FORECASTING TECHNIQUES

Qualitative Approaches to Forecasting

Quantitative Approaches to Forecasting
The Components of a Time Series
Using Smoothing Methods in Forecasting
Measures of Forecast Accuracy
Using Trend Projection in Forecasting
Using Regression Analysis in Forecasting

1
 Forecasting Introduction

An essential aspect of managing any organization is

planning for the future.
Organizations employ forecasting techniques to
determine future inventory, costs, capacities, and
interest rate changes.
There are two basic approaches to forecasting:
-Qualitative
-Quantitative

2
 Qualitative Approaches to Forecasting

Delphi Approach
– A panel of experts, each of whom is physically separated from
the others and is anonymous, is asked to respond to a
sequential series of questionnaires.
– After each questionnaire, the responses are tabulated and the
information and opinions of the entire group are made known to
each of the other panel members so that they may revise their
previous forecast response.
– The process continues until some degree of consensus is
achieved.

3
 Qualitative Approaches (continued)

Scenario Writing
– Scenario writing consists of developing a conceptual scenario
of the future based on a well defined set of assumptions.
– After several different scenarios have been developed, the
decision maker determines which is most likely to occur in the
future and makes decisions accordingly.

4
 Qualitative Approaches (continued)

Subjective or Interactive Approaches

– These techniques are often used by committees or panels
seeking to develop new ideas or solve complex problems.
– They often involve "brainstorming sessions".
– It is important in such sessions that any ideas or opinions be
permitted to be presented without regard to its relevancy and
without fear of criticism.

5
 Quantitative Approaches to Forecasting

Quantitative methods are based on an analysis of historical data

concerning one or more time series.
A time series is a set of observations measured at successive
points in time or over successive periods of time.
If the historical data used are restricted to past values of the series
that we are trying to forecast, the procedure is called a time series
method.
If the historical data used involve other time series that are believed
to be related to the time series that we are trying to forecast, the
procedure is called a causal method.
Quantitative approaches are generally preferred. In this chapter we
will focus on quantitative approaches to forecasting.

6
 Time Series Data

Time Series Data is usually plotted on a graph to

determine the various characteristics or components of
the time series data.
There are 4 Major Components: Trend, Cyclical,
Seasonal, and Irregular Components.

7
 Components of a Time Series

The trend component accounts for the gradual shifting

of the time series over a long period of time.
Any regular pattern of sequences of values above and
below the trend line is attributable to the cyclical
component of the series.
The seasonal component of the series accounts for
regular patterns of variability within certain time periods,
such as over a year.
The irregular component of the series is caused by
short-term, unanticipated and non-recurring factors that
affect the values of the time series. One cannot attempt
to predict its impact on the time series in advance.

8
 Time Series Data

We will learn the following Forecasting Approaches:

Smoothing
Trend Projections

9
 Excel Instructions for Drawing a Scatter Plot

1. Enter data in the Excel spreadsheet.

2. Click on Insert on the toolbar and then click on the Chart tab. The
Chart Wizard will appear. In step 1 on select the XY (scatter) chart
type and then click next.
3. In step 2 specify the cells where your data is located in the data
range box.
4. In step 3 you can give your chart a title and label your axes. In
step 4 specify where you want the chart to be placed.

10
 Example: Robert’s Drugs
During the past ten weeks, sales of cases of Comfort
brand headache medicine at Robert's Drugs have been as follows:

Week Sales Week Sales

1 110 6 120
2 115 7 130
3 125 8 115
4 120 9 110
5 125 10 130

Plot this data.

11
 Plot Robert’s Drugs Example

Excel Spreadsheet Showing Input Data. Specify cells A4:B13 as the Data
Range. A B
1 Robert's Drugs
2
3 Week (t ) Salest
4 1 110
5 2 115
6 3 125
7 4 120
8 5 125
9 6 120
10 7 130
11 8 115
12 9 110
13 10 130
14 11
12
 Plot Robert’s Drugs Example
I labeled
Robert’s Drug
Robert's Drug Example
Example as
The Chart title
135
130
125
Sales

120
115
I labeled 110
Sales as 105 I labeled
My Value (y) Week, t as
0 5 10 15
axis My Value (x)
Week, t axis

13
 Smoothing Methods

In cases in which the time series is fairly stable and

has no significant trend, seasonal, or cyclical effects,
one can use smoothing methods to average out the
irregular components of the time series.
Three common smoothing methods are:
– Moving average
– Weighted moving average
– Exponential smoothing

14
 Smoothing Methods: Moving Average

Moving Average Method

The moving average method consists of
computing an average of the most recent n data values
for the series and using this average for forecasting the
value of the time series for the next period.

15
 Robert Drug’s Example: Moving Average

Our scatter plot for Robert’s Drug Sales has no

significant trend, seasonal, or cyclical effects. Thus we
should employ a smoothing technique for forecasting
sales.

Forecast the sales for period 11 using a three period

moving average (MA3).

16
 Example: Robert’s Drugs: Moving Average

Steps to Moving Average Using Excel

Step 1: Select the Tools pull-down menu.
Step 2: Select the Data Analysis option.
Step 3: When the Data Analysis Tools dialog
appears, choose Moving Average.
Step 4: When the Moving Average dialog box
appears:
This specifies
Enter B4:B13 in the Input Range
the value of nbox.

This is the column Enter 3 in the Interval box.

following our data,
and one row below where
Enter C5 in the Output Range box.
our data begins. Select OK.
17
 Robert’s Drugs: Moving Average

MA3 (Three period Moving average) for Robert’s Drug Example

Robert's Drug Ft is the forecast for week t.

n=3
Week (t ) Yt Ft
1 110
2 115 #N/A
3 125 #N/A F4 (forecast for week 4)=116.7
4 120 116.6667
5 125 120
6 120 123.3333
7 130 121.6667
8 115 125
9 110 121.6667
10 130 118.3333
11 118.3333 F11 (forecast for week 11)=118.3
Thus we would forecast the sales
for Week 11 to be 118.3
18
Smoothing Methods: Weighted Moving Average

Weighted Moving Average Method

The weighted moving average method consists of computing a
weighted average of the most recent n data values for the series
and using this weighted average for forecasting the value of the
time series for the next period. The more recent observations are
typically given more weight than older observations. For
convenience, the weights usually sum to 1.
The regular moving average gives equal weight to past data
values when computing a forecast for the next period. The
weighted moving average allows different weights to be allocated
to past data values.
There is no Excel command for computing this so you must do this
manually. You can either manually enter the formulas into excel
and apply to all periods or compute value by hand.

19
 Smoothing Methods: Weighted Moving Average

Use a 3 period weighted moving average to forecast the sales for

week 11 giving a weight of 0.6 to the most recent period, 0.3 to the
second most recent period, and 0.1 to the third most recent period.

F11 = (0.6)*130 + (0.3)*110 + (0.1)* 115= 122.5

Sales for the Sales for 2nd Sales for 3rd

most recent most recent most recent
period period period

Thus we would forecast the sales for week 11 to be 122.5.

20
 Smoothing Methods: Exponential Smoothing
Exponential Smoothing
– Using exponential smoothing, the forecast for the next
period is equal to the forecast for the current period plus a
proportion () of the forecast error in the current period.
– Using exponential smoothing, the forecast is calculated by:
Ft+1=Yt + (1- )Ft This is the same as
Ft+1 = Ft + α (Yt – Ft)
where:
 is the smoothing constant (a number between 0 and
1)
Ft is the forecast for period t
Ft +1 is the forecast for period t+1
Yt is the actual data value for period t
21
 Robert’s Drugs: Exponential Smoothing

Forecast the sales for period 11 using Exponential

Smoothing α= 0.1.

22
 Robert’s Drugs: Exponential Smoothing

Steps to Exponential Smoothing Using Excel

Step 1: Select the Tools pull-down menu.
Step 2: Select the Data Analysis option.
Step 3: When the Data Analysis Tools dialog
appears, choose Exponential Smoothing.
Step 4: When the Exponential Smoothing dialog box
appears:
Enter B4:B13 in the Input Range box.
Damping factor Enter 0.9 (for  = 0.1) in Damping Factor
is always 1-α box.
Enter C4 in the Output Range box.
Select OK.

23
 Robert’s Drugs: Exponential Smoothing
Robert's Drugs
α=0.1
Week (t ) Salest Ft
1 110 #N/A
2 115 110
3 125 110.5
4 120 111.95
5 125 112.755
6 120 113.9795
7 130 114.5816
8 115 116.1234
9 110 116.0111
10 130 115.4099
11

F11 = 0.1 * Y10 + .9 F10

Thus we would
= .1 *130 + .9 * 115.4099
forecast sales for
week 11 to be 116.87 = 116.87

24
 Questions That You Should Be Asking

For the Moving Average technique, how do I determine the best

value of n to use for forecasting?
For Exponential Smoothing, how do I determine the best value of α
to use?
If I realize that a smoothing technique should be employed, how do
you know which smoothing technique is best?

In order to answer the above questions, we need criteria for

judging the accuracy of a forecasting technique. Once we select a
criterion, the method (or parameter) which provides the best value
for our criterion is the best method (or parameter) to use for
forecasting our scenario.

25
 Measures of Forecast Accuracy
Mean Squared Error (MSE)
The average of the squared forecast errors for the historical data is
calculated. The forecasting method or parameter(s) which minimize
this mean squared error is then selected.

Mean Absolute Deviation (MAD)

The mean of the absolute values of all forecast errors is calculated,
and the forecasting method or parameter(s) which minimize this
measure is selected. The mean absolute deviation measure is less
sensitive to individual large forecast errors than the mean squared
error measure.

You may choose either of the above criteria for evaluating the
accuracy of a method (or parameter).

26
Selecting the best Smoothing Technique for Robert’s Drugs

Determine the smoothing technique that is best for forecasting

Robert’s Drug sales: A two period moving average, a three period
moving average, exponential smoothing (α=0.1), or exponential
smoothing (α=0.2)

Realistically we should have experimented with more values of n

for the moving average, and α for exponential smoothing to
determine the absolute best parameters to use for our technique.

On the next slide we randomly chose to use the MSE criterion to

judge the best technique.

27
 Robert’s Drugs :Comparing Smoothing Techniques
Double click on the Excel sheet below to enter actual Excel spreadsheet
that I created. Clicking on individual cells will provide the formulas that were
entered to compute the observed values.
Robert's Drug
Sales n=2 Error
2
Week (t ) Yt Ft (Yt - Ft) (Yt - Ft) MSE for MA2
1 110
2 115 #N/A
3 125 112.5 12.5 156.25
4 120 120 0 0
5 125 122.5 2.5 6.25
6 120 122.5 -2.5 6.25
7 130 122.5 7.5 56.25
8 115 125 -10 100
9 110 122.5 -12.5 156.25
10 130 112.5 17.5 306.25
11 120
MSE 98.4375

Dr. C. Lightner 28
Fayetteville State University
 Robert’s Drugs :Comparing Smoothing Techniques
Robert's Drug
Sales n=3 Error
2
Week (t ) Yt Ft (Yt - Ft) (Yt - Ft)
1 110
2 115 #N/A
3 125 #N/A MSE for MA3
4 120 116.6667 3.333333 11.11111
5 125 120 5 25
6 120 123.3333 -3.33333 11.11111
7 130 121.6667 8.333333 69.44444
8 115 125 -10 100
9 110 121.6667 -11.6667 136.1111
10 130 118.3333 11.66667 136.1111
11 118.3333
MSE 69.84127

29
Robert’s Drugs :Comparing Smoothing Techniques

Sales α=0.1 Error

2
Week (t ) Yt Ft (Yt - Ft) (Yt - Ft)
1 110 #N/A
2 115 110 5 25
3 125 110.5 14.5 210.25 MSE for Exponential
Smoothing α=0.1
4 120 111.95 8.05 64.8025
5 125 112.755 12.245 149.94
6 120 113.9795 6.0205 36.24642
7 130 114.5816 15.41845 237.7286
8 115 116.1234 -1.1234 1.262016
9 110 116.0111 -6.01106 36.13279
10 130 115.4099 14.59005 212.8696
11
MSE 108.248

30
 Robert’s Drugs :Comparing Smoothing Techniques
Sales α=0.2 Error
2
Week (t ) Yt Ft (Yt - Ft) (Yt - Ft)
1 110 #N/A
2 115 110 5 25
3 125 111 14 196
4 120 113.8 6.2 38.44
MSE for Exponential
5 125 115.04 9.96 99.2016 Smoothing α=0.2
6 120 117.032 2.968 8.809024
7 130 117.6256 12.3744 153.1258
8 115 120.1005 -5.10048 26.0149
9 110 119.0804 -9.08038 82.45337
10 130 117.2643 12.73569 162.1979
11
MSE 87.91584

31
Robert’s Drugs :Comparing Smoothing Techniques

Since the three period moving average technique

(MA3) provides to lowest MSE value, this is the best
smoothing technique to use for forecasting Robert’s
Drug Sales.

32
 Trend Projection

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.
Least squares, also used in regression analysis, determines the
unique trend line forecast which minimizes the mean square
error between the trend line forecasts and the actual observed
values for the time series.
The independent variable is the time period and the dependent
variable is the actual observed value in the time series.

33
 Trend Projection
Using the method of least squares, the formula for the trend
projection is:
Yt = b0 + b1t.

where: Yt = trend forecast for time period t

b1 = slope of the trend line
b0 = trend line projection for time 0

b0  Y  b1 t
b1 = ntYt - t Yt
nt 2 - (t )2
where: Yt = observed value of the time series at time period t
t
Y
= average of the observed values for Yt
t
=t average time period for the n observations
34
 Example: Auger’s Plumbing Service
The number of plumbing repair jobs performed by Auger's Plumbing
Service in each of the last nine months are listed below.
Month Jobs Month Jobs Month Jobs
March 353 June 374 September 399
April 387 July 396 October 412
May 342 August 409 November 408

Forecast the number of repair jobs Auger's will perform in

December using the least squares method.

35
 Auger’s Plumbing Service: Trend Projection
Trend Projection
(month) t Yt tYt t2
(Mar.) 1 353 353 1
(Apr.) 2 387 774 4
(May) 3 342 1026 9
(June) 4 374 1496 16
(July) 5 396 1980 25
(Aug.) 6 409 2454 36
(Sep.) 7 399 2793 49
(Oct.) 8 412 3296 64
(Nov.) 9 408 3672 81
Sum 45 3480 17844 285
36
 Example: Auger’s Plumbing Service
Trend Projection (continued)

t t = 45/9 = 5 Y = 3480/9 = 386.667

ntYt -  t  Yt (9)(17844) - (45)(3480)

b1 = = = 7.4
n  t 2 - ( t)2 (9)(285) - (45)2

b0  Y  b1 t = 386.667 - 7.4(5) = 349.667

Thus our trend line is Yt = 349.667 + 7.4 t.

Y10 = 349.667 + (7.4)(10) = 423.667

For December t=10 37
Auger’s Plumbing Service: Trend Line in Excel

Excel Spreadsheet Showing Input Data

A B C
1 Auger's Plumbing Service
2
3 Month Calls
4 1 353
5 2 387
6 3 342
7 4 374
8 5 396
9 6 409
10 7 399
11 8 412
12 9 408
13
38
 Example: Auger’s Plumbing Service

Steps to Trend Projection Using Excel

Step 1: Select an empty cell (B13) in the worksheet.
Step 2: Select the Insert pull-down menu.
Step 3: Choose the Function option.
Step 4: When the Select Category dialog box appears:
Choose Statistical in Function Category box.
Choose Forecast in the Function Name box.
Select OK.
Step 5: When the Forecast dialog box appears:
Enter 10 in the x box (for month 10).
Enter B4:B12 in the Known y’s box.
Enter A4:A12 in the Known x’s box.
Select OK.
39
 Example: Auger’s Plumbing Service

Spreadsheet Showing Trend Projection for Month 10

Auger's Plumbing Service

Month Calls
1 353
2 387
3 342
4 374
5 396
6 409
7 399
8 412
9 408
10 423.667 Projected

40
 Roberts Drug Example
Suppose we neglected to plot Robert’s Drug example, and therefore we
do not know that a trend does not exist. Use trend analysis to forecast
the sales for month 11.
Week (t ) Yt
1 110
2 115
3 125
4 120
5 125
6 120
7 130
8 115
9 110
10 130
11 124 Forecast

41
 Question????

How could we use the MSE or MAD to verify that the

MA3 is a better smoothing technique than trend analysis
for Robert’s Drug Sales data?

42
 Causal Method: Regression Analysis

Regression Analysis is similar to trend analysis, except

the independent variable is not restricted to time. Refer
to Robert’s Drug example. Instead of letting time
represent our independent variable, we could forecast
sales based upon the price of the product. Since
products often go on sale, we could collect data over
several months collecting the weekly price and number
of items sold for the week. For this model, we would
find the regression equation in the same manner in
which we found the trend line except we would call the
independent variable x, instead of t.

43
 Regression Equation
Using the method of least squares, the formula for the regression
line is:
Y = b0 + b1x.

where: Y= dependent variable which depends on the value of x

b1 = slope of the regression line
b0 = regression line projection for x= 0

b1 = nXiYi - Xi Yi b0  y  b1 x

nXi2 - (Xi)2
where: Yt = observed value of the time series at time period t
t
Y
= average of the observed values for Yt
tt
= average time period for the n observations
44
 Regression Analysis in Excel

The dependent variable Y can predicted using the

same forecast function in Excel as used to forecast a
trend line. Follow the same steps provided on slide 39.

45
The factors to be considered for making the choice
of techniques for forecasting are as follows:
(a) The purpose of forecast.
(b) The degree of accuracy desirable.
(c) The time period to be forecast.
(d) Cost and benefit of the forecast to the company.
(e) The time available for making the analysis.
(f) Component of the system for which forecast has to
be made.

46
Features of forecasting
It is concerned with future events.
It is necessary for planning process.
The impact of future events has to be considered in
the planning process.
It is a guessing of future events.
It considers all the factors which affect organizational
functions.
Personal observation also helps forecasting.

4
7
 Process of
1.
forecasting
Thorough preparation of foundation
The very purpose of thorough preparation of a
foundation is that the forecasting is based on the
foundation.
2. Estimation of future
The brightness of future period can be estimated in
consultation with the key personnel & it may be
communicated to all the employees of the business
unit.

4
8
 Cont….
3. Collection of results
Relevant records are prepared & maintained to collect
the result.
Comparison of results
4. The actual results are compared with estimated results
to know deviations. This will help the management to
estimate the future.
5. Refining the forecast
The forecast can be refined in the
light of deviations which seem to be more realistic.

4
9
 Importance of
1.
forecasting
Pivotal role in an organization:-
Many organizations have failed because of lack of
forecasting or faulty forecasting. The reason is that
planning is based on accurate forecasting.
2. Development of a business:-
The performance of specified objectives depends upon
the proper forecasting. So the development of a
business or an organization is fully based on the
forecasting.

5
0
Cont…
3. Co-ordination:-
Forecasting helps to collect the information about internal
and external factors. Thus collected information
provides a basis for co-ordination.
4. effective control:-
Management executive can ascertain the strength and
weaknesses of sub-ordinates or employees through
forecasting.
5. Key to success:-
All business organizations are facing risks.
Forecasting provides clues and reduce risk and
uncertainties. The management executives can save
the business and get success by taking appropriate
action. 5
1
Cont…
6.Implementation of project:-
Many entrepreneurs implement a project on the basis of
their experience .Forecasting helps an
entrepreneur to gain experience and ensures him
success.

7. Primacy to planning:-
The information required for planning is supplied by
forecasting. So, forecasting is the primacy to the
planning.

5
2
 Role of Forecasting:

Since planning involves the future, no usable plan can be

made unless the manager is able to take all possible future
events into account. This explains why forecasting is a critical
element in the planning process. In fact, every decision in the
organization is based on some sort of forecasting.
It helps the managers in the following ways:
1. Basis of Planning:
Forecasting is the key to planning. It generates the planning
process. Planning decides the future course of action which
is expected to take place in certain circumstances and
conditions. Unless the managers know these conditions, they
cannot go for effective planning.

53
Forecasting provides the knowledge of planning premises
within which the managers can analyse their strengths and
weaknesses and can take appropriate actions in advance
before actually they are put out of market. Forecasting
provides the knowledge about the nature of future conditions.
2. Promotion of Organization:
The objectives of an organisation are achieved through the
performance of certain activities. What activities should be
performed depends on the expected outcome of these
activities. Since expected outcome depends on future events
and the way of performing various activities, forecasting of
future events is of direct relevance in achieving an objective.

54
3. Facilitating Co-ordination and Control:
Forecasting indirectly provides the way for effective co-
ordination and control. Forecasting requires information
about various factors. Information is collected from
various internal and external sources. Almost all units of
the organisation are involved in this process.
It provides interactive opportunities for better unity and
co-ordination in the planning process. Similarly,
forecasting can provide relevant information for
exercising control. The managers can know their
weaknesses in the forecasting process and they can
take suitable action to overcome these.

55
 4. Success in Organisation:
All business enterprises are characterised by risk and
have to work within the ups and downs of the industry.
The risk depends on the future happenings and
forecasting provides help to overcome the problem of
uncertainties.
Though forecasting cannot check the future happenings, it
provides clues about those and indicates when the
alternative actions should be taken. Managers can save
their business and face the unfortunate happenings if
they know in advance what is going to happen.

56
Advantages
Effective handling of uncertainty
Better labor relations
Balanced work-load
Minimization in the fluctuations of production
Better use of production facilities
Better material management
Better customer service
Better utilization of capital and resources
Better design of facilities and production
system.
5
7
Limitation
Forecasting is to be made on the basis of certain
assumptions and human judgments which yield wrong
result.
It can not be considered as a scientific method for
guessing future events.
It does not specify any concrete relationship between past
and future events.
It requires high degree of skill.
It needs adequate reliable information so difficult to
collect reliable information.
Heavy cost and time consuming.
It can not be applied to a long period.

5
8