FORECASTING

FORECAST – a statement about the future value of a variable of interest. We make forecasts about such
things as weather, demand, and resource availability.It is important element in making informed
decisions.

TWO (2) IMPORTANT ASPECTS OF FORECASTS

1. Expected level of demand- The level of demand may be a function of some structural variation
such as trend or seasonal variation
2. Accuracy- Related to the potential size of forecast error

FEATURES COMMON TO ALL FORECASTS

1. Techniques assume some underlying causal system that existed in the past will persist into the
future
2. Forecasts are not perfect
3. Forecasts for groups of items are more accurate than those for individual items
4. Forecast accuracy decreases as the forecasting horizon increases

ELEMENTS OF GOOD FORECASTS

• Forecast should be timely
• Forecast should be accurate
• Forecast should be reliable
• Forecast should be expressed in
meaningful units
• Forecast should be in writing
• Forecasting technique should be simple
to understand and use
• Forecast should be cost effective
STEPS IN FORECASTING PROCESS
1. Determine the purpose of the forecast
2. Establish a time horizon
3. Select a forecasting technique
4. Obtain, clean, and analyze appropriate
data
5. Make the forecast
6. Monitor the forecast

Forecasting Approaches
• Qualitative Forecasting
– Qualitative techniques permit the inclusion of sof information such as: Human factors,
Personal opinions. (These factors are difficult, or impossible, to quantify)

• Quantitative Forecasting
– Quantitative techniques involve either the projection of historical data or the
development of associative methods that attempt to use causal variables to make a
forecast. These techniques rely on hard data
CLASSIFICATION OF FORECASTING TECHNIQUES
1. JUDGMENTAL FORECASTS- Forecast that use subjective inputs such as opinions from consumer
surveys, sales staff, managers, executives and experts. Ex. Small group of upper level managers
meet collectively develop a forecast. This approach is often used as a part of a long-range
planning and new product development. It has the advantage of bringing together the
considerable knowledge and talents of various managers. There is the risk that the view of one
person will prevail.
2. TIME-SERIES FORECASTS- Forecasts that projects patterns identified in recent time-series
observations.

FORECASTS BASED ON TIME SERIES DATA

TIME SERIES is a time ordered sequence of observations taken at regular intervals. (Ex. Hourly, daily,
weekly, monthly, quarterly, annually) the data may be measurements of demand, earnings, profits,
shipments, accidents, output, precipitation, productivity or the consumer price index.

TIME SERIES BEHAVIORS

 TRENDS- refer to a long term upward or downward movement in the data. (Population shifts,
Changing incomes)
 SEASONALITY- refer to a short term, fairly regular variations generally related to factors such as
the calendar or time of day. (Restaurants, service call centers, and theaters all experience
seasonal demand)
 CYCLES- Wavelike variations lasting more than one year’s duration. These are often related to a
variety of economic, political, or even agricultural conditions
 IRREGULAR VARIATIONS- Are due to unusual circumstances such as severe weather conditions,
strikes or major changes in a product or service.
 RANDOM VARIATIONS- are residual variations that remain after all other behaviours have been
accounted for.

3. ASSOCIATIVE MODEL- Forecasting technique that uses explanatory variables to predict future
demand. Ex. Demand for paint might be related to variables such as the price per gallon and the
amount spent on advertising, as well as to specific characteristics of the paint. (drying time, ease
of cleanup)
 Forecast Accuracy and Control

• Forecasters want to minimize forecast errors

– It is nearly impossible to correctly forecast real-world variable values on a regular basis
– So, it is important to provide an indication of the extent to which the forecast might
deviate from the value of the variable that actually occurs
• Forecast accuracy should be an important forecasting technique selection criterion
• Forecast errors should be monitored
1. Error = Actual – Forecast
2. If errors fall beyond acceptable bounds, corrective action may be necessary

FORECAST ACCURACY METRICS

MAD 
 Actual t  Forecast t MAD weights all errors evenly
n
MSE weights errors according to their squared values
  Actual  Forecast t 
2
t
MSE 
n 1
Actualt  Forecast t
 Actualt
100 MAPE weights errors according to relative error
MAPE 
n

Actual Forecast (A-F)

Period
(A) (F) Error |Error| Error2 [|Error|/Actual]x100
1 107 110 -3 3 9 2.80%
2 125 121 4 4 16 3.20%
3 115 112 3 3 9 2.61%
4 118 120 -2 2 4 1.69%
5 108 109 1 1 1 0.93%
Sum 13 39 11.23%
n=5 n-1 = 4 n=5
MSE=
MAD =2.6 MAPE =2.25%
9.75