Forecasting

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For other uses, see Forecast (disambiguation). Forecasting is the process of making statements about events whose actual outcomes (typically) have not yet been observed. A commonplace example might be estimation of some variable of interest at some specified future date. Prediction is a similar, but more general term. Both might refer to formal statistical methods employing time series, cross-sectional or longitudinal data, or alternatively to less formal judgemental methods. Usage can differ between areas of application: for example, in hydrology, the terms "forecast" and "forecasting" are sometimes reserved for estimates of values at certain specific future times, while the term "prediction" is used for more general estimates, such as the number of times floods will occur over a long period. Risk and uncertainty are central to forecasting and prediction; it is generally considered good practice to indicate the degree of uncertainty attaching to forecasts. In any case, the data must be up to date in order for the forecast to be as accurate as possible.[1] Although quantitative analysis can be very precise, it is not always appropriate. Some experts in the field of forecasting have advised against the use of mean square error to compare forecasting methods. [2]

Definition of 'Forecasting'
The use of historic data to determine the direction of future trends. Forecasting is used by companies to determine how to allocate their budgets for an upcoming period of time. This is typically based on demand for the goods and services it offers, compared to the cost of producing them. Investors utilize forecasting to determine if events affecting a company, such as sales expectations, will increase or decrease the price of shares in that company. Forecasting also provides an important benchmark for firms which have a long-term perspective of operations

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Forecast Types
Sales Forecast:

What Customers will Order ($) Sales forecasting is a self-assessment tool for a company. You have to keep taking the pulse of your company to know how healthy it is. Sales forecast reports & graphs enable you to analyze the health of your business. It can make the difference between just surviving and being highly successful in business. It is a vital cornerstone of a company's budget. The future direction of the company may rest on the accuracy of your sales forecasting.
Demand Forecast:

What Needs to be Procured / Made to meet the Sales Forecast (Qty)Demand Forecasting is the activity of estimating the quantity of a product or service that consumers will

purchase and thus can be based on the Sales Forecast. However the Demand Forecast should strip out Inventory, apply supply chain constraints and accuracy factors.
Revenue Forecast:

Revenue Forecast: What Money will be made by meeting the Sales Forecast ($)The Revenue Forecast is an assessment of the profit that a company might make (gross cost = net) providing a financial baseline to measure achievement of business strategy.

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Contents
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1 Categories of forecasting methods

o o o o o o o o

1.1 Qualitative vs. quantitative methods 1.2 Nave approach 1.3 Reference class forecasting 1.4 Time series methods 1.5 Causal / econometric forecasting methods 1.6 Judgmental methods 1.7 Artificial intelligence methods 1.8 Other methods

2 Forecasting accuracy 3 Applications of forecasting 4 Limitations 5 See also 6 References 7 External links

[edit]Categories [edit]Qualitative

of forecasting methods
vs. quantitative methods

Qualitative forecasting techniques are subjective, based on the opinion and judgment of consumers, experts; appropriate when past data is not available. It is usually applied to intermediate-long range decisions. Examples of qualitative forecasting methods are:[citation needed] informed opinion and judgment, the Delphi method, market research, historical life-cycle analogy. Quantitative forecasting models are used to estimate future demands as a function of past data; appropriate when past data are available. The method is usually applied to short-intermediate range decisions. Examples of quantitative forecasting methods are:[citation needed] last period demand, simple and weighted moving averages (N-Period), simple exponential smoothing, multiplicative seasonal indexes.

[edit]Nave

approach

Nave forecasts are the most cost-effective and efficient objective forecasting model, and provide a benchmark against which more sophisticated models can be compared. For stable time series data, this approach says that the forecast for any period equals the previous period's actual value.

[edit]Reference

class forecasting

Reference class forecasting was developed by Oxford professor Bent Flyvbjerg to eliminate or reduce bias in forecasting by focusing on distributional information about past, similar outcomes to that being forecasted.[3] Daniel Kahneman, Nobel Prize winner in economics, calls Flyvbjerg's counsel to use reference class forecasting to de-bias forecasts, "the single most important piece of advice regarding how to increase accuracy in forecasting.[4]

[edit]Time

series methods

Time series methods use historical data as the basis of estimating future outcomes.

Moving average Weighted moving average Kalman filtering Exponential smoothing Autoregressive moving average (ARMA) Autoregressive integrated moving average (ARIMA) e.g. Box-Jenkins

Extrapolation Linear prediction Trend estimation Growth curve

[edit]Causal

/ econometric forecasting methods

Some forecasting methods use the assumption that it is possible to identify the underlying factors that might influence the variable that is being forecast. For example, including information about weather conditions might improve the ability of a model to predict umbrella sales. This is a model of seasonality which shows a regular pattern of up and down fluctuations. In addition to weather, seasonality can also be due to holidays and customs such as predicting that sales in college football apparel will be higher during football season as opposed to the off season.[5] Casual forecasting methods are also subject to the discretion of the forecaster. There are several informal methods which do not have strict algorithms, but rather modest and unstructured guidance. One can forecast based on, for example, linear relationships. If one variable is linearly related to the other for a long enough period of time, it may be beneficial to predict such a relationship in the future.

This is quite different from the aforementioned model of seasonality whose graph would more closely resemble a sine or cosine wave. The most important factor when performing this operation is using concrete and substantiated data. Forecasting off of another forecast produces inconclusive and possibly erroneous results. Such methods include:

Regression analysis includes a large group of methods that can be used to predict future values of a variable using information about other variables. These methods include both parametric(linear or non-linear) and non-parametric techniques.

Autoregressive moving average with exogenous inputs (ARMAX)[6]

[edit]Judgmental

methods

Judgmental forecasting methods incorporate intuitive judgements, opinions and subjective probability estimates.

Composite forecasts Delphi method Forecast by analogy Scenario building Statistical surveys Technology forecasting

[edit]Artificial

intelligence methods

Artificial neural networks Group method of data handling Support vector machines

Often these are done today by specialized programs loosely labeled

Data mining

[edit]Other

methods

Simulation Prediction market Probabilistic forecasting and Ensemble forecasting

[edit]Forecasting

accuracy

The forecast error is the difference between the actual value and the forecast value for the corresponding period.

where E is the forecast error at period t, Y is the actual value at period t, and F is the forecast for period t. Measures of aggregate error:

Mean absolute error (MAE)

Mean Absolute Percentage Error (MAPE)

Mean Absolute Deviation (MAD)

Percent Mean Absolute Deviation (PMAD)

Mean squared error (MSE)

Root Mean squared error (RMSE)

Forecast skill (SS)

Average of Errors (E)

Business forecasters and practitioners sometimes use different terminology in the industry. They refer to the PMAD as the MAPE, although they compute this as a volume weighted MAPE.[citation needed] For more information see Calculating demand forecast accuracy. Reference class forecasting was developed to increase forecasting accuracy by framing the forecasting problem so as to take into account available distributional information.[7] Daniel Kahneman, winner of the Nobel Prize in economics, calls the use of reference class forecasting "the single most important piece of advice regarding how to increase accuracy in forecasting.[8] Forecasting accuracy, in contrary to belief, cannot be increased by the addition of experts in the subject area relevant to the phenomenon to be forecast.[9] See also

Calculating demand forecast accuracy Consensus forecasts Forecast error Predictability Prediction intervals, similar to confidence intervals Reference class forecasting

[edit]Applications

of forecasting

The process of climate change and increasing energy prices has led to the usage of Egain Forecasting of buildings. The method uses forecasting to reduce the energy needed to heat the building, thus reducing the emission of greenhouse gases. Forecasting is used in the practice of Customer Demand Planning in every day business forecasting for manufacturing companies. Forecasting has also been used to predict the development of conflict situations. Experts in forecasting perform research that use empirical results to gauge the effectiveness of certain forecasting models.[10]Research has shown that there is little difference between the accuracy of forecasts performed by experts knowledgeable of the conflict situation of interest and that performed by individuals who knew much less.[11] Similarly, experts in some studies argue that role thinking does not contribute to the accuracy of the forecast.[12] The discipline of demand planning, also sometimes referred to as supply chain forecasting, embraces both statistical forecasting and a consensus process. An important, albeit often ignored aspect of forecasting, is the relationship it holds with planning. Forecasting can be described as predicting what the future will look like, whereas planning predicts what the future should look like.[13][14] There is no single right forecasting method to use. Selection of a method should be based on your objectives and your conditions (data etc.).[15] A good place to find a method, is by visiting a selection tree. An example of a selection tree can be found here.[16]Forecasting has application in many situations:

Supply chain management - Forecasting can be used in Supply Chain Management to make sure that the right product is at the right place at the right time. Accurate forecasting will help retailers reduce excess inventory and therefore increase profit margin. Studies have shown that extrapolations are the least accurate, while company earnings forecasts are the most reliable.[17] Accurate forecasting will also help them meet consumer demand.

Economic forecasting Earthquake prediction Egain Forecasting Land use forecasting Player and team performance in sports Political Forecasting Product forecasting Sales Forecasting Technology forecasting Telecommunications forecasting Transport planning and Transportation forecasting Weather forecasting, Flood forecasting and Meteorology

[edit]Limitations
As proposed by Edward Lorenz in 1963, long range weather forecasts, those made at a range of two weeks or more, are impossible to definitively predict the state of the atmosphere, owing to thechaotic nature of the fluid dynamics equations involved. Extremely small errors in the initial input, such as temperatures and winds, within numerical models doubles every five days.[18]

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