Course

Year

: Quantitative Methods
: 2013

Forecasting
Session 3

Outline Todays
Forecasting Approaches
Overview of Qualitative Methods
Overview of Quantitative Methods
Time-Series Forecasting
Decomposition of a Time Series
Naive Approach
Moving Averages
Exponential Smoothing
Exponential Smoothing with Trend
Adjustment
Trend Projections
Seasonal Variations in Data
Cyclical Variations in Data

What is Forecasting?
Process of predicting a
future event
Underlying basis of
all business decisions
Production
Inventory
Personnel
Facilities

??

Seven Steps in Forecasting

Determine the use of the forecast

Select the items to be forecasted
Determine the time horizon of the forecast
Select the forecasting model(s)
Gather the data
Make the forecast
Validate and implement results

Time Series Components

Trend

Cyclical

Seasonal

Random

Demand for product or service

Components of Demand
Trend
component
Seasonal peaks
Actual
demand

|
1

Average
demand over
four years

Random
variation
|
2

|
3
Year

|
4

Trend Component
Persistent, overall upward or downward
pattern
Changes due to population, technology,
age, culture, etc.
Typically several years duration

Seasonal Component
Regular pattern of up and down
fluctuations
Due to weather, customs, etc.
Occurs within a single year
Period
Week
Month
Month
Year

Length
Day
7
Week
4-4.5
Day
28-31
Quarter

Number of
Seasons

Cyclical Component
Repeating up and down movements
Affected by business cycle, political, and
economic factors
Multiple years duration
Often causal or
associative
relationships

10

15

20

Random Component
Erratic, unsystematic, residual
fluctuations
Due to random variation or unforeseen
events
Short duration and
nonrepeating

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

Moving Average Method

MA is a series of arithmetic means
Used if little or no trend
Used often for smoothing
Provides overall impression of data over
time
demand in previous n periods
Moving average =
n

Moving Average Example

Month
January
February
March
April
May
June
July

Actual
Shed Sales
10
10
12
12
13
13
16
19
23
26

3-Month
Moving Average

(10 + 12 + 13)/3 = 11 2/3

(12 + 13 + 16)/3 = 13 2/3
(13 + 16 + 19)/3 = 16
(16 + 19 + 23)/3 = 19 1/3

Shed Sales

Graph of Moving Average

30
28
26
24
22
20
18
16
14
12
10

Moving
Average
Forecast
Actual
Sales

|
J

|
F

|
M

|
A

|
M

|
J

|
J

|
A

|
S

|
O

|
N

|
D

Weighted Moving Average

Used when trend is present
Older data usually less important
Weights based on experience and intuition

Weighted
moving average

(weight for period n)

x (demand in period n)
=
weights

Weighted

Month
January
February
March
April
May
June
July

Weights Applied
Period
3
Last month
2
Two months ago
1 Average
Three months ago
Moving
6
Sum of weights

Actual
Shed Sales
10
10
12
12
13
13
16
19
23
26

3-Month Weighted
Moving Average

[(3 x 13) + (2 x 12) + (10)]/6 = 121/6

[(3 x 16) + (2 x 13) + (12)]/6 = 141/3
[(3 x 19) + (2 x 16) + (13)]/6 = 17
[(3 x 23) + (2 x 19) + (16)]/6 = 201/2

Potential Problems With

Moving Average
Increasing n smooths the forecast but
makes it less sensitive to changes
Do not forecast trends well
Require extensive historical data

Moving Average And

Weighted Moving Average
30

Sales demand

25
20

Weighted
moving
average

Actual
sales

15

Moving
average

10
5
|
J

|
F

|
M

|
A

|
M

|
J

|
J

|
A

|
S

|
O

|
N

|
D

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

Requires smoothing constant ()

Ranges from 0 to 1
Subjectively chosen

Involves little record keeping of past data

Exponential Smoothing
=

Last periods forecast

+ (Last periods actual demand
Last periods forecast)

where

Ft = Ft 1 + (At 1 - Ft
1)
Ft = new forecast

Ft 1 = previous forecast
= smoothing (or weighting)
constant (0 1)

Exponential Smoothing Example

Predicted demand = 142 Ford Mustangs

Actual demand = 153
Smoothing constant a = .20

Exponential Smoothing Example

Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant a = .20

New forecast

= 142 + .2(153 142)

Exponential Smoothing Example

Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant a = .20
New forecast

= 142 + .2(153 142)

= 142 + 2.2
= 144.2 144 cars

Common Measures of Error

Mean Absolute Deviation (MAD)
|Actual - Forecast|
MAD =
n
Mean Squared Error (MSE)
(Forecast Errors)2
MSE =
n

Common Measures of Error

Mean Absolute Percent Error (MAPE)
n

MAPE =

100|Actuali - Forecasti|/Actuali

i=1

Exponential Smoothing with Trend

Adjustment
When a trend is present, exponential
smoothing must be modified
Forecast
Exponentially
including (FITsmoothed
(Ft) +
t) =
trend
forecast

Exponentially
(Tt) smoothed
trend

Exponential Smoothing with Trend

Adjustment
Ft = a(At - 1) + (1 - a)(Ft - 1 + Tt - 1)
Tt = b(Ft - Ft - 1) + (1 - b)Tt - 1
Step 1: Compute Ft
Step 2: Compute Tt
Step 3: Calculate the forecast FITt = Ft + Tt

Exponential Smoothing with Trend

Adjustment Example
Actual
Month(t) Demand (At)
1
2
3
4
5
6
7
8
9
10

12
17
20
19
24
21
31
28
36

Smoothed
Forecast, Ft

Smoothed
Trend, Tt

Forecast
Including
Trend, FITt

11

13.00

Exponential Smoothing with Trend

Adjustment Example
Actual
Month(t) Demand (At)
1
2
3
4
5
6
7
8
9
10
Table 4.1

12
17
20
19
24
21
31
28
36

Smoothed
Forecast, Ft

Smoothed
Trend, Tt

Forecast
Including
Trend, FITt

11

13.00

Step 1: Forecast for Month 2

F2 = A1 + (1 - )(F1 + T1)
F2 = (.2)(12) + (1 - .2)(11 + 2)
= 2.4 + 10.4 = 12.8 units

Exponential Smoothing with

Trend Adjustment Example
Actual
Month(t) Demand (At)
1
2
3
4
5
6
7
8
9
10

12
17
20
19
24
21
31
28
36

Smoothed
Forecast, Ft

Smoothed
Trend, Tt

Forecast
Including
Trend, FITt

11
12.80

13.00

Step 2: Trend for Month 2

T2 = (F2 - F1) + (1 - )T1
T2 = (.4)(12.8 - 11) + (1 - .4)(2)
= .72 + 1.2 = 1.92 units

Exponential Smoothing with Trend

Adjustment Example
Actual
Month(t) Demand (At)
1
2
3
4
5
6
7
8
9
10

12
17
20
19
24
21
31
28
36

Smoothed
Forecast, Ft

Smoothed
Trend, Tt

11
12.80

2
1.92

Forecast
Including
Trend, FITt

Step 3: Calculate FIT for Month 2

FIT2

= F2 + T1

FIT2

= 12.8 + 1.92
= 14.72 units

13.00

Exponential Smoothing with Trend

Adjustment Example
Actual
Month(t) Demand (At)
1
2
3
4
5
6
7
8
9
10

12
17
20
19
24
21
31
28
36

Smoothed
Forecast, Ft

Smoothed
Trend, Tt

Forecast
Including
Trend, FITt

11
12.80
15.18
17.82
19.91
22.51
24.11
27.14
29.28
32.48

2
1.92
2.10
2.32
2.23
2.38
2.07
2.45
2.32
2.68

13.00
14.72
17.28
20.14
22.14
24.89
26.18
29.59
31.60
35.16

Exponential Smoothing with Trend

Adjustment Example
35

Product demand

30 Actual demand (At)

25
20
15

Forecast including trend (FITt)

with = .2 and = .4

10
5
0

|
1

|
2

|
3

|
4

|
5

|
6

Time (month)

|
7

|
8

|
9

Trend Projections
Fitting a trend line to historical data points to
project into the medium to long-range
Linear trends can be found using the least squares
technique
y^= a + bx
^

where y = computed value of the

variable to be predicted (dependent
variable)
a = y-axis intercept
b = slope of the regression line
x = the independent variable

Values of Dependent Variable

Least Squares Method

Actual observation
(y value)

Deviation7

Deviation5

Deviation6

Deviation3
Deviation4
Deviation1
(error)

Deviation2

Trend line, y^ = a + bx

Time period

Values of Dependent Variable

Least Squares Method

Actual observation
(y value)

Deviation7

Deviation5
Deviation3

Deviation6

Least squares method minimizes

the sum of the squared errors
(deviations)
Deviation
4

Deviation1
Deviation2

Trend line, y^ = a + bx

Time period

Least Squares Method

Equations to calculate the regression variables
^

y = a + bx
Sxy - nxy
b=
Sx2 - nx2
a = y - bx

Least Squares Example

Year
2001
2002
2003
2004
2005
2005
2007

Time
Electrical Power
Period (x)
Demand
1
74
2
79
3
80
4
90
5
105
6
142
7
122
x = 28
y = 692
x2 =
x=4
y = 98.86
b=

x2
1
4
9
16
25
36
49
140

xy
74
158
240
360
525
852
854
xy = 3,063

xy - nxy 3,063 - (7)(4)(98.86)

=
= 10.54
140 - (7)(42)
x2 - nx2

a = y - bx = 98.86 - 10.54(4) = 56.70

Least Squares Example

Year

Time
Period (x)

Electrical Power
Demand

1999
1
74
2000
2
79
The trend
line is
2001
3
80
2002
4
90
y^
=556.70 + 10.54x
2003
105
2004
6
142
2005
7
122
x = 28
y = 692
x=4
y = 98.86

x2

xy

1
4
9
16
25
36
49
x2 = 140

74
158
240
360
525
852
854
xy = 3,063

3,063 - (7)(4)(98.86)
xy - nxy
b = x2 - nx2 =
= 10.54
140 - (7)(42)
a = y - bx = 98.86 - 10.54(4) = 56.70

Least Squares Example

Power demand

160
150
140
130
120
110
100
90
80
70
60
50

Trend line,
y^
= 56.70 + 10.54x

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2001 2002 2003 2004 2005 2006 2007 2008 2009
Year

Reference

David R. Anderson [et.al]. (2008). Quantitative

Methods for Business. 11. SOWES. New York. ISBN:
10: 0324651813.

Bina Nusantara University

43

Thank You

Bina Nusantara University

44