FORECASTING

Forecasting-Need, Types and Methods (Qualitative and Quantitative)-Forecasting

Errors, Cost and Accuracy of Forecasting Methods.
When a game of cricket or football is played, spectators predict which team will
win. Each tries to give reasons for such a prediction. Same is the case in horse
racing where people bet. There are various kinds of predictions like astrological
and weather etc. When various factors the past and present performances are
also taken into account, the prediction becomes a little more scientific. It is called
forecast. Forecast involves calculations. It is a calculated guess or prediction.
Hence forecast may not be perfect. It may be erroneous. The extent of error in
forecast and methodology used to forecast therefore are important. Then why
forecast in Management activities?
Forecast has become fundamental activity of management just as planning is the
essence. It is extensively used in national policy making and planning. National
trends in population, economics, energy, transportation and technology over a
period are very useful in forecasting the demand in immediate short and long
term periods. Both quantitative and qualitative forecasting techniques are used.
In business, forecasting is useful and largely applied in the following areas:1.
2.
3.
4.

Financial & economic

Sales
Inventory control
Simulation.

Every business is affected or influenced by both largely uncontrollable external

and fairly controllable internal environments. National economy, customers or
consumers and competitors influence uncontrollable external environment.
Marketing, production, financial and executive functions in an organization
influence controllable internal environment. Business cycle trends, competition,
its products and prices, customers characteristics like incomes, consumption
pattern, preference etc Advertisement, distribution, product design & features,
inventions etc influence the industry demand and the companys share. Based on
these, each company prepares its own marketing plans and strategies, product
and production plans. This is based on a sales forecast or in other words the
demand that will be created. This forecast forms the basis for production plans.
Hence the accuracy of forecast becomes crucial to the success of the company and
its profits.
Dr. M KOTEESWARAN

MBA II SEM

POM 2012

Hand Out 2

Page 21

FORECASTING

Forecasting for the next periods of activities-sales or service, will decide the
scheduling resources of production, transportation, cash, workers etc. It will
decide the demands for product, men, machines, material and money in different
time periods.
The scheduling will lead to determining the resource needs and acquiring them.
Thus forecasting links every activity of the business and in short drives and
directs the business itself. Errors in forecasting and slippages in forecast plans
could lead to lost opportunities and business loss.
Patterns
1. Horizontal when data valued are around a constant mean. Products which
sell without significant increase or decrease in demand. The demand is
stationary.
2. Seasonal where the demand is influenced by seasonal factors like higher
demand for cold drinks during summer months, higher demand for fans
and AC during summer months and heaters during winter. More sales of
apparels during festive seasons etc.
3. Cyclical where the sale of products follow business cycle as in the case of
cars and major appliances.
4. Trend is a long term increase or decrease in valued as in the case of
consumption of electricity, sale of housing flats, cars and cycles etc.
Forecasting Models
Both quantitative and qualitative techniques are used for forecasting. They are
Simple Moving Average
Double Moving Average
Single exponential Smoothing
Double exponential Smoothing
Simple regression
Multiple regressions
Delphi type Market survey} Qualitative Techniques.
Choice of technique depends on several factors such as
Period
Dr. M KOTEESWARAN

MBA II SEM

POM 2012

Hand Out 2

Page 22

FORECASTING
Pattern of data
Cost
Accuracy
Ease of application
Forecasting alone is not enough. Its accuracy is more important. Hence there are
methods to measure the accuracy of forecast or to measure the error in forecast.
They are
MAD - Mean Absolute Deviation
MSE - Mean Square Error
MFE Mean Forecast Error
MAPE Mean Absolute % Error
Moving Average Method
Forecasting is based on the actual demands over several periods of time.
The recent values may reflect the current trend. Hence the average of the set of
recent values is taken and continued sequentially.

1
2
3

Demand for
the period
D1
D1 = 100
D2 = 110
D3 = 90

D4 = 118

D5 = 101

D6 = 108

Period

Moving Average for 3

periods (M)

M1
100
M2
106
M3
103
M4
109

= (D1+D2+D3)/3 =

Forecast
(F)

Error
(e)

= (D2+D3+D4)/3 = F1 = 100
= (D3+D4+D5)/3 = F2 = 106
= (D4+D5+D6)/3 = F3 = 103

(D4
-F1)=
+18
(D5-F2)
=
-5
(D6-F3)
=
+5

The moving average may be calculated for different sets of periods like
3 periods Moving Average (D1+D2+D3)/3
4 periods Moving Average (D1+D2+D3+D4)/4
6 periods Moving Average (D1+D2+D3+D4+D5+D6)/6. etc.
Dr. M KOTEESWARAN

MBA II SEM

POM 2012

Hand Out 2

Page 23

FORECASTING

It may be seen that the Mean forecast error is different for different sets. To
correct this, weightage or a factor is assigned to each period of the set to reflect
the reality, the most recent period being assigned the heaviest weightage like in a
3 months moving average, the weightage for 1,2, & 3 periods may be assigned as
0.2, 0.3, and 0.5.
The Moving Average M1
=

0.2*D1+0.3*D2+0.5*D3
0.2 + 0.3 + 0.5

M2 = 0.2*D2+0.3*D3+0.5*D4
M3 = 0.2*D3+0.3*D4+0.5*D5 and so on.
Single Exponential Smoothing is a method which adjusts the forecast for each
period in proportion to the difference between the actual demand and forecast
made for the previous period.
So Forecast for 3rd period t3 is
F3= F2 + (D2-F2)
= D2 + (1-) F2 where is between more than 0 and less than 1
Period
1
2
3
4
5

Dr. M KOTEESWARAN

Demand
D
100
120
130
160
150

MBA II SEM

Forecast
F
110
108
110

POM 2012

Hand Out 2

Page 24

FORECASTING
Assume = 0.2
F2 = D1 + (1 ) F1
= 0.2 * 100 + 0.8*110
= 20 + 88 = 108
F3 = .2 * 120 + .8*108
= 24 + 86 = 110.
Linear Regression is to ascertain the relationship between dependent and
independent variables like profit and sales. It is given by y = a+bx.
Y and X are the dependent and independent variables and a and b are
constant and trend respectively.
a= Y -b X
b = XY n XY
X2 n X 2
& Y = Y
X = X
n
n
Various types of vehicles are manufactured and sold like passenger cars,
public transport vehicles, 2 and 3 wheelers. The production depends on
the forecast and sale the actual demand. The data over a period help to
build up a model for forecasting.
The error on accuracy is calculated using MAD, MSE, MFE, MAPE.
n
MAD = |Dt Ft|
1_________________

n
n
MSE = ( Dt Ft)2
1_________________

n
w
MFE = ( Dt Ft)
Dr. M KOTEESWARAN

MBA II SEM

POM 2012

Hand Out 2

Page 25

FORECASTING
1_________________

MAPE =

1
n

n
|Dt Ft|
1_________________

* 100

Dt

Dr. M KOTEESWARAN

MBA II SEM

POM 2012

Hand Out 2

Page 26