FORECASTING

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 Process of predicting a future
event

What is
Forecasting? Production
Underlying basis of Inventory
all business Personnel
decisions Facilities

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 Forecasting Time Horizons
Short-range forecast
Up to 1 year, generally less than 3
months
Purchasing, job scheduling,
workforce levels, job assignments,
production levels
Medium-range forecast
3 months to 3 years
Sales and production planning,
budgeting
Long-range forecast
3+ years
New product planning, facility
location, research and development
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Influence of Product
Life Cycle
• Introduction and growth require longer forecasts
than maturity and decline
• As product passes through life cycle, forecasts are
useful in projecting
• Staffing levels
• Inventory levels
• Factory capacity

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 Economic forecasts

• Address business cycle – inflation rate,

money supply, housing starts, etc.

Technological forecasts
Types of
• Predict rate of technological progress
Forecasts • Impacts development of new products

Demand forecasts

• Predict sales of existing products and

services

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Seven Steps in
Forecasting
1. Determine the use of the forecast
2. Select the items to be forecasted
3. Determine the time horizon of the
forecast
4. Select the forecasting model(s)
5. Gather the data
6. Make the forecast
7. Validate and implement results

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 THE REALITIES!

Most techniques
Forecasts are assume an
seldom perfect underlying stability
in the system

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Forecasting
Approaches
Qualitative Methods
• Used when situation is vague and little
data exist
• New products
• New technology
• Involves intuition, experience
• e.g., forecasting sales on internet

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 Quantitative Methods

Used when situation is ‘stable’ and

Forecasting historical data exist
Approaches • Existing products
• Current technology

Involves mathematical techniques

• e.g., forecasting sales of colour televisions

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 Jury of executive opinion

Overview of • Pool opinions of high-level experts, sometimes

augment by statistical models

Qualitative Delphi method

Methods
Panel of experts, queried iteratively

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Time-Series Components

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TREND
COMPONENT

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SEASONAL
COMPONENT

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RANDOM
COMPONEN
T

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Overview of Quantitative Approaches

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Naive Approach

• Assumes demand in next period is the

same as demand in most recent period
• e.g., If January sales were 68, then
February sales will be 68
• Sometimes cost effective and efficient
• Can be good starting point

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METHOD OF
SEMI AVERAGE

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METHOD
OF SEMI
AVERAGE

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METHOD
OF SEMI
AVERAGE

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METHOD OF MOVING AVERAGES

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3 yearly moving average

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3 yearly
moving average

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3 yearly
moving average

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3 yearly
moving average

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4 yearly
moving average

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4 yearly
moving average

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 Form of weighted moving average
Most recent data weighted
Weights decline exponentially
most

Exponential Requires smoothing constant (α)

Smoothing Ranges from 0 to 1 Subjectively chosen

Involves little record keeping of past data

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EXPONENTIAL
SMOOTHING
EXAMPLE
• After observing the demand Dt+1, for period t+1
• Lt is the best guess at period t of what the systematic
demand level
Example You’re organizing an international meeting.
You want to forecast attendance for 1999 using
exponential smoothing (α= 0.10).
1994 Forecast: 175.
• 1994 ACTUAL : 180
• 1995 ACTUAL: 168
• 1996 ACTUAL : 159
• 1997 ACTUAL: 175
• 1998 ACTUAL: 190

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EXPONENTIAL SMOOTHING EXAMPLE

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Three
Common
Measures
of Error

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Mean Absolute
Deviation (MAD)
• The Mean Absolute Deviation (MAD) is
the sum of absolute differences between
the actual value and the forecast divided by
the number of observations. MAD is the
same as MAE, Mean Absolute Error.

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Mean square error
(MSE)
• Mean square error (MSE) is probably the
most commonly used error metric. It
penalizes larger errors because squaring
larger numbers has a greater impact than
squaring smaller numbers. The MSE is the
sum of the squared errors divided by the
number of observations.

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The Root Mean
Square Error
(RMSE)
• The Root Mean Square Error
(RMSE) is the square root of the MSE.
RMSE is used to convert MSE back into
the same units as the actual data.

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Mean Absolute
Percentage Error
(MAPE)
• Mean Absolute Percentage Error
(MAPE) is the average of absolute errors
divided by actual observation values

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Three Common Measures of Error

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Determining the Mean Absolute Deviation
(MAD)

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Determining the Mean Square Error
(MSE)

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A MAPE greater than
10% but less than 25%
indicates low, but
acceptable accuracy
and MAPE greater than
25% is very low
accuracy, so low that
the forecast is not
acceptable in terms of
its accuracy.

https://www.forecastpro.com/Trends/forecasting101August201
1.html

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Correlation

Correlation is a statistical tool that helps to

measure and analyze the degree of
relationship between two variables.

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TYPES OF
CORRELATION
• Positive Correlation: The correlation is said
to be positive correlation if the values of
two variables changing with same
direction.
As X is increasing, Y is increasing
As X is decreasing, Y is decreasing
E.g., As height increases, so does weight.
• Negative Correlation: The correlation is
said to be negative correlation when the
values of variables change with opposite
direction. Ex. Price & qty. demanded.

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METHODS
OF
CORRELATI
ON
KARL PEARSON
COEFFICIENT
OF
CORRELATION

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KARL
PEARSON
COEFFICIENT
OF
CORRELATIO
N

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REGRESSION

Regression Analysis is a very powerful tool

in the field of statistical analysis in
predicting the value of one variable, given
the value of another variable, when those
variables are related to each other.

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LEAST SQUARE REGRESSION

Line of Best Fit

Our aim is to calculate the values m (slope) and b (y-intercept) in the equation of a line :
y = mx + b
Where:
y = dependent variable
x = independent variable
m = Slope
b = the Y Intercept (where the line crosses the Y axis)

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Coefficient of
Determination
Coefficient of Determination, r2, measures
the percent of change in y predicted by the
change in x
• Values range from 0 to 1
• Easy to interpret
For the Nodel Construction example:
r = .901
r2 = .81

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THANK YOU

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