It is the process of predicting future events.

By using various Qualitative and Quantitative methods.

Underlying basis of all business decisions : Production, inventory etc.
Forecasting Time Horizon
On the basis of time horizon, Forecasting is of three types :
Short Range Forecast:
Time span up to one year but generally less than 3 months.
This forecast is used for planning, purchasing, job scheduling , job
assignment and determining the production level etc.
Medium Range Forecast :
Intermediate forecast ranging from 3 months to 3 years.
Useful for the purposes : Sales planning, production planning and
budgeting analysis of various operational plans.
Long Range Forecast :
It is 3 years or more in time span.
This forecast is used for the purposes like : planning for the new
product, capital expenditure, facility location, Research and
Development etc.
Difference between Short Range and
Long Range Forecasting
Short Range forecasting employs quantitative
techniques for production. It uses the techniques like :
Moving average method,
Exponential smoothing
Trend extrapolation etc.
Short term forecast is more accurate as it is for small
time horizon.
Long range forecast deals with more comprehensive
issues and support management decisions regarding
planning and products, plants and processes.
Types of Forecast
Forecasting can be categorised as :
Economic Forecast
Technological Forecast
Demand Forecast


Economic Forecast
It addresses the business cycle by predicting various
features like :
Inflation rates
Money supply etc.
It is helpful for the organisation to prepare medium and
long term forecast.
Technological Forecast
These are concerned with technological progress which
result in the birth of execution of a new product.
Predict rate of technological progress
Impacts development of new products
Long term forecast are concerned with the rate of
technological forecast.
Demand Forecast
Predict sales of existing products and services
These are useful for the projection of demand for a
companys product or services over a period of time.

Companys Production Capacity Scheduling System
serve as an input to financial, marketing and personal
planning.
Demand forecasting that is the estimation of demand is
must in the introductory phase of a product.

Strategic importance of Forecasting
Good forecast are of critical importance in all aspects
of a business. Forecast is the only estimate of demand
until actually demand became known.
Product forecast have impacts on several activities of
an organisation like:
Human Resources
Capacity
Supply Chain Management

Human Resources
Hiring , training and laying off workers : these all
depends upon the anticipated demand.

Demand forecast is the determinant for the decisions like :
Hiring and training etc.
Capacity
Inadequate capacity/capacity shortage of an
organisation results in the factors like ;
Loss of customers
Loss of Market


Supply Chain Management
Good Supplier relationship
Price advantage for material
Depends upon the accurate forecast.
As extensive components of Boeing 787 jets are manufactured
in dozens of countries
Coordination driven by forecast is essential
Seven Steps in Forecasting System
Determine the use of forecast.
Select the item to forecasting.
Determine time horizon of forecast.
Select the forecasting models.
Gather the data needed to make the forecast.
Make the Forecast.
Validate and implement the result.

These steps present a systemic way of initiating,
designing and implementing forecast.

Forecasting approach
Qualitative Method
Used when situation is vague and little data exist. It is used
for the
New product and new technology _ going to be introduced.
It involve : intuition , personal experience and value system
in reaching a forecast.
Quantitative Method
Used when situation is stable and historical data exist of the
existing product and current technology.
Forecast that employee one or more mathematical
techniques. Such as sales of LCD and LED televisions by LG.
An Overview of the Qualitative Methods
Jury or Executive opinion
Delphi Method
Sales Force Composite
Customer Market Survey

Jury of Executive Opinion
Sales Force Composite
Delphi Method
Iterative group process,
continues until
consensus is reached
3 types of participants
Decision makers
Staff
Respondents
Staff
(Administering
survey)
Decision Makers
(Evaluate responses and
make decisions)
Respondents
(People who can make
valuable judgments)
Consumer Market Survey
Overview of Quantitative
Approaches
1. Naive approach
2. Moving averages
3. Exponential smoothing
4. Trend projection
5. Linear regression
Time-
Series
Model
Associative
Model
A Technique that uses a series of past data points to
make a forecast.
It require Set of evenly spaced (weekly, monthly,
quarterly) numerical data
Assumes that factors influencing past and present will
continue influence in future
Forecast based only on past values, no other variables
important


Trend
Seasonal
Cycles
Random


Time Series Components/Decomposition of
Time series
It is the gradual upward or downward
movement of data over time.
Changes due to population, technology,
age, culture, etc.
Trend Component
It is the data pattern that repeats itself after a period
of days, weeks, months or quarter.
Due to weather, customs, etc.
Occurs within a single year .
There are six common seasonality pattern
Seasonal Component
Number of
Period Length Seasons
Week Day 7
Month Week 4-4.5
Month Day 28-31
Year Quarter 4
Year Month 12
Year Week 52
Cycles are the pattern in which data that occur
every several years.
Repeating up and down movements
Affected by business cycle, political, and
economic factors
Often causal or
associative
relationships
Cyclical Component
0 5 10 15 20
These are the fluctuation in the data caused by
an unusual situation.
Erratic, unsystematic, residual fluctuations
Due to random variation or unforeseen events
They follow no visible
pattern, so cant be predicted.
Random Component
M T W T F
Naive Approach
A forecasting method that uses an average of the
n most recent period.
Used if little or no trend
Used often for smoothing
Provides overall impression of data over time
Moving Average Method






Moving Average Example




Graph of Moving Average
| | | | | | | | | | | |
J F M A M J J A S O N D
S
h
e
d

S
a
l
e
s

30
28
26
24
22
20
18
16
14
12
10
Actual Sales
Moving Average
Forecast
Weighted Moving Average
=










Weighted Moving Average









Potential Problems With
Moving Average
Exponential Smoothing
Exponential Smoothing



Choosing
The objective is to obtain the most
accurate forecast no matter the
technique.
We generally do this by selecting the model
that gives us the lowest forecast error
Common Measures of Error
MAD =

Mean Squared Error (MSE)
MSE =
Comparison of Forecast Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded = .10 = .10 = .50 = .50
1 180 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62

Comparison of Forecast Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded = .10 = .10 = .50 = .50
1 180 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62

MAD =
|deviations|
n
= 82.45/8 = 10.31
For = .10
= 98.62/8 = 12.33
For = .50
Comparison of Forecast Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded = .10 = .10 = .50 = .50
1 180 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
MAD 10.31 12.33

= 1,526.54/8 = 190.82
For = .10
= 1,561.91/8 = 195.24
For = .50
MSE =
(forecast errors)
2

n
Comparison of Forecast Error
Rounded Absolute Rounded Absolute
Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded = .10 = .10 = .50 = .50
1 180 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
MAD 10.31 12.33
MSE 190.82 195.24
MAPE 5.59% 6.76%
Trend Projections
Fitting a trend line to historical data points to
project into the medium to long-range
Linear trends can be found using the least
squares technique
y = a + bx
^
where y = computed value of the variable to be predicted
(dependent variable)
a = y-axis intercept
b = slope of the regression line
x = the independent variable
^
Least Squares Method
Time period
V
a
l
u
e
s

o
f

D
e
p
e
n
d
e
n
t

V
a
r
i
a
b
l
e

Figure 4.4
Deviation
1

(error)
Deviation
5

Deviation
7

Deviation
2

Deviation
6

Deviation
4

Deviation
3

Actual observation
(y value)
Trend line, y = a + bx
^
Least Squares Method
Time period
V
a
l
u
e
s

o
f

D
e
p
e
n
d
e
n
t

V
a
r
i
a
b
l
e

Figure 4.4
Deviation
1

Deviation
5

Deviation
7

Deviation
2

Deviation
6

Deviation
4

Deviation
3

Actual observation
(y value)
Trend line, y = a + bx
^
Least squares method minimizes the
sum of the squared errors (deviations)
Least Squares Method
Equations to calculate the regression variables
b =
Sxy - nxy
Sx
2
- nx
2

y = a + bx
^
a = y - bx
Least Squares Example
b = = = 10.54
xy - nxy
x
2
- nx
2

3,063 - (7)(4)(98.86)
140 - (7)(4
2
)
a = y - bx = 98.86 - 10.54(4) = 56.70
Time Electrical Power
Year Period (x) Demand x
2
xy
2001 1 74 1 74
2002 2 79 4 158
2003 3 80 9 240
2004 4 90 16 360
2005 5 105 25 525
2005 6 142 36 852
2007 7 122 49 854
x = 28 y = 692 x
2
= 140 xy = 3,063
x = 4 y = 98.86
Least Squares Example
b = = = 10.54
Sxy - nxy
Sx
2
- nx
2

3,063 - (7)(4)(98.86)
140 - (7)(4
2
)
a = y - bx = 98.86 - 10.54(4) = 56.70
Time Electrical Power
Year Period (x) Demand x
2
xy
1999 1 74 1 74
2000 2 79 4 158
2001 3 80 9 240
2002 4 90 16 360
2003 5 105 25 525
2004 6 142 36 852
2005 7 122 49 854
Sx = 28 Sy = 692 Sx
2
= 140 Sxy = 3,063
x = 4 y = 98.86
The trend line is
y = 56.70 + 10.54x
^
Associative Forecasting
Used when changes in one or more independent
variables can be used to predict the changes in the
dependent variable
Most common technique is linear
regression analysis
Associative Forecasting
Forecasting an outcome based on predictor
variables using the least squares technique
y = a + bx
^
where y = computed value of the variable to be predicted
(dependent variable)
a = y-axis intercept
b = slope of the regression line
x = the independent variable though to predict the value
of the dependent variable
^
Associative Forecasting Example
Sales Local Payroll
($ millions), y ($ billions), x
2.0 1
3.0 3
2.5 4
2.0 2
2.0 1
3.5 7
4.0
3.0
2.0
1.0

| | | | | | |
0 1 2 3 4 5 6 7
S
a
l
e
s

Area payroll
Associative Forecasting Example
Sales, y Payroll, x x
2
xy
2.0 1 1 2.0
3.0 3 9 9.0
2.5 4 16 10.0
2.0 2 4 4.0
2.0 1 1 2.0
3.5 7 49 24.5
y = 15.0 x = 18 x
2
= 80 xy = 51.5
x = x/6 = 18/6 = 3
y = y/6 = 15/6 = 2.5
b = = = .25
xy - nxy
x
2
- nx
2

51.5 - (6)(3)(2.5)
80 - (6)(3
2
)
a = y - bx = 2.5 - (.25)(3) = 1.75
Associative Forecasting Example
4.0
3.0
2.0
1.0

| | | | | | |
0 1 2 3 4 5 6 7
S
a
l
e
s

Area payroll
y = 1.75 + .25x
^
Sales = 1.75 + .25(payroll)
If payroll next year is
estimated to be $6 billion,
then:
Sales = 1.75 + .25(6)
Sales = $3,250,000
3.25