Anne Liah D.

Romero

BSA2205 – BSMA 1E

Activity 3

CHAPTER 3: FORECASTING

Forecasting is the practice of generating future predictions based on past and present data. This is most
typically accomplished through trend analysis. A common example would be the estimate of a variable of
interest at some future date. Prediction is a similar but broader concept. Both terms can apply to formal
statistical approaches that use time series, cross-sectional, or longitudinal data, as well as less formal
judgmental procedures. In hydrology, for example, the terms “forecast” and “forecasting” are frequently
reserved for estimates of values at specific future dates, but the term “prediction” is used for more general
estimates, such as the number of times floods will occur over a long period.

 Forecasting help managers to:

- Plan the system

- Plan the use of system

 Forecasts affect decisions and activities throughout an organization

 Accounting – cost/profit estimates
 Finance – cash flow and funding
 Human resources – hiring/ recruiting/ training
 Marketing – pricing, promoting, strategy
 MIS – IT/IS systems, services
 Operations – schedules, MRP, workloads
 Product / service design – new products and services

 FEATURES COMMON TO ALL FORECASTS

A wide range of forecasting techniques are in use. They are really different from one another in many
ways.

1. In general, forecasting techniques imply that the same underlying casual system that existed in the past
would continue to exist in the future.

2. Forecasts are rarely perfect; actual outcomes frequently vary from predicted values.

3. Forecasts for groups of items are generally more accurate than forecasts for individual items because
forecasting errors among items in a group usually cancel each other out.

4. Forecast accuracy reduces as the forecast time period—the time horizon—increases.

FORECASTS ARE GENERALLY WRONG…

Forecasts are generally wrong, yet they are an important element of business planning, management, and
strategy.

That may seem pessimistic, but it is truth, and there is an essential trap for business people to overcome.
Statisticians understand that every forecast has an error band surrounding it, and they would claim that
forecasts are correct as long as the actuals fall within that range. However, those boundaries may be too
broad for your business. Depending on the circumstances, the numbers might fall within that range while
yet costing you a lot of money – or a lot of lost earnings.

Another pitfall for business people is developing overconfidence in forecasts, especially after spending
time and money in expensive forecasting systems. Depending on the circumstances, this overconfidence
may be quite deadly.

 ELEMENTS OF GOOD FORECASTS

1. Timely – The forecasting horizon must include the time required to make such adjustments.
2. Reliable – It should work consistently.
3. Accurate – Degree of accuracy should be stated.
4. Meaningful - Should be stated in meaningful units. Financial planners should know how much
money is necessary, production should know how many units are needed, and schedulers should
know what machines and abilities are required.
5. Written - To ensure that the same information is used and to make comparisons to actual results
easier.
6. Easy to use – Users should be comfortable working with forecast.

 STEPS IN THE FORECASTING PROCESS

  APPROACHES TO FORECASTING

There are two general approaches to forecasting: qualitative and quantitative

1. Qualitative Method

Qualitative forecasting is a method to predict a company's finances that relies on expert judgment. Expert
employees do qualitative forecasting by finding and assessing the relationship between past operations
knowledge and probable future operations. This enables the experts to make predictions about how a firm
will do in the future based on their opinions and information gathered from other sources, such as staff
polls or market research.

It is essential for assisting executives in making business choices. Qualitative forecasting may help a firm
decide how much inventory to maintain, whether to hire additional employees, and how to adjust their
sales operations. Qualitative forecasting is particularly important for project development, such as
marketing campaigns, because it can give information about a company's service, highlighting the aspects
of the firm to focus in advertisements.

Some advantages of qualitative forecasting include the capacity to use sources other than numerical data,
the ability to foresee future business trends and occurrences, and the utilization of information from
industry experts.

Examples of Qualitative Forecasting Methods:

a. Delphi Method - The Delphi method involves questioning a panel of experts individually to
collect their opinions. Interviewing or gathering information from the experts one at a time rather
than in a group can help to prevent bias and ensure that any consensus about business predictions
stems from the expert opinions on their own. Other employees then analyze the experts' responses
and return them with additional questions until settling on a prediction that makes sense for the
company.

b. Jury of Executive Opinion - This approach relies on judgments from experts in sales, finance,
purchasing, and administration or production teams. Forecasting by executive opinion can ensure
that a team completes a forecast quickly and considers multiple perspectives from different
departments to best inform their forecast. Some companies might use executive opinion
forecasting along with a quantitative method.

c. Market Research - Market research evaluates the success of a company's services or products by
introducing them to potential customers and recording details about how they react. Companies
can conduct market research with the help of their own employees or by hiring outside agencies
that specialize in market research activities. Some ways to conduct market research include focus
groups, consumer surveys or blind product testing, where a customer tries a product without
having heard of it before. Based on the reaction of participants, companies can decide which
products or services to continue producing and which might need revision in the production stage.
 d. Consumer Surveys - Consumer surveys ask customers of a business about their experience as a
consumer. Companies might send consumer surveys to customers through mail-in questionnaires
or forms sent through email. Other options for conducting consumer surveys include cold-calling
customers on the phone and inviting customers in to the office for personal interviews. After
collecting information from consumer surveys, employees can use the details they learn to help
inform their predictions about a company's future based on the experience of their existing
customers.

e. Sales Force Polling - Sales force polling involves speaking with sales staff who work closely
with customers and might have thorough information about their satisfaction and experiences
with the company. One advantage of sales force polling is that it uses information from
employees who are most frequently involved in the actual business operations, which can ensure
that the details are correct and relevant. Sales force polling is also simple to conduct since it only
requires meeting with salespeople and focuses on the information they provide.

2. Quantitative Method

Quantitative forecasting differs from qualitative forecasting in that it uses numerical values and
calculations to create forecasts and guide decision-making. While qualitative reasoning analyzes
judgements and opinions, quantitative reasoning uses objective data from previous operations to guide a
company's decisions. Quantitative data is further divided into two types: historical data forecasts and
associative data forecasts. These forecasts are based on mathematical calculations and can assist a firm in
identifying trends in areas such as sales or investments.

Examining data and creating inferences using quantitative forecasting is important because it provides:

 Objectivity: Numbers are neutral and free from any subjective judgment. Examining empirical
data provides a standard of objectivity that is useful for making important business decisions. This
makes realistic projections easier to calculate and guarantees that the information is trustworthy.
 Reliability: As analysts’ record and use accurate data in quantitative forecasting, the inferences
made become more reliable. Quantitative forecasting takes advantage of the available information
to provide reliable and accurate predictions based on an established history. This makes it easier
for business owners or salespeople to pinpoint areas for growth.
 Transparency: Because data reflects exactly how a business is performing, it provides a level of
transparency that can be very useful for quantitative forecasts. The collected records present all of
the information accurately and openly, which provides an added level of clarity for making future
business decisions.
 Predictability: When businesses monitor their history and record their data for quantitative
forecasts, it makes trends easier to identify and predict. Using this information, businesses can set
realistic expectations and adjust their goals to measure growth.
Examples of Quantitative Forecasting Methods:

a. Naive Method - The naive method bases future predictions by anticipating similar results to
the data gathered from the past. This method does not account for seasonal trends or any
other patterns that might arise in the collected data. It is the most straightforward forecast
method and is often used to test the accuracy of other methods.

b. Straight-line Method - The straight-line method calculates future sales while also
considering potential future growth. This is one of the simplest methods for quantitative
forecasting because it requires only a reasonable estimate of expected growth, often using
past revenue growth as an example.

c. Seasonal Index - The seasonal index method for quantitative forecasting analyzes available
data while accommodating the calculations for any seasonal patterns that appear. Begin by
separating data by year and season.

d. Revenue Run Rate Method - You can use the revenue run rate method to estimate the
revenue a business can expect over a longer time span. This method is often used to project
sales year per year to show annual performance using projections from smaller periods
throughout the year. These smaller periods can be groups of months, financial quarters or
other blocks of time as decided by the forecaster. The run rate method operates under the
assumption that the current sales rate will continue, using this pattern as a basis upon which
to project earnings over an extended period.

e. Moving Average Method - The moving average method forecasts long-term trends by
calculating an average of a subset that represents a long amount of time. It's possible to
calculate moving averages using any subset of data, typically in three-year, four-year or five-
year groups.

 FORECASTS BASED ON JUDGMENT AND OPINION

The most important thing to understand before forecasting is that a forecast is really just a judgment made
by someone. Some techniques rely more on judgment than others, however, and they are generally known
as judgment techniques. These techniques include executive opinions, salesforce opinion, consumer
surveys, and other approach.

Executive Opinions

A small group of upper-level managers may meet and collectively develop a forecast. This
approach is often used as a part of long-range planning and new product development. It has the
advantage of bringing together the considerable knowledge and talents of various managers. However,
there is the risk that the view of one person will prevail, and the possibility that diffusing responsibility
for the forecast over the entire group may result in less pressure to produce a good forecast.

Salesforce Opinions

The sales staff or the customer service staff is often a good source of information because of their
direct contact with customers. They are often aware of any plans the customer may be considering for the
future. There are, however, several drawbacks to this approach. One is that they may be unable to
distinguish between what customers would like to do and what they actually will do. Another us that
these people are sometimes overly influence by recent experiences. Thus after several prior of low sales,
their estimates may tend to become more pessimistic. After several periods of good sales, they may tend
to be too optimistic. In addition, if forecasts are used to establish sales quotas, there will be a conflict of
interest because it is to the sales person’s advantage to provide low sales estimates.

Consumer Surveys

Because it is the consumers who ultimately determine demand, it seems natural to solicit input
from them. In some instances, every customer or potential customer can be contacted. However, there are
usually too many customers or no way to identify all potential customers. Therefore, organizations
seeking consumer input usually resort to consumer surveys, which enable them to sample customer
opinions. The obvious advantage to consumer surveys is that they can tap information that might not be
available elsewhere. On the other hand, a considerable amount of knowledge and skill is requires to
construct a survey, administer it and correctly interpret the results for valid information.

Other Approaches

A manager may solicit opinions from a number of other managers and staff people. Occasionally,
outside experts are needed to help with a forecast. Advice may be needed on political or economic
conditions. Another approach is the Delphi Method. It involves a series of questionnaires among
individuals who possess the knowledge and ability to contribute meaningfully. Responses are kept
anonymous, which tends to encourage honest responses and reduces the risk that one person’s opinion
will prevail. Each new questionnaire is developed using the information extracted from the previous one,
thus enlarging the scope of information on which participants can base their judgments. The goal is to
achieve a consensus forecast.

 FORECASTS BASED ON TIME SERIES DATA

A time series is a time-ordered sequence of observations taken at regular intervals. The may be
measured of demand, earning profits, shipments, accidents, output, precipitation, productivity, and the
consumer price index. It is based on the assumption that future values of the series can be estimated from
past values. Although no attempt is made to identify variables that influence the series, these methods are
widely used, often with quite satisfaction.
 Analysis of time series data requires the analyst to identify the underlying behavior of the series.
This can often be accomplished by merely plotting the data and visually examining the plot. One or more
patterns might appear: trends, seasonal variations, cycles or variations around an average.

1. Trend refers to a long-term upward or downward movement in the data.

2. Seasonality refers to short-term, fairly regular variations generally related to factors such as the
calendar to time of day.
3. Cycles are wavelike variations more than one year’s duration.
4. Irregular variations are due to unusual circumstances such as severe weather conditions, strikes or
a major change in a product or service.
5. Random variations are residual variations that remain after all other behaviors have been
accounted for.

A Naïve forecast uses a single previous value of a time series as the basis of a forecast. The naïve
approach can be used with a stable series, with seasonal variations, or with trend. With a stable series, the
last data point becomes the forecast for the next period.

Techniques for Averaging

Historical data typically contain a certain amount of random variation, or white noise that tends to
obscure systematic movements in the data. This randomness arises from the combined influence of many
relatively unimportant factors.

A Moving Average forecast uses a number recent actual data values in generating a forecast.

Weighted Average is similar to a moving average, except that it assigns more weight to the most
recent values in a time series. More recent values in a series are given more weight in computing a
forecast.

Exponential Smoothing is a sophisticated weighted averaging method that is still relatively easy
to use and understand. Each new forecast is based on the previous forecast plus a percentage of the
difference between that forecast and the actual value of the series at that point.

Techniques for Trend

Analysis of trend involves developing an equation that will suitably describe trend. The trend
component may be linear or it may not. A simple plot of the data often can reveal the existence and nature
of a trend. A linear trend equation has the form F1 = a + bt.

A variation of simple exponential smoothing can be used when a time series exhibits a linear
trend. It is called trend- adjusted exponential smoothing or, sometimes, double smoothing, to differentiate
it from simple exponential smoothing which is appropriate only when data vary around an average or
have step or gradual changes. If a series exhibits trend, and simple smoothing is used on it, the forecasts
will all lag the trend: if the data are increasing, each forecast will be too low: if decreasing, each forecast
will be too high.
Techniques for Seasonality

Seasonal variations in time series data are regularly repeating upward or downward movements in
series values that can be recurring events. Seasonality may refer to regular variations. Familiar examples
of seasonality are weather variations and vacations or holidays. The term seasonal variations is also
applied to daily, weekly, monthly, and other regularly recurring patterns in data.

Seasonality in a time series is express in terms of the amount that actual values deviate from the
average value of a series. If the series tends to vary around an average value, then seasonality is expressed
in terms if that average; if trend is present, seasonality is expressed in terms of the trend value.

Using Seasonal Relatives

Seasonal relatives are used in two different ways in forecasting. One was is to deseasonalize
data; the other way is to incorporate seasonality in a forecast.

To deseasonalize data is to remove the seasonal component from the data in order to get a
clearer picture of the non-seasonal components. Incorporating seasonality in a forecast is useful when
demand has both trend and seasonal components.

Computing Seasonal Relatives

A commonly used method for representing the trend portion of a time series involves a
centered moving average. Computations and the resulting values are the same as those for a moving
average forecast. However, the values are not projected as in a forecast; instead, they are positioned in
the middle of the periods used to compute the moving average.

Techniques for Cycles

Cycles are up and down movements similar to seasonal variations but longer duration— say, two
to six years between peaks. When cycles occur in time series data, their frequent irregularity makes it
difficult or impossible to project them from past data because turning points are difficult to identify.

 ASSOCIATIVE FORECASTING TECHNIQUES

Associative techniques rely on identification of related variables that can be used to predict values
of the variable of interest. The essence of associative techniques is the development of an equation that
summarizes the effects of predictor variables. The primary method of analysis is known as regression. A
brief overview of regression should suffice to place this approach into perspective relative to the other
forecasting approaches.

Simple Linear Regression

The simplest and most widely used for of regression involves a linear relationship between two
variables. The object in linear regression is to obtain an equation of a straight line that minimizes the sum
of squared vertical deviations of data points from the line.
 Correlations measure the strength and direction of relationship between two variables. Correlation
can range from -1.00 + 1.00. A correlation of +1.00 indicates that changes in one variable are always
match by changes in the other, a correlation of -1.00 indicates that increases in one variable are match by
decreases in the other, and a correlation close to zero indicates little linear relationship between two
variables.

Curvilinear and Multiple Regression Analysis

Simple linear regression may prove inadequate to handle certain problems because a linear model
in inappropriate or because more than one predictor variable is involved. When nonlinear relationships
are present, you should employ curvilinear regression; models that involve more than one predictor
require the use of multiple regression analysis. The computations lent themselves more to computers than
to hand calculation. Multiple regression forecasting substantially increases data requirements. In each
case, it is necessary to weigh the additional cost and effort against potential improvements in accuracy of
predictions.

Accuracy and Control of Forecasts

Accuracy and control is a vital aspect of forecasting. The complex nature of most real-world
variables makes it almost impossible to correctly predict future values of those variables on a regular
basis. Consequently, it is important to include an indication of the extent to which the forecast might
deviate from the variable that actually occurs. This will provide the forecast user with a better perspective
on how far off a forecast might be.

Forecast error is the difference between the value that occurs and the value was predicted for a
given time period.

Controlling the Forecast

Because forecast errors are the rule rather than the exception, there will be a succession of
forecast errors. Tracking the forecast errors and analyzing them can provide useful insight on whether or
not forecasts are performing satisfactorily.

There are a variety of possible sources of forecast errors, including the following:

1. The model may be inadequate due to the omission of an important variable, b a change or shift in
the variable that the model cannot deal with, c the appearance of a new variable.
2. Irregular variations may occur due to severe weather or other natural phenomena, temporary
shortages or breakdowns, catastrophes, or similar events.
3. The forecasting technique may be used incorrectly or the results misinterpreted.
4. There are always random variations in the data. Randomness us the inherent variation that
remains in the data after all causes of variation have been accounted for.
Choosing a Forecasting Technique

Many different kinds of forecasting techniques are available, and no single technique works best
in every situation. When selecting a technique for a given situation, the manager or analyst must take a
number of factors into consideration.

Other factors to consider in selecting a forecasting technique include the availability of historical
data; the availability of computer software; the availability of decision makers to utilize certain
techniques; the time needed to gather and analyze data and to prepare the forecast; and any prior
experience with a technique. The forecast horizon is important because come techniques are more suited
to long-range forecasts while other works best for the short-range.

The two most important factors are cost and accuracy. Generally speaking, the higher accuracy,
the higher the cost, so it is important to weigh cost-accuracy trade-offs carefully. The best forecast is not
necessarily the most accurate or the least costly; rather, it sis me combination of accuracy and cost
deemed best by management.

Using Forecast Information

A manager can take a reactive or a proactive approach to a forecast. A reactive approach views
forecasts as probable of future demand, and a manager reacts to meet that demand. Conversely, a
proactive approach seeks to actively influence demand.

Generally speaking, a proactive approach requires either an explanatory model, or a subjective

assessment of the influence on demand. It is possible that a manager might take two forecasts one to
predict what will happen under the status quo and a second one based on a “what if” approach, if the
results of the status quo forecast are unacceptable.

Computer in Forecasting

Computer play an important role in preparing forecasts based on quantitative data. Their use
allows managers to develop and revise forecasts quickly, and without the burden of manual computations.
There is a wide range of software packages available for forecasting. There are templates for moving
averages, exponential smoothing, linear trend equation, trend-adjusted exponential smoothing, and simple
linear regression.

References:

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80467.html
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development/qualitative-forecasting

Mendoza, G. (n.d.). Features Common to All Forecasts. Retrieved September 2, 2021, from

https://www.scribd.com/document/161547016/Features-Common-to-All-Forecasts

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https://www.academia.edu/6465224/Forecasting_in_Operations_Management