted moving average to forecast the sales for
week 11 giving a weight of 0.6 to the most recent period, 0.3 to the
second most recent period, and 0.1 to the third most recent period.
F11 = (0.6)*130 + (0.3)*110 + (0.1)* 115= 122.5
Sales for the
most recent
period

Sales for 2nd

most recent
period

Sales for 3rd

most recent
period

Thus we would forecast the sales for week 11 to be 122.5.

Dr. C. Lightner
Fayetteville State University

20

Smoothing Methods: Exponential Smoothing

Exponential Smoothing
Using exponential smoothing, the forecast for the next period
is equal to the forecast for the current period plus a
proportion () of the forecast error in the current period.

Using exponential smoothing, the forecast is calculated by:

This is the same as
Ft+1= Yt + (1- )Ft
Ft+1 = Ft + (Yt Ft)

where:
is the smoothing constant (a number between 0 and 1)
Ft is the forecast for period t
Ft +1 is the forecast for period t+1
Yt is the actual data value for period t
Dr. C. Lightner
Fayetteville State University

21

Roberts Drugs: Exponential Smoothing

Forecast the sales for period 11 using Exponential
Smoothing = 0.1.

Dr. C. Lightner
Fayetteville State University

22

Roberts Drugs: Exponential Smoothing

Steps to Exponential Smoothing Using Excel
Step 1: Select the Tools pull-down menu.
Step 2: Select the Data Analysis option.
Step 3: When the Data Analysis Tools dialog
appears, choose Exponential Smoothing.
Step 4: When the Exponential Smoothing dialog box
appears:
Enter B4:B13 in the Input Range box.
Enter 0.9 (for = 0.1) in Damping Factor box.
Damping factor
is always 1-
Enter C4 in the Output Range box.
Select OK.

Dr. C. Lightner
Fayetteville State University

23

Roberts Drugs: Exponential Smoothing

Robert's Drugs
=0.1
Week (t )
1
2
3
4
5
6
7
8
9
10
11

Thus we would
forecast sales for
week 11 to be 116.87

Salest
110
115
125
120
125
120
130
115
110
130

Ft
#N/A
110
110.5
111.95
112.755
113.9795
114.5816
116.1234
116.0111
115.4099

F11 = 0.1 * Y10 + .9 F10

= .1 *130 + .9 * 115.4099
= 116.87
Dr. C. Lightner
Fayetteville State University

24

Questions That You Should Be Asking

For the Moving Average technique, how do I determine the best
value of n to use for forecasting?
For Exponential Smoothing, how do I determine the best value of
to use?
If I realize that a smoothing technique should be employed, how do
you know which smoothing technique is best?
In order to answer the above questions, we need criteria for
judging the accuracy of a forecasting technique. Once we select a
criterion, the method (or parameter) which provides the best value
for our criterion is the best method (or parameter) to use for
forecasting our scenario.

Dr. C. Lightner
Fayetteville State University

25

Measures of Forecast Accuracy

Mean Squared Error (MSE)
The average of the squared forecast errors for the historical
data is calculated. The forecasting method or parameter(s) which
minimize this mean squared error is then selected.
Mean Absolute Deviation (MAD)
The mean of the absolute values of all forecast errors is
calculated, and the forecasting method or parameter(s) which
minimize this measure is selected. The mean absolute deviation
measure is less sensitive to individual large forecast errors than the
mean squared error measure.
You may choose either of the above criteria for evaluating the
accuracy of a method (or parameter).
Dr. C. Lightner
Fayetteville State University

26

Selecting the best Smoothing Technique for Roberts Drugs

Determine the smoothing technique that is best for forecasting
Roberts Drug sales: A two period moving average, a three period
moving average, exponential smoothing (=0.1), or exponential
smoothing (=0.2)

Realistically we should have experimented with more values of n

for the moving average, and for exponential smoothing to
determine the absolute best parameters to use for our technique.
On the next slide we randomly chose to use the MSE criterion to
judge the best technique.

Dr. C. Lightner
Fayetteville State University

27

Roberts Drugs :Comparing Smoothing Techniques

Double click on the Excel sheet below to enter actual Excel spreadsheet
that I created. Clicking on individual cells will provide the formulas that were
entered to compute the observed values.
Robert's Drug
Sales
Week (t )

Yt

1
2
3
4
5
6
7
8
9
10
11

110
115
125
120
125
120
130
115
110
130

n=2

Error

Ft

(Yt - Ft) (Yt - Ft)

#N/A
112.5
120
122.5
122.5
122.5
125
122.5
112.5
120

12.5
0
2.5
-2.5
7.5
-10
-12.5
17.5
MSE

Dr. C. Lightner
Fayetteville State University

MSE for MA2

156.25
0
6.25
6.25
56.25
100
156.25
306.25
98.4375
28

Roberts Drugs :Comparing Smoothing Techniques

Robert's Drug
Sales
Week (t )

Yt

1
2
3
4
5
6
7
8
9
10
11

110
115
125
120
125
120
130
115
110
130

n=3

Error

Ft

(Yt - Ft) (Yt - Ft)

#N/A
#N/A
116.6667 3.333333 11.11111
120
5
25
123.3333 -3.33333 11.11111
121.6667 8.333333 69.44444
125
-10
100
121.6667 -11.6667 136.1111
118.3333 11.66667 136.1111
118.3333
MSE
69.84127

Dr. C. Lightner
Fayetteville State University

MSE for MA3

29

Roberts Drugs :Comparing Smoothing Techniques

Sales
Week (t )

Yt

1
2
3
4
5
6
7
8
9
10
11

110
115
125
120
125
120
130
115
110
130

=0.1
Ft

Error
(Yt - Ft) (Yt - Ft)2

#N/A
110
5
25
110.5
14.5
210.25
111.95
8.05 64.8025
112.755
12.245
149.94
113.9795
6.0205 36.24642
114.5816 15.41845 237.7286
116.1234
-1.1234 1.262016
116.0111 -6.01106 36.13279
115.4099 14.59005 212.8696
MSE

Dr. C. Lightner
Fayetteville State University

MSE for Exponential

Smoothing =0.1

108.248

30

Roberts Drugs :Comparing Smoothing Techniques

Sales
Week (t )

Yt

1
2
3
4
5
6
7
8
9
10
11

110
115
125
120
125
120
130
115
110
130

=0.2
Ft

Error
(Yt - Ft) (Yt - Ft)2

#N/A
110
5
111
14
113.8
6.2
115.04
9.96
117.032
2.968
117.6256 12.3744
120.1005 -5.10048
119.0804 -9.08038
117.2643 12.73569
MSE

25
196
38.44
99.2016
8.809024
153.1258
26.0149
82.45337
162.1979

MSE for Exponential

Smoothing =0.2

87.91584

Dr. C. Lightner
Fayetteville State University

31

Roberts Drugs :Comparing Smoothing Techniques

Since the three period moving average technique
(MA3) provides to lowest MSE value, this is the best
smoothing technique to use for forecasting Roberts
Drug Sales.

Dr. C. Lightner
Fayetteville State University

32

Trend Projection
If a time series exhibits a linear trend, the method of least
squares may be used to determine a trend line (projection) for
future forecasts.
Least squares, also used in regression analysis, determines the
unique trend line forecast which minimizes the mean square
error between the trend line forecasts and the actual observed
values for the time series.
The independent variable is the time period and the dependent
variable is the actual observed value in the time series.

Dr. C. Lightner
Fayetteville State University

33

Trend Projection
Using the method of least squares, the formula for the trend
projection is:
Yt = b0 + b1t.
where:

Yt = trend forecast for time period t

b1 = slope of the trend line
b0 = trend line projection for time 0

b1 = n tYt - t Yt

b0 Y b1 t

nt 2 - (t )2
where: Yt = observed value of the time series at time period t
t

Y = average of the observed values for Yt

tt

= average time period for the n observations

Dr. C. Lightner
Fayetteville State University

34

Example: Augers Plumbing Service

The number of plumbing repair jobs performed by Auger's Plumbing
Service in each of the last nine months are listed below.

Month Jobs
March 353
April
387
May
342

Month Jobs
June
374
July
396
August 409

Month
September
October
November

Jobs
399
412
408

Forecast the number of repair jobs Auger's will perform in

December using the least squares method.

Dr. C. Lightner
Fayetteville State University

35

Augers Plumbing Service: Trend Projection

Trend Projection
(month) t

(Mar.)
(Apr.)
(May)
(June)
(July)
(Aug.)
(Sep.)
(Oct.)
(Nov.)
Sum

1
2
3
4
5
6
7
8
9
45

Yt

tYt

t2

353
387
342
374
396
409
399
412
408
3480

353
774
1026
1496
1980
2454
2793
3296
3672
17844

1
4
9
16
25
36
49
64
81
285

Dr. C. Lightner
Fayetteville State University

36

Example: Augers Plumbing Service

Trend Projection (continued)

t t = 45/9 = 5

Y = 3480/9 = 386.667

ntYt - t Yt
b1 =
=
n t 2 - ( t)2

b0 Y b1 t

(9)(17844) - (45)(3480)
= 7.4
(9)(285) - (45)2

= 386.667 - 7.4(5) = 349.667

Thus our trend line is Yt = 349.667 + 7.4 t.

Y10 = 349.667 + (7.4)(10) = 423.667
For December t=10

Dr. C. Lightner
Fayetteville State University

37

Augers Plumbing Service: Trend Line in Excel

Excel Spreadsheet Showing Input Data
A
B
C
1
Auger's Plumbing Service
2
3
Month
Calls
4
1
353
5
2
387
6
3
342
7
4
374
8
5
396
9
6
409
10
7
399
11
8
412
12
9
408
13
Dr. C. Lightner
Fayetteville State University

38

Example: Augers Plumbing Service

Steps to Trend Projection Using Excel
Step 1: Select an empty cell (B13) in the worksheet.
Step 2: Select the Insert pull-down menu.
Step 3: Choose the Function option.
Step 4: When the Select Category dialog box appears:
Choose Statistical in Function Category box.
Choose Forecast in the Function Name box.
Select OK.
Step 5: When the Forecast dialog box appears:
Enter 10 in the x box (for month 10).
Enter B4:B12 in the Known ys box.
Enter A4:A12 in the Known xs box.
Select OK.
Dr. C. Lightner
Fayetteville State University

39

Example: Augers Plumbing Service

Spreadsheet Showing Trend Projection for Month 10
Auger's Plumbing Service
Month
1
2
3
4
5
6
7
8
9
10

Calls
353
387
342
374
396
409
399
412
408
423.667

Dr. C. Lightner
Fayetteville State University

Projected
40

Roberts Drug Example

Suppose we neglected to plot Roberts Drug example, and therefore we
do not know that a trend does not exist. Use trend analysis to forecast
the sales for month 11.

Week (t )

Yt

1
2
3
4
5
6
7
8
9
10
11

110
115
125
120
125
120
130
115
110
130
124

Forecast

Dr. C. Lightner
Fayetteville State University

41

Question????
How could we use the MSE or MAD to verify that the
MA3 is a better smoothing technique than trend analysis
for Roberts Drug Sales data?

Dr. C. Lightner
Fayetteville State University

42

Causal Method: Regression Analysis

Regression Analysis is similar to trend analysis, except
the independent variable is not restricted to time. Refer
to Roberts Drug example. Instead of letting time
represent our independent variable, we could forecast
sales based upon the price of the product. Since
products often go on sale, we could collect data over
several months collecting the weekly price and number
of items sold for the week. For this model, we would
find the regression equation in the same manner in
which we found the trend line except we would call the
independent variable x, instead of t.

Dr. C. Lightner
Fayetteville State University

43

Regression Equation
Using the method of least squares, the formula for the regression
line is:
Y = b0 + b1x.
where:

Y= dependent variable which depends on the value of x

b1 = slope of the regression line
b0 = regression line projection for x= 0

b1 = n XiYi - Xi Yi

b0 y b1 x

nXi2 - (Xi)2
where: Yt = observed value of the time series at time period t
t

Y = average of the observed values for Yt

tt

= average time period for the n observations

Dr. C. Lightner
Fayetteville State University

44

Regression Analysis in Excel

The dependent variable Y can predicted using the
same forecast function in Excel as used to forecast a
trend line. Follow the same steps provided on slide 39.

Dr. C. Lightner
Fayetteville State University

45

THE END

See your textbook for more

examples and detailed explanations
of all topics discussed in these notes.

Dr. C. Lightner
Fayetteville State University

46