FORECASTING

Shane Garcia
Jaymar Bagon
Glen Jonas De los Trinos
Lecture Outline
Forecasting basics
Moving Average
Exponential
Smoothing
Linear Trend Line
Forecast Accuracy
 Forecasting Basics

Forecast – is a prediction of something that

is likely to occur in the future.
A variety of forecasting methods exist, and
their applicability is dependent on the:
–time frame of the forecast (i.e., how far in
the future we are forecasting),
 Forecasting Basics

A variety of forecasting methods exist, and

their applicability is dependent on the:
–the existence of patterns in the forecast
(i.e., seasonal trends, peak periods), and
–the number of variables to which the
forecast is related.
 Forecasting

Components

Time Frames of Forecast

Short Range
Medium Range
Long Range
Can exhibits:
Trend
Random Variations
Cycle
Seasonal Pattern
Short Range
encompass the immediate
future and are concerned with
the daily operations rarely
goes beyond a couple months
into the future.
Medium Range

encompasses anywhere from Long Range

1 or 2 months to 1 year. encompasses a period longer than 1 or 2 years.

–More closely related to a It is Related to management's attempt to plan
yearly production plan and new products for changing markets, build new
will reflect such items as facilities, or secure long-term financing.
peaks and valleys in demand.
 Can exhibit:

Trend is a long-term movement of

the item being forecast.
Random variations are movements
that are not predictable and follow no
pattern (and thus are virtually
unpredictable).
Seasonal pattern is an oscillating Cycle is an undulating movement in
movement in demand that occurs demand, up and down, that repeats
periodically (in the short run) and is
itself over a lengthy time span (i.e.,
repetitive.
more than 1 year).
Seasonality is often weather related.
Forecasting Components: Forecast Patterns

Forms of forecast movement: (a) trend, (b) cycle, (c) seasonal

pattern, and (d) trend with seasonal pattern
 Forecasting

Methods

The forecasting component determines to

a certain extent the type of forecasting
method that can or should be used.

Time Series - is a category of statistical

techniques that uses historical data to
predict future behavior.
 Regression (or causal) methods - attempt
to develop a mathematical relationship
(in the form of a regression model)
between the item being forecast and
factors that cause it to behave the way it
does.
•Qualitative methods - use
management judgment, expertise, and
opinion to make forecasts.
•They are the most common type of
•Often called "the jury of executive
forecasting method for the long-term
strategic planning process.
opinion,"
 Time Series

Methods

1. The Moving Average

Simple Moving Average
Weighted Moving Average
2. Exponential Smoothing
The moving average method uses
several values during the recent
past to develop a forecast.
The moving average method is
good for stable demand with no
pronounced behavioral patterns.
Moving averages are computed
for specific periods, such as 3
months or 5 months, depending
on how much the forecaster
desires to smooth the data.
Simple Moving Average

Moving averages are computed for specific

periods, such as 3 months or 5 months,
depending on how much the forecaster desires
to smooth the data.
Moving average forecast may be computed for
specified time period as follows:

where
n = number of periods in the moving average
D = data in period i
The major disadvantage of the Simple Moving
Average method is that it does not react well to
variations that occur for a reason, such as
trends and seasonal effects (although this
method does reflect trends to a moderate
extent).
The Simple Moving Average method can be
adjusted to reflect more closely more recent
fluctuations in the data and seasonal effects.
This adjusted method is referred to as a
Weighted Moving Average method.
Weighted Moving

Average

is a time series forecasting method in

which the most recent data are weighted.
•It may be computed for specified time
period using the following:
Time Series –
Exponential Smoothing
EXPONENTIAL SMOOTHING
•The Exponential Smoothing forecast method is an averaging method that
weights the most recent past data more strongly than more distant past
data.

•There are two forms of exponential smoothing:

1.Simple Exponential Smoothing
2.Adjusted Exponential Smoothing (adjusted for trends, seasonal patterns,
etc.)
Time Series –
Exponential Smoothing
EXPONENTIAL SMOOTHING
Simple Exponential Smoothing
•The simple exponential smoothing forecast is computed by using the
formula:
Time Series –
Exponential Smoothing
SIMPLE EXPONENTIAL SMOOTHING

where:

Ft+1 = the forecast for the next period

Dt = the actual demand for the present period
Ft = the previously determined forecast for the present periods
α= a weighting factor referred to as the smoothing constant
Time Series –
Exponential Smoothing
SIMPLE EXPONENTIAL SMOOTHING
•The smoothing constant, α, is betw. 0 & 1.
•It reflects the weight given to the most recent demand data.

»For example, if α = .20,

»Ft+1 = .20Dt + .80Ft

•This means that our forecast for the next period is based on 20% of recent
demand (Dt) and 80% of past demand.
Time Series –
Exponential Smoothing
SIMPLE EXPONENTIAL SMOOTHING

•The higher α is (the closer α is to one), the more sensitive the forecast will be
to changes in recent demand.

•Alternatively, the closer α is to zero, the greater will be the dampening or

smoothing effect.
Time Series –
Exponential Smoothing
SIMPLE EXPONENTIAL SMOOTHING

•The most commonly used values of αare in the range from .01 to .50.

•However, the determination of α is usually judgmental and subjective and

will often be based on trial-and-error experimentation.
Time Series – Simple Exponential Smoothing

•A company - PM Computer Services

has accumulated demand data in
table for its computers for the past 12
months.
•It wants to compute exponential
smoothing forecasts, using smoothing
constants (α) equal to 0.30 and 0.50.
Time Series –
Exponential Smoothing
SIMPLE EXPONENTIAL SMOOTHING
Simple Exponential Smoothing Example

•To develop the series of forecasts for the data i, start with period 1 (January)
and compute the forecast for period 2 (February) by using α = 0.30.

•The formula for exponential smoothing also requires a forecast for period 1,
which we do not have, so we will use the demand for period 1 as both demand
and the forecast for period 1.
Time Series –
Exponential Smoothing
SIMPLE EXPONENTIAL SMOOTHING
Simple Exponential Smoothing Example

•Thus the forecast for February is:

F2 = αD1 + (1 - α)F1
= (.30)(37) + (.70)(37) = 37 units
Time Series –
Exponential Smoothing
SIMPLE EXPONENTIAL SMOOTHING
Simple Exponential Smoothing Example

•The forecast for period 3 is computed similarly:

F3 = α D2 + (1 - α)F2 = (.30)(40) + (.70)(37) = 37.9 units

•The final forecast is for period 13, January, and is the forecast of interest to
PM Computer Services:
F13 = α D12 + (1 - α)F12 = (.30)(54) + (.70)(50.84) = 51.79 units
Time Series – Simple Exponential Smoothing
Time Series – Simple Exponential Smoothing

• In general, when demand is relatively stable, without any trend, using a small
value for α is more appropriate to simply smooth out the forecast.

• Alternatively, when actual demand displays an increasing (or decreasing)

trend, as is the case, a larger value of α is generally better.
Time Series –
Exponential Smoothing
ADJUSTED EXPONENTIAL SMOOTHING
•The adjusted exponential smoothing forecast consists of the exponential
smoothing forecast with a trend adjustment factor added to it.
•The formula for the adjusted forecast is:
Time Series –
Exponential Smoothing
ADJUSTED EXPONENTIAL SMOOTHING
•The trend factor is computed much the same as the exponentially
smoothed forecast.
•It is, in effect, a forecast model for trend:
Time Series –
Exponential Smoothing
ADJUSTED EXPONENTIAL SMOOTHING

•Like α, β is a value between 0 and 1.

•It reflects the weight given to the most recent trend data.

•Also like α, β is often determined subjectively, based on the judgment of the

forecaster.
Time Series –
Exponential Smoothing
ADJUSTED EXPONENTIAL SMOOTHING

•A highβ reflects trend changes more than a low β.

•It is not uncommon for β to equal α in this method.

•The closer βis to one, the stronger a trend is reflected.

Time Series –
Exponential Smoothing
SIMPLE EXPONENTIAL SMOOTHING
Adjusted Exponential Smoothing Example

• PM Computer Services now wants to develop an adjusted exponentially

smoothed forecast, using the same 12 months of demand.

• The adjusted forecast for February, AF2, is the same as the exponentially
smoothed forecast because the trend computing factor will be zero (i.e., F1
and F2 are the same and T2 = 0).
Time Series –
Exponential Smoothing
SIMPLE EXPONENTIAL SMOOTHING
Adjusted Exponential Smoothing Example

•Thus, we will compute the adjusted forecast for March, AF3, as follows,
starting with the determination of the trend factor, T3:
Time Series –
Exponential Smoothing
SIMPLE EXPONENTIAL SMOOTHING
Adjusted Exponential Smoothing

•Period 13 is computed as follows:

T13 = β(F13 - F12) + (1 β)T12 = (.30)(53.61 - 53.21) + (.70)(1.77) = 1.36
and

•AF13 = F13 + T13 = 53.61 + 1.36 = 54.96 units

Time Series – Simple Exponential Smoothing
Time Series – Simple Exponential Smoothing
Time Series –
Linear Trend Line
Linear Trend Line

A Time Series is a sequence of data points recorded at regular time intervals.

Think of it like tracking something over time, such as:

Daily temperature
Monthly sales
Yearly population growth
Time Series –
Linear Trend Line
Linear Trend Line
Linear regression is most often thought of as a causal method of forecasting
in which a mathematical relationship is developed between demand and
some other factor that causes demand behavior.

However, when demand displays an obvious trend over time, a least squares
regression line, or linear trend line, can be used to forecast demand.

A linear trend line is a linear regression model that relates demand to time.
Time Series – Linear Trend Line
The linear regression takes form of a linear equation as follows:

01 where

a = intercept
b = slope of the line
x = the time period
y = forecast for demand for period x
Time Series – Linear Trend Line
The linear regression takes form of a linear equation as follows:

02 The parameters of the trend line

may be calculated as follows:
Where,

and and
Time Series – Linear Trend Line
The linear regression takes form of a linear equation as follows:

x (period) y (demand) xy x2
1 37 37 1
2 40 80 4
3 41 123 9
4 37 148 16
5 45 225 25
6 50 300 36
7 43 301 49
8 47 376 64
9 56 504 81
10 52 520 100
11 55 605 121
12 54 648 144
78 557 3,867 650
Time Series – Linear Trend Line
Using these values for ẋ and ӯ the values, the parameters for the
linear trend line are computed as follows:

x (period) y (demand) xy x2

1 37 37 1

2 40 80 4

3 41 123 9

4 37 148 16

5 45 225 25

6 50 300 36

7 43 301 49

8 47 376 64

9 56 504 81

10 52 520 100

11 55 605 121

12 54 648 144

78 557 3,867 650

Time Series – Linear Trend Line
Therefore, the linear trend line is

y = 35.2 + 1.72x

To calculate a forecast for period 13, x = 13 would be substituted in the

linear trend line:

y = 35.2 + 1.72(13) = 57.56

A linear trend line will not adjust to a change in trend as will exponential
smoothing.
Time Series – Linear Trend Line
Time Series –
Seasonal Adjustments
Seasonal Adjustments

Many demand items exhibit seasonal behavior or pattern, that is, a

repetitive up-and-down movement in demand. It is possible to adjust the
seasonality of a normal forecast by multiplying it by a seasonal factor.

A seasonal factor, which is a numerical value is multiplied by the normal

forecast to get a seasonally adjusted forecast.
Time Series –
Seasonal Adjustments
Seasonal Adjustments

One method for developing a demand for seasonal factors is dividing the actual demand for
each seasonal period by the total annual demand, according to the following formula:

The resulting seasonal factors are between 0 and 1.

These seasonal factors are thus multiplied by the annual forecasted demand to yield seasonally
adjusted forecasts for each period.
Time Series – Seasonal Adjustments
Example Problem 1:

A company sells winter jackets and records the following quarterly demand over the past year:

Quarter Actual Demand

Q1 1,200
Q2 1,800
Q3 2,400
Q4 2,600

The marketing team forecasts a total annual demand of 3,600 jackets for next year.

Calculate the seasonal factors for each quarter.

Use the seasonal factors to estimate the seasonally adjusted forecast for each quarter next
year.
Time Series – Seasonal Adjustments
Example Problem 1:

📌 Step 1: Find the Total Actual Demand

📌 Step 2: Calculate Seasonal Factors using:

Time Series – Seasonal Adjustments
Example Problem 1:

📌 Step 2: Calculate Seasonal Factors using:

Quarter Seasonal Factor

Q1 1,200 1,200 / 8,000 0.15

Q2 1,800 1,800 / 8,000 0.225

Q3 2,400 2,400 / 8,000 0.3

Q4 2,600 2,600 / 8,000 0.325

✅ Check: 0.15 + 0.225 + 0.30 + 0.325 = 1.0

Time Series – Seasonal Adjustments
Example Problem 1:

📌 Step 3: Apply Seasonal Factors to the Forecasted Annual Demand

Annual forecast: 3,600 Jackets

Quarter Seasonal Factor Forecasted Demand

Q1 0.15 3,600 × 0.15 = 540

Q2 0.225 3,600 × 0.225 = 810

Q3 0.3 3,600 × 0.30 = 1,080

Q4 0.325 3,600 × 0.325 = 1,170

✅ Total = 540 + 810 + 1,080 + 1,170 = 3,600 jackets

Time Series – Seasonal Adjustments
Example Problem 1:

📋 Final Answer:
Seasonal Factors: Seasonally Adjusted Forecast:
Q1: 0.15 Q1: 540 jackets
Q2: 0.225 Q2: 810 jackets
Q3: 0.30 Q3: 1,080 jackets
Q4: 0.325 Q4: 1,170 jackets
Time Series – Seasonal Adjustments
Seasonal Adjustments Example 2:
Turkey Demand (1,000s)

Year QUARTER 1 QUARTER 2 QUARTER 3 QUARTER 4 TOTAL

2003 12.6 8.6 6.3 17.5 45

2004 14.1 10.3 7.5 18.2 50.1

2005 15.3 10.6 8.1 19.6 53.6

Total 42 29.5 21.9 55.3 148.7

Next, multiply the forecasted

demand for the next year, 2006,
by each of the seasonal factors
to get the forecasted demand
for each quarter.
Time Series – Seasonal Adjustments
Seasonal Adjustments Example 2:
Turkey Demand (1,000s)
Year QUARTER 1 QUARTER 2 QUARTER 3 QUARTER 4 TOTAL
2003 12.6 8.6 6.3 17.5 45
2004 14.1 10.3 7.5 18.2 50.1
2005 15.3 10.6 8.1 19.6 53.6
Total 42 29.5 21.9 55.3 148.7

However, to accomplish this, we need a demand forecast for 2006.

In this case, because the demand data in the table seem to exhibit a generally increasing trend,
we compute a linear trend line for the 3 years of data in the table to use as a rough forecast
estimate:
y = 40.97 + 4.30x = 40.97 + 4.30(4) = 58.17 or 58,170 turkey
Time Series – Seasonal Adjustments
Seasonal Adjustments Example 2:
Turkey Demand (1,000s)
Year QUARTER 1 QUARTER 2 QUARTER 3 QUARTER 4 TOTAL
2003 12.6 8.6 6.3 17.5 45
2004 14.1 10.3 7.5 18.2 50.1
2005 15.3 10.6 8.1 19.6 53.6
Total 42 29.5 21.9 55.3 148.7

Using this annual forecast of demand, the seasonally adjusted forecasts, SFi, for 2006 are as
follows:
Thank You
For Listening!