Forecasting
Why forecast?
Features Common to all Forecasts
Conditions in the past will continue in the future
Rarely perfect
Forecasts for groups tend to be more accurate than forecasts for individuals
Forecast accuracy declines as time horizon increases
Elements of a Good Forecast
Timely
Accurate
Reliable (should work consistently)
Forecast expressed in meaningful units
Communicated in writing
Simple to understand and use
Steps in Forecasting Process
Determine purpose of the forecast
Establish a time horizon
Select forecasting technique
Gather and analyze the appropriate data
Prepare the forecast
Monitor the forecast
Types of Forecasts
Qualitative
o Judgment and opinion
o Sales force
o Consumer surveys
o Delphi technique
Quantitative
o Regression and Correlation (associative)
o Time series
Forecasts Based on Time Series Data
What is Time Series?
Components (behavior) of Time Series data
o Trend
o Cycle
o Seasonal
o Irregular
o Random variations
Naïve Methods
Naïve Forecast – uses a single previous value of a time series as the basis of a
forecast.
Ft yt 1
Techniques for Averaging
What is the purpose of averaging?
Common Averaging Techniques
o Moving Averages
o Exponential smoothing
Moving Average
A i
Ft i 1
n
Exponential Smoothing
Ft Ft 1 ( At 1 Ft 1 )
Techniques for Trend
Linear Trend Equation
yt a bt
where :
t specified number of time periods from t 0
y t forecast for time period t
a value of yt at t
b slope of the line
Curvilinear Trend Equation
yt a bt ct 2
where :
t specified number of time periods from t 0
y t forecast for time period t
a value of yt at t
b slope of the line
Techniques for Seasonality
What is seasonality?
What are seasonal relatives or indexes?
How seasonal indexes are used:
o Deseasonalizing data
o Seasonalizing data
How indexes are computed (see Example 7 on page 109)
Accuracy and Control of Forecasts
Measures of Accuracy
o Mean Absolute Deviation (MAD)
o Mean Squared Error (MSE)
o Mean Absolute Percentage Error (MAPE)
Forecast Control Measure
o Tracking Signal
Mean Absolute Deviation (MAD)
MAD
Actual Forecast
n
Mean Squared Error (or Deviation) (MSE)
MSE
( Actual Forecast ) 2
n 1
Mean Square Percentage Error (MAPE)
Actual Forecast X 100
MAPE Actual
n
Tracking Signal
Tracking Signal
( Actual Forecast )
MAD
Problems:
2 – Plot, Linear, MA, exponential Smoothing
5 – Applying a linear trend to forecast
15 – Computing seasonal relatives
17 – Using indexes to deseasonalize values
26 – Using MAD, MSE to measure forecast accuracy
Problem 2 (110)
National Mixer Inc., sells can openers. Monthly sales for a seven-month period were as follows:
Sales
Month (000 units)
Feb 19
March 18
April 15
May 20
June 18
July 22
August 20
(a) Plot the monthly data on a sheet of graph paper.
(b) Forecast September sales volume using each of the following:
(1) A linear trend equation
(2) A five-month moving average
(3) Exponential smoothing with a smoothing constant equal to 0.20, assuming March forecast of
19(000)
(4) The Naïve Approach
(5) A weighted average using 0.60 for August, 0.30 for July, and 0.10 for June
(c) Which method seems least appropriate? Why?
(d) What does use of the term sales rather than demand presume?
EXCEL SOLUTION
(a) Plot of the monthly data
How to superimpose a trend line on the graph
Click on the graph created above (note that when you do this an item called CHART will appear
on the Excel menu bar)
Click on Chart > Add Trend Line
Click on the most appropriate Trend Regression Type
Click OK
(b) Forecast September sales volume using:
(1) Linear Trend Equation
Create a column for time period (t) codes (see column B)
Click Tools > Data Analysis > Regression
Fill in the appropriate information in the boxes in the Regression box that appears
Sales data
Coded time period
Coded time period
(2) Five-month moving average
(3) Exponential Smoothing with a smoothing constant of 0.20, assuming March forecast of 19(000)
Enter the smoothing factor in D1
Enter “19” in D5 as forecast for March
Create the exponential smoothing formula in D6, then copy it onto D7 to D11
(4) The Naïve Approach
(5) A weighted average using 0.60 for August, 0.30 for July, and 0.10 for June
Problem 5 (110)
A cosmetics manufacturer’s marketing department has developed a linear trend equation that can be used to
predict annual sales of its popular Hand & Foot Cream.
yt =80 + 15 t
where: yt = Annual sales (000 bottles) t0 = 1990
(a) Are the annual sales increasing or decreasing? By how much?
(b) Predict annual sales for the year 2006 using the equation
Problem 15 (113)
Obtain estimates of daily relatives for the number of customers at a restaurant for the evening meal, given the
following data. (Hint: Use a seven-day moving average)
Day Number Day Number
Served Served
1 80 15 84
2 75 16 77
3 78 17 83
4 95 18 96
5 130 19 135
6 136 20 140
7 40 21 37
8 82 22 87
9 77 23 82
10 80 24 98
11 94 25 103
12 125 26 144
13 135 27 144
14 42 28 48
Excel Solution
Type a 7-day average formula in E6 ( =average(C3:c9) )
In F6, type the formula =C6/E6
Copy the formulas in E6 and F6 onto cells E7 to E27
Compute the average ratio for Day 1 (see formula in E12)
Copy and paste the formula in E12 onto E13 to E18 to complete the indexes for Days 2 to 7
Problem 17 (113) – Using indexes to deseasonalize values
New car sales for a dealer in Cook County, Illinois, for the past year are shown in the following table, along with
monthly (seasonal) relatives, which are supplied to the dealer by the regional distributor.
Units Units
Month Sold Index Month Sold Index
Jan 640 0.80 Jul 765 0.90
Feb 648 0.80 Aug 805 1.15
Mar 630 0.70 Sept 840 1.20
April 761 0.94 Oct 828 1.20
May 735 0.89 Nov 840 1.25
Jun 850 1.00 Dec 800 1.25
(a) Plot the data. Does there seem to be a trend?
(b) Deseasonalize car sales
(c) Plot the deseasonalized data on the same graph as the original data. Comment on the two graphs.
Excel Solution
(a) Plot of original data (seasonalized car sales)
(b) Deseasonalized Car Sales
Create formula in F6 (see
circled formula), then copy
onto F7 to F17
(c) Graph of seasonalized car sales versus deseasonalized car sales
Problem 26 (115) – Using MAD, MSE, and MAPE to measure forecast accuracy
Two different forecasting techniques (F1 and F2) were used to forecast demand for cases of bottled water. Actual
demand and the two sets of forecasts are as follows:
Predicted Demand
Period Demand F1 F2
1 68 66 66
2 75 68 68
3 70 72 70
4 74 71 72
5 69 72 74
6 72 70 76
7 80 71 78
8 78 74 80
(a) Compute MAD for each set of forecasts. Given your results, which forecast appears to be the most
accurate? Explain.
(b) Compute MSE for each set of forecasts. Given your results, which forecast appears to be the most
accurate? Explain.
(c) In practice, either MAD or MSE would be employed to compute forecast errors. What factors might lead
you to choose one rather than the other?
(d) Compute MAPE for each data set. Which forecast appears to be more accurate?
Excel Solution =ABS(c7-d7) =(c7-d7)^2 =ABS(c7-d7)/c7
=AVERAGE(G8:G15)
=SUM(J8:J15)/(COUNT(J8:J15)-1)
=AVERAGE(M8:M15)
