Forecasting Techniques

FORECASTING TECHNIQUES
Chapter 16
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
Dr. C. Lightner
Fayetteville State Univer
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
Dr. C. Lightner
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.
Dr. C. Lightner
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.
Dr. C. Lightner
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.
Dr. C. Lightner
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.
Dr. C. Lightner
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.
Dr. C. Lightner
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.
Dr. C. Lightner
Time Series Data

We will learn the following Forecasting Approaches:
Smoothing
Trend Projections
Dr. C. Lightner
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.
Dr. C. Lightner
10
Example: Roberts Drugs

During the past ten weeks, sales of cases of Comfort brand
headache medicine at Robert's Drugs have been as follows:
Week Sales
1
110
2
115
3
125
4
120
5
125
Week
6
7
8
9
10
Sales
120
130
115
110
130
Plot this data.
Dr. C. Lightner
11
Plot Roberts Drugs Example

Excel Spreadsheet Showing Input Data. Specify cells A4:B13 as the Data
Range.
Dr. C. Lightner
12
Plot Roberts Drugs Example

I labeled
Roberts Drug
Example as
The Chart title
I labeled
Sales as
My Value (y)
axis
I labeled
Week, t as
My Value (x)
axis
Dr. C. Lightner
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
Dr. C. Lightner
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.
Dr. C. Lightner
15
Robert Drugs Example: Moving Average

Our scatter plot for Roberts 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).
Dr. C. Lightner
16
Example: Roberts 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:
Enter B4:B13 in the Input Range box.
This specifies
the value of n
Enter 3 in the Interval box.
This is the column
Enter C5 in the Output Range box.
following our data,
and one row below where Select OK.
our data begins.
Dr. C. Lightner
17
Roberts Drugs: Moving Average

MA3 (Three period Moving average) for Roberts Drug Example
Ft is the forecast for week t.
F4 (forecast for week 4)=116.7
F11 (forecast for week 11)=118.3

Thus we would forecast the sales
for Week 11 to be 118.3
Dr. C. Lightner
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.
Dr. C. Lightner
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
most recent
period
Sales for 2nd

most recent
period
Sales for 3rd

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

Dr. C. Lightner
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:

This is the same as
Ft+1=Yt + (1- )Ft
Ft+1 = Ft + (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
Dr. C. Lightner
21
Roberts Drugs: Exponential Smoothing

Forecast the sales for period 11 using Exponential
Smoothing = 0.1.
Dr. C. Lightner
22

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.
Enter 0.9 (for = 0.1) in Damping Factor box.
Damping factor
is always 1-
Enter C4 in the Output Range box.
Select OK.
Dr. C. Lightner
23
Thus we would
forecast sales for
week 11 to be 116.87
F11 = 0.1 * Y10 + .9 F10

= .1 *130 + .9 * 115.4099
= 116.87
Dr. C. Lightner
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
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.
Dr. C. Lightner
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).
Dr. C. Lightner
26
Selecting the best Smoothing Technique for Roberts Drugs

Determine the smoothing technique that is best for forecasting
Roberts Drug sales: A two period moving average, a three period
moving average, exponential smoothing (=0.1), or exponential
smoothing (=0.2)
Realistically we should have experimented with more values of n

for the moving average, and 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.
Dr. C. Lightner
27
Roberts 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.
MSE for MA2
Dr. C. Lightner
28
MSE for MA3
Dr. C. Lightner
29
MSE for Exponential

Smoothing =0.1
Dr. C. Lightner
30
MSE for Exponential

Smoothing =0.2
Dr. C. Lightner
31

Since the three period moving average technique
(MA3) provides to lowest MSE value, this is the best
smoothing technique to use for forecasting Roberts
Drug Sales.
Dr. C. Lightner
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.
Dr. C. Lightner
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
b1 = ntYt
- t Yt
b0 Y b1t
nt 2 - (t )2
tt
where: Yt = observed value of the time series at time period t

Y
= average of the observed values for Yt
t t = average time period for the n observations

Dr. C. Lightner
34
Example: Augers 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
March 353
April
387
May
342
Month Jobs
June
374
July
396
August 409
Month
September
October
November
Jobs
399
412
408
Forecast the number of repair jobs Auger's will perform in December

using the least squares method.
Dr. C. Lightner
35
Augers Plumbing Service: Trend Projection

Trend Projection
(month) t
(Mar.) 1
(Apr.)
(May)
(June)
(July)
(Aug.)
(Sep.)
(Oct.)
(Nov.)
Sum 45
3480
Yt
tYt
t2
353
353
1
2
387
774
4
3
342 1026
9
4
374 1496 16
5
396 1980 25
6
409 2454 36
7
399 2793 49
8
412 3296 64
9
408 3672 81
17844 285
Dr. C. Lightner
36

Trend Projection (continued)
tt
(3480)
b1 =
= 45/9 = 5 Y
ntYt - t Yt
nt
b0 Y b1t
=
- ( t)2
= 3480/9 = 386.667
(9)(17844) - (45)
= 7.4
(9)(285) - (45)2
= 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
Dr. C. Lightner
37
Augers Plumbing Service: Trend Line in Excel

Excel Spreadsheet Showing Input Data
Dr. C. Lightner
38

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 ys box.
Enter A4:A12 in the Known xs box.
Select OK.
Dr. C. Lightner
39

Spreadsheet Showing Trend Projection for Month 10
Dr. C. Lightner
40
Roberts Drug Example

Suppose we neglected to plot Roberts Drug example, and therefore we
do not know that a trend does not exist. Use trend analysis to forecast
the sales for month 11.
Dr. C. Lightner
41
Question????
How could we use the MSE or MAD to verify that the
MA3 is a better smoothing technique than trend analysis
for Roberts Drug Sales data?
Dr. C. Lightner
42
Causal Method: Regression Analysis

Regression Analysis is similar to trend analysis, except
the independent variable is not restricted to time. Refer
to Roberts 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.
Dr. C. Lightner
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 = nXiYi
- Xi Yi
b0 y b1 x
nXi2 - (Xi)2
tt
where: Yt = observed value of the time series at time period t

Y
= average of the observed values for Yt
t t = average time period for the n observations

Dr. C. Lightner
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.
Dr. C. Lightner
45
THE END
See your textbook for more

examples and detailed explanations
of all topics discussed in these notes.
Dr. C. Lightner
46

Forecasting Techniques

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FORECASTING TECHNIQUES

Qualitative Approaches to Forecasting

Qualitative Approaches (continued)

Qualitative Approaches (continued)

Quantitative Approaches to Forecasting

Time Series Data

Components of a Time Series

Time Series Data

Excel Instructions for Drawing a Scatter Plot

Example: Roberts Drugs

Plot this data.

Plot Roberts Drugs Example

Plot Roberts Drugs Example

Smoothing Methods: Moving Average

Robert Drugs Example: Moving Average

Example: Roberts Drugs: Moving Average

Roberts Drugs: Moving Average

F4 (forecast for week 4)=116.7

F11 (forecast for week 11)=118.3

Smoothing Methods: Weighted Moving Average

Smoothing Methods: Weighted Moving Average

Sales for 2nd

Sales for 3rd

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

Smoothing Methods: Exponential Smoothing

Using exponential smoothing, the forecast is calculated by:

Roberts Drugs: Exponential Smoothing

Roberts Drugs: Exponential Smoothing

Roberts Drugs: Exponential Smoothing

F11 = 0.1 * Y10 + .9 F10

Questions That You Should Be Asking

Measures of Forecast Accuracy

Selecting the best Smoothing Technique for Roberts Drugs

Realistically we should have experimented with more values of n

Roberts Drugs :Comparing Smoothing Techniques

MSE for MA2

Roberts Drugs :Comparing Smoothing Techniques

MSE for MA3

Roberts Drugs :Comparing Smoothing Techniques

MSE for Exponential

Roberts Drugs :Comparing Smoothing Techniques

MSE for Exponential

Roberts Drugs :Comparing Smoothing Techniques

Yt = trend forecast for time period t

where: Yt = observed value of the time series at time period t

t t = average time period for the n observations

Example: Augers Plumbing Service

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

Augers Plumbing Service: Trend Projection

Example: Augers Plumbing Service

= 386.667 - 7.4(5) = 349.667

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

Augers Plumbing Service: Trend Line in Excel

Example: Augers Plumbing Service

Example: Augers Plumbing Service

Roberts Drug Example

Causal Method: Regression Analysis

Y= dependent variable which depends on the value of x

where: Yt = observed value of the time series at time period t

t t = average time period for the n observations

Regression Analysis in Excel

See your textbook for more