Planning and Forecasting

(Part B)

Eng. Ahmed Bakhsh

 What is Forecasting?

• Process of predicting a Sales will

future event be $200
Million!
• Underlying basis of
all business decisions
– Production
– Inventory
– Personnel
– Facilities
 Types of Forecasts by Time
Horizon
• Short-range forecast
– Up to 1 year; usually less than 3 months
– Job scheduling, worker assignments
• Medium-range forecast
– 3 months to 3 years
– Sales & production planning, budgeting
• Long-range forecast
– 3+ years
– New product planning, facility location
 Types of Forecasts
• Economic forecasts
– Address business cycle, e.g., inflation rate,
money supply etc.
• Technological forecasts
– Predict rate of technological progress
– Predict acceptance of new product
• Demand forecasts
– Predict sales of existing product
Planning and Forecasting Forecasting

To predict/approximate what a certain future event or condition will be.

One can forecast:

Production levels
Technological developments
Needed manpower
Governmental regulations
Needed Funds
Training needs
Resource needs
Sale levels.  The most critical information to forecast.
 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
Planning and Forecasting Forecasting

Two types of information to forecast:

Qualitative Information

Quantitative Information
Planning and Forecasting Forecasting

Qualitative Forecasting
Used when:

Past data cannot be used reliably to predict the future.

Technological trends
Regulations
When no past data is available, usually because
the situation is very new.
Entry into new markets
Development of new products
Planning and Forecasting Forecasting

Qualitative Forecasting

Methods

•Jury of executive opinion

•Delphi Method
•Sales Force Composite
•Consumer Market Survey (User’s Expectations)
 Jury of Executive Opinion
• Involves small group of high-level managers
– Group estimates demand by working together
• Combines managerial experience with statistical
models
• Relatively quick
• ‘Group-think’
disadvantage

© 1995 Corel Corp.

 Delphi Method
• Iterative group
process Decision Makers
• 3 types of people (Sales?)
Staff (Sales will be 50!)
– Decision makers
(What will
– Staff sales be?
– Respondents survey)

• Reduces ‘group-
Respondents
think’
(Sales will be 45,
50, 55)
 Sales Force Composite
• Each salesperson projects
Sales
his or her sales
• Combined at district &
national levels
• Sales reps know
customers’ wants
• Tends to be overly
optimistic
© 1995 Corel Corp.
 Consumer Market Survey
• Ask customers How many hours will
you use the Internet
about purchasing next week?
plans
• What consumers
say, and what they
actually do are often
different
• Sometimes difficult
to answer © 1995 Corel
Corp.
Planning and Forecasting Forecasting

Quantitative Information

Used when data is tangible, can be used reliably to

predict the future, and there is sufficient historical
data upon which to base forecasts.

Sales
Profits
Production levels
Quantitative Forecasting Methods

Quantitative
Forecasting

Time Series Associative

Models Models

Moving Exponential Trend Linear

Average Smoothing Projection Regression
 What is a Time Series?
• Set of evenly spaced numerical data
– Obtained by observing response variable at regular time
periods
• Forecast based only on past values
– Assumes that factors influencing past and present will
continue influence in future
• Example
Year: 1998 1999 2000 2001 2002
Sales: 78.7 63.5 89.7 93.2 92.1
 Time Series Components
Trend Cyclical

Seasonal Random
 Seasonal Component
• Regular pattern of up & down fluctuations
• Due to weather, customs etc.
• Occurs within 1 year
Summe
r
Respons
e
© 1984-1994 T/Maker Co.

Mo.,
Qtr.
Common Seasonal Patterns
Period of “Season” Number of
Pattern Length “Seasons” in
Pattern
Week Day 7
Month Week 4–4½
Month Day 28 – 31
Year Quarter 4
Year Month 12
Year Week 52
 Cyclical Component
• Repeating up & down movements
• Due to interactions of factors influencing
economy
• Usually 2-10 years duration

Cycle
Response


Mo., Qtr., Yr.
 Random Component
• Erratic, unsystematic, ‘residual’ fluctuations
• Due to random variation or unforeseen events
© 1984-1994 T/Maker Co.

– Union strike
– Tornado

• Short duration &

nonrepeating
 Product Demand Charted over 4
Years with Trend and Seasonality
Demand for product or service

Seasonal peaks Trend component

Actual
demand
line
Average
demand
Rando over four
m years
Year
variati
Year Year Year
1 on 2 3 4
 Naive Approach
• Assumes demand in next
period is the same as
demand in most recent
period
– e.g., If May sales were 48,
then June sales will be 48
• Sometimes cost effective &
efficient
© 1995 Corel Corp.
 Moving Average
• Simple Moving Average Method

• Weighted Moving Average Method

Planning and Forecasting Forecasting

Quantitative Forecasting

Methods 1. Simple Moving Average:

Assumptions

Time series has a level and a random component only

No Trend
No seasonal or cyclical variations

1 n
Fn +1 = ∑t =1 At
n
n=current value n+1 = forecast value for next
A=actual value
 Moving Average Example
You’re manager of a museum store that sells
historical replicas. You want to forecast sales
(000) for 2003 using a 3-period moving
average.
1998 4
1999 6
2000 5
2001 3
2002 7
© 1995 Corel Corp.
Moving Average Solution

Time
Moving Average Solution

Time
Moving Average Solution

Time
 Moving Average Graph
Sales
8 Actual
6
Forecas
4 t
2
95 96 97 98 99 00
Year
Planning and Forecasting Forecasting

Quantitative Forecasting
Methods 2. Weighted Moving Average:
Assumptions

Used when trend is present

Older data usually less important
Weights based on intuition
Often lay between 0 & 1, & sum to 1.0

Fn +1 = ∑t =1 wt At where ∑
n n
t =1
wt = 1
n=current value n+1 = forecast value for next
A=actual value w=weight value
Planning and Forecasting Forecasting

Quantitative Forecasting

Methods 2. Weighted Moving Average:

Fn +1 = ∑t =1 wt At where ∑
n n
t =1
wt = 1
Example
Period Actual Value Weights are (0.1, 0.2, 0.3, 0.4)
1999 2500 respectively.
2000 1500
Find Sales for the year 2003?
2001 1000
2002 500
Planning and Forecasting Forecasting

Quantitative Forecasting

Methods 2. Weighted Moving Average:

Fn +1 = ∑t =1 wt At where ∑
n n
t =1
wt = 1
Solution
Period Actual Value Weight F(2003) = 0.1*2500
1999 2500 0.1 + 0.2*1500
2000 1500 0.2 + 0.3*1000
+ 0.4*500
2001 1000 0.3
2002 500 0.4 F(2003) = 1050
 Disadvantages of
Moving Average Methods
• Increasing n makes forecast less
sensitive to changes
• Do not forecast trend well
• Require much historical data
• All data (in the simple moving
average technique) are weighted
equally and data which are too old to
be included are weighted by zero
Planning and Forecasting Forecasting

Quantitative Forecasting

Methods 3. Exponential Smoothing Equations:

Fn +1 = Fn + α ( An − Fn )
= α An + (1 − α ) Fn
– Fn+1 = Forecast value
– An = Actual value
−α = Smoothing constant

(Use for computing forecast)

 Exponential Smoothing Example
During the past 8 quarters, the Port of Baltimore has unloaded large quantities
of grain. (α = .10). The first quarter forecast was 175..
Quarter Actual
1 180
2 168
3 159
Find the
4 175 forecast for
5 190 the 9th
6 205 quarter.
7 180
8 182
9 ?
 Exponential Smoothing Solution
Fn+1 = Fn + 0.1(An -
Fn)Forecast, FN+1
QuarterActual
(α = .10)
1 180 175.00 (Given)
2 168 175.00 +
3 159
4 175
5 190
6 205
 Exponential Smoothing Solution
Fn+1 = Fn + 0.1(An - Fn)
Forecast, FN+1
QuarterActual
Actua
(α = .10)
1 180 175.00 (Given)
2 168 175.00 + .10(
3 159
4 175
5 190
6 205
 Exponential Smoothing Solution
Fn+1 = Fn + 0.1(An - Fn)
Forecast, FN+1
QuarterActual
(α = .10)
1 180 175.00 (Given)
2 168 175.00 + .10(180 -
3 159
4 175
5 190
6 205
 Exponential Smoothing Solution
Fn+1 = Fn + 0.1(An - Fn)
Forecast, FN+1
QuarterActual
(α = .10)
1 180 175.00 (Given)
2 168 175.00 + .10(180 - 175.00)
3 159
4 175
5 190
6 205
 Exponential Smoothing Solution
Fn+1 = Fn + 0.1(An - Fn)
Forecast, FN+1
Quarter Actual
( α = .10)
1 180 175.00 (Given)
2 168 175.00 + .10(180 - 175.00) = 175.50
3 159
4 175
5 190
6 205
 Exponential Smoothing Solution
Fn+1 = Fn + 0.1(An -
FnForecast,
) FN+1
QuarterActual
(α= .10)
1 180 175.00 (Given)
2 168 175.00 + .10(180 - 175.00) = 175.50
3 159 175.50 + .10(168 - 175.50) = 174.75
4 175
5 190
6 205
 Exponential Smoothing Solution
Fn+1 = Fn + 0.1(An -

Actual
Quarter
FForecast,
n) FN+1
(α= .10)
1995 180 175.00 (Given)
1996 168 175.00 + .10(180 - 175.00) = 175.50
1997 159 175.50 + .10(168 - 175.50) = 174.75
1998 175 174.75 + .10(159 - 174.75)= 173.18
1999 190
2000 205
 Exponential Smoothing Solution
Fn+1 = Fn + 0.1(An -
FnForecast,
) FN+1
QuarterActual
(α= .10)
1 180 175.00 (Given)
2 168 175.00 + .10(180 - 175.00) = 175.50
3 159 175.50 + .10(168 - 175.50) = 174.75
4 175 174.75 + .10(159 - 174.75) = 173.18
5 190 173.18 + .10(175 - 173.18) = 173.36
6 205
 Exponential Smoothing Solution
Fn+1 = Fn + 0.1(An -
FnForecast,
) FN+1
QuarterActual
(α= .10)
1 180 175.00 (Given)
2 168 175.00 + .10(180 - 175.00) = 175.50
3 159 175.50 + .10(168 - 175.50) = 174.75
4 175 174.75 + .10(159 - 174.75) = 173.18
5 190 173.18 + .10(175 - 173.18) = 173.36
6 205 173.36 + .10(190 - 173.36) = 175.02
Exponential Smoothing Solution
Fn+1 = Fn + 0.1(An -
FnForecast,
) FN+1
Time Actual
(α= .10)
4 175 174.75 + .10(159 - 174.75) = 173.18
5 190 173.18 + .10(175 - 173.18) = 173.36
6 205 173.36 + .10(190 - 173.36) = 175.02
7 180 175.02 + .10(205 - 175.02) = 178.02
8
9
Exponential Smoothing Solution
Fn+1 = Fn + 0.1(An -
FnForecast,
) FN+1
Time Actual
(α= .10)
4 175 174.75 + .10(159 - 174.75) =
5 190 173.18
173.18 + .10(175 - 173.18) =
6 205 173.36
173.36 + .10(190 - 173.36) =
7 180 175.02 + .10(205 - 175.02) =
8 18 178.02 + .10(180 -
178.02
9 2? 178.02)
178.22 +=.10(182
178.22 -
178.22) = 178.58
 Impact of α
250

200 F o re c as t (0.5)

150 F o re c as t (0.1)
A c tual
Actual Tonage

100

50

0
1 2 3 4 5 6 7 8 9
Q u a r te r
Planning and Forecasting Forecasting
Quantitative Forecasting
Methods 3. Exponential Smoothing
Same data assumptions as Moving Average

It overcomes disadvantages of Moving Average.

Forecast for current period is found as the

forecast for the last period plus a proportion of
the error made in the last forecast.
Planning and Forecasting Forecasting
Quantitative Forecasting
Methods 3. Exponential Smoothing Advantages:
No waiting period before reliable forecasts can
be calculated.

It is only required to retain three figures for

any forecast: the past forecast for current
period, the current actual, and the smoothing
constant.

The value of αcan be made to change or

adapt to changed circumstances, such as for
example to make the series more sensitive to
rapidly changing data