FORECASTING

Tahir Hameed
Nirbhay Pratap Singh
Pallavi Sharma
Pratyush Thakur
 What Is Forecasting?

• Process of Sales will be

predicting a $200 Million!
future event
• Underlying basis of

business
decisions
• Basis for most
important
planning
 What is forecasting?
Sales will
 Could be a be $200
Could be a
prediction Million!
prediction
 based on past based on
 behaviour and expertise and
 mathematical intuition
models

Could be a prediction based on both a model and a

manager’s expertise
 Forecasting Approaches
Qualitative Methods Quantitative Methods

• Based on judgment, •Used when data is available.

opinion & past
experience •Involves mathematical
• techniques.
• Involves intuition, –Example: forecasting sales
experience.
of color televisions.
 Forecasting Methods
Forecasting
Techniques

Qualitative Time Series Causal

Models Methods Methods

Delphi Moving Regression

Methods Average Analysis

Jury of Exponential Multiple

Executive Smoothing Regression
Opinion
Sales Force Trend
Composite Projections

Consumer
Market Survey
 Quantitative Forecasting
methods
Quantitative Forecasting Methods can be classified in to two
categories
1. Time series analysis -
 Analysis of the past behavior of the data over time and
forecasting under the assumption that the forces that
generated the past data will also generate the future -
Analysis of past demand pattern provides a good basis for
forecasting future demand


2.
 Causal models:
 Associate models – Regression – Simple and Multiple
 Components of Forecasting
Demand
1.Time Frame
• Short to mid range forecast
-eg. HP- 12 to 18 months

• Long range forecast

- For more than 2 years. Eg. FIAT-upto
10 years


2. Demand Behaviour

 Demand Behaviour

Trend Cyclical

Seasonal Random
 Demand Behaviour- Trend
Quantity

Time

Trend: Data consistently increase or decrease over a period

of time.
 Seasonal Variation
Regular fluctuations or periodic changes that repeat year


after year.


Possible Causes: weather, social and religious customs…



Example: sales of sweets, umbrella, ice creams, call



traffic from US to INDIA

 Seasonal component

Year 1
Quantity

Year 2

| | | | | | | | | | | |
J F M A M J J A S O N D
Months
Seasonal: Data consistently show peaks and valleys at
the same time each year.
 Cyclical Variation
Repetitive fluctuations or swings of varying length


and intensity in the long-term.



 Possible Causes: business or economic conditions.



 Example: Economic cycles of growth or

contraction, inflation, recession, etc.
 Cyclical component

Quantity

| | | | | |
1 2 3 4 5 6
Years

Cyclical: Data reveal gradual increases

and decreases over
extended periods.
 Random Variation
Unpredictable random variations in the time-series that the


above three components fail to account for.



Possible Causes: Unforeseen events such as catastrophes,



strikes, war etc.



Example: Loss of customers of an airline due to a strike.


 Random component of time
series
• Examples –
• Sudden increase in the price of oil
due to outbreak of war in gulf
• Sudden drop in the production due to
lockouts
• Unanticipated strike increasing the
prices of essential commodities


•
Quantity Random or Chance component

Time
 Forecasting Process
1. Identify the 2. Collect historical 3. Plot data and
purpose of forecast data identify patterns

6. Check forecast 5. Develop/compute 4. Select a

accuracy with one forecast for period forecast model
or more measures of historical data that seems
appropriate for
data
7.
Is accuracy No 8b. Select new
of forecast
acceptable? forecast model or
adjust parameters
of existing model

Yes
9. Adjust forecast 10. Monitor results
8a. Forecast over and measure
planning horizon based on additional
qualitative forecast accuracy
information and
insight
 Time Series Analysis
Forecasting Models –
1. Moving averages

2. Weighted moving average

3. Exponential Smoothing Model

4. Adjusted Exponential Smoothing Model

5. Linear Trend Line

Also a brief discussion on



ØExponential smoothing model with trend

and seasonal fluctuations
 MOVING AVERAGE
• The simple moving average model
assumes an average is a good
estimator of future behavior.
• Best suited for stable demand
• The formula for the simple moving
average is:
•
Ft = Forecast for the coming period
n = Number of periods to be averaged
A t-1 = Actual occurrence in the past period for upto “n” periods
 Advantages and disadvantages
Advantage :


• Easy to compute and easy to understand



Disadvantage:


• All values in the average are weighted equally

• Required to retain great deal of data carry it from forecast
period to forecast period.
• Does not react to seasonality, cyclicality, etc.
 Weighted moving Average
• It assigns more weight to the most recent values in a time
series
– Idea: most recent observations must be better indicators
of the future than older observations
–
• Weights decrease for older data
•
• Weights sum to 1.0.
WMA =n ∑
i=1 WiDi
 EXPONENTIAL
SMOOTHENING
Averaging method
Weights most recent data more strongly
Reacts more to recent changes
Widely used, accurate method

Ft +1 = α Dt + (1 - α )Ft
where:
Ft +1 = forecast for next period
Dt = actual demand for present period
Ft = previously determined forecast for
present period
α = weighting factor, smoothing
constant
 Linear Trend Line
• Linear regression is a method of forecasting in
which a mathematical relationship is
developed between demand & factors
causing demand behavior.
• 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.
•
 Seasonal adjustments
• Seasonal pattern is a repetitive
increase and decrease in demand.
(monthly, weekly, daily, weather,
festival etc)
– Sales of apparels
– Sales of greeting cards
–
• The seasonal fluctuations are
adjusted by multiplying the Di normal
forecast
S e a so nby a cto
a lfa seasonal
r = S = factor.
i D

 Forecast Accuracy
• Forecast error
Σ | Dt -
– difference between forecast and actual demand Ft |
MAD =
– MAD n
• mean absolute deviation (avg absolute difference
between the forecast & demand)
|Dt - Ft|
• Smaller the MAD value relative to magnitude of the
data more accurate is the forecast
– MAPD MAPD =
• mean absolute percent deviation(absolute error as aDt
%age of demand rather than period)
• Eliminates the problem of interpreting the measure of
accuracy relative to the magnitude of demand &
forecast values.
E = et
• Lower %age deviation implies more accurate forecast.
– Cumulative error
• Summing the forecast errors, large ±E indicates
forecast is highly biased.
et
• Large +E shows biased low/Large –E shows biased
high. E = n
– Average error or bias
• Averaging cumulative error over no of periods
 Forecast Control
• Tra ckin g sig n a l
n m o n ito rs th e fo re ca st to se e if it is
b ia se d h ig h o r lo w
n ( Dt - Ft) E
Tra
n
ckin g sig n a l = MAD = MAD
n R e co m p u te d e a ch p e rio d

n 1 M A D ≈ 0 .8

n C o n tro llim its o f 2 to 5 M A D s a re u se d

m o st fre q u e n tly
 Statistical Control Charts
• ( Dt - Ft)2
•  = n - 1
•
•
Using  we can calculate statistical
control limits for the forecast
error
Control limits are typically set at 
3
 Regression Methods

Linear regression
a mathematical technique that relates a dependent variable to an
independent variable in the form of a linear equation
y = a + bx
Multiple Regression
Study the relationship of demand to two or more independent
variables
y = β 0 + β 1x1 + β 2x2 … + β kxk
Where
β 0 = the intercept
β 1, … , β k = parameters for the independent variables
x1, … , xk = independent variables
 Correlation and Coefficient
of Determination

Correlation, r
Measure of strength of relationship
Varies between -1.00 and +1.00
Coefficient of determination, r2
Percentage of variation in dependent
variable resulting from changes in
the independent variable
 Multiple Regression
 Study the relationship of demand to
two or more independent variables


y = β 0 + β 1x1 + β 2x2 … + β kxk

where

 β 0 = the intercept
 β
1, … , β k = parameters for the
independent variables
 x1, … , xk = independent variables
•