Forecasting

Forecasting helps managers and businesses develop meaningful plans

and reduce uncertainty of events in the future. Managers want to match supply
with demand; therefore, it is essential for them to forecast how much space they
need for supply to each demand.
Forecasting is a method used to predict and place all information mainly in
design and operating systems. They both estimate what that information will look
like in the future. In order to do so, one must determine the purpose, establish a
time horizon, select a forecasting technique, make it, and then monitor the new
forecast. The methods used to decrease error include: Delphi method, naive
method, and weighted average method. A major issue in forecasting is seasonal
variations because it has a repeating movement

Common Features
1. Forecasting Techniques generally assume that the same underlying
casual system that existed in the past will continue to exist in the future.
2. Forecasts are rarely perfect. Actual results usually differ from predicted
values. Allowances should be made for inaccuracies.
3. Forecasts for group of items tend to be more accurate than forecasts for
individual items. This is because forecasting errors among items.
4. Forecast accuracy decreases as the time period-covered by the forecast
the time horizon increases.

Elements of a Good Forecast

1. Timely a certain amount of time is needed to respond to the information
contained in a forecast.
2. Accurate forecasts should be accurate and the degree of accuracy
should be stated. This will enable users to plan for possible errors and will
provide a basis for comparing alternative forecasts.
3. Reliable forecasts should work consistently.
4. Meaningful Units Financial planners need to know how many
dollars/pesos will be needed, production planners need to know how many
units will be needed and schedulers need to know what machines and
skills will be required.
5. In Writing It will not guarantee that all concerned are using the
information but it will at least increase the likelihood of it. In addition, a
written forecast will permit an objective basis for evaluating the forecast
once actual results are in.
6. Simple to understand and use Users often lack confidence in forecasts
based on sophisticated techniques; not knowing the circumstances in
which the techniques are appropriate or the limitations of the techniques.
Fairly crude forecasting techniques enjoy a widespread popularity
because users are more comfortable working with them.

Steps in Forecasting Process

1. Determine the purpose of the forecast

This will provide an indication of the level of detail required in the forecast,
the amount of resources that can be justified and the level of accuracy
necessary.
2. Establish a time horizon
The forecast must indicate a time limit, keeping in mind that accuracy
decreases as the time horizon increases.
3. Select a forecasting technique
4. Gather and analyze relevant data
Before a forecast can be prepared, data must be gathered and analysed.
Identify any assumptions that are made in conjunction with preparing and
using the forecast.
5. Prepare the forecast
Use an appropriate technique
6. Monitor the forecast
A forecast has to be monitored to determine whether it is performing in a
satisfactory manner. If it is not, re-examine the method, assumptions, and
validity of data, and so on; modify as needed; and prepare a revised
forecast.

Approaches to Forecasting
There are two (2) general approaches to forecasting: Qualitative and
Quantitative. In practice, either or both approaches might be used to develop a
forecast.
Qualitative Technique permit inclusion of soft information (e.g. human factors,
personal opinions and hunches) in forecasting. Those factors often omitted or
downplayed when quantitative techniques are used because they are difficult or
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impossible to quantify. It consists mainly of subjective inputs, which often defy

precise numerical description.
Quantitative Technique involve either the extension of historical data or
development of associative models that attempt to utilize causal (explanatory)
variables to make a forecast. It consists mainly of analyzing objective, or hard
data. They usually avoid personal biases that sometimes contaminate qualitative
methods.

Forecast Based on Judgement and Opinion

Judgemental Forecasts rely on analysis of subjective inputs obtained
from various sources, such as consumer surveys, the sales staff, managers and
executives, and panels of experts. Quite frequently, these sources provide
insights that are not otherwise available.

Executive Opinions
A small group of upper-level managers (e.g. in marketing, finance and
operations) may meet and collectively develop a forecast. This approach is often
used as a part of long-range planning and new product development. It has the
advantage of bringing together the considerable knowledge and talents of
various managers. The risk is the view of one person will prevail and the

possibility that diffusing responsibility for the forecast over the entire group may
result in less pressure to produce a good forecast.

Consumer Surveys
Organizations seeking consumer input usually resort to consumer
surveys, which enable them to sample consumer opinions. The obvious
advantage of consumer surveys is that they can tap information that might not be
available elsewhere. On the other hand, a considerable amount of knowledge
and skill is required to construct a survey, administer it, and correctly interpret the
results for valid information. Surveys can be expensive and time-consuming. In
addition, even under the best conditions, surveys of the general public must
contend with the possibility of irrational behaviour patterns.

Delphi Method
It involves circulating a series of questionnaires among individuals who
possess the knowledge and ability to contribute meaningfully. The goal is to
achieve a consensus forecast. It is useful for technological forecasting; the
technique is a method for assessing changes in technology and their impact on
an organizations.
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Forecasts Based on Time Series Data

A time-ordered sequence of observations taken at regular intervals over
time. The data may be measurements of demand, earnings, profits, shipments,
accidents, output, precipitation, productivity and the consumer price index. It is
made on the assumption that future values of the series can be estimated from
past values. This can often be accomplished by merely plotting the data and
visually examining the plot. These patterns are:
1. Trend A long term upward or downward movement in data.
2. Seasonality Short term regular variations related to the calendar or time
of day.
3. Cycle Wavelike variation lasting more than one year. These are often
related to a variety of economic, political, and even agricultural conditions.
4. Irregular Variations caused by unusual circumstances, not reflective of
typical behaviour such as severe weather conditions, strikes, or a major
change in product or service.
5. Random Variations residual variations after all other behaviours are
accounted for.

Nave Methods
Uses a single previous value of a time series as the basis of a forecast. It
can be used with a stable series, with seasonal variations or with trend. The
forecast for any period equals the previous periods actual value.

The forecast for any period equals the previous periods actual value.

where

= forecast at time , and

= actual data at time

No cost.

Quick and easy to prepare.

Easy to understand.

Can be applied to data with seasonality and trend.

where

= forecast at time ,
= time lag,
= actual data at time

= season/trend dependent constant, and

= a season/trend time leg.
The increased accuracy of other methods needs to justify the additional resource
required to achieve that accuracy.

Techniques for Averaging

Averaging techniques generate forecasts that reflect recent value of time
series. These techniques work best when a series tends to vary around an
average, although they can also handle step changes or gradual changes in
the level of the series. There are 3 techniques for averaging:
1. Moving Average Technique that averages a number of recent actual
values, updated as new values become available.
2. Weighted Average More recent values in a series are given more
weight in computing a forecast.
3. Exponential Smoothing Weighted averaging method based on
previous forecast plus a percentage of the forecast error.

Techniques for Trend

There are two important techniques that can be used to develop a forecast
when trend is present. The first one is linear trend and the other one is the
extension of exponential smoothing

Linear Trend Equation:

Yt = a + bt
Where:
t = specified number of time periods

Yt = forecast for period

a = value of y at t = 0
b = slope of the line
Trend-Adjusted Exponential Smoothing
Variation of exponential smoothing used when a smoothing used when a
time series exhibits.
TAFt +1 = St + Tt
Where:
St = Smoothed Forecast
Tt = Current Trend Estimate

Techniques for Seasonality

Seasonal variations in time series data are regularly repeating upward or
downward movements in series values that can be tied to recurring events.

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Seasonality in a time series is expressed in terms of the actual amount that

actual values deviate from the average series.
Seasonal relative is used. It is the percentage of average or trend.
Techniques for Cycles
When cycles occur in time series data, their frequent irregularity makes it
difficult or impossible to project them from past data because turning points are
difficult to identify. The most commonly used approach is explanatory: Search for
another variable that relates to and leads the variable of interest.

Associative Forecasting Techniques

Associative techniques rely on identification of related variables that can
be used to predict values of the variable of interest. The essence of associative
techniques is the development of an equation that summarizes the effects of
predictor variables. The primary method of analysis is known as regression.
Predictor variables are variables that can be used to predict values of the
variable of interest. Regression is the technique for fitting a line to a set of points.

Simple Linear Regression

The simplest and most widely used form of regression involves a linear
relationship between two variables.

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Yc = a + bx
Where:
Yc = predicted (dependent variable)
x = predictor (independent variable)
b = slope of the line
a = value of Yc when x = 0

Accuracy and Control Forecast

It is important to include an indication of the extent to which the forecast
might deviate from the value of variable that actually occurs. This will provide the
forecast user with a better perspective on how far off a forecast might be. This
also provides a decision maker a measure of accuracy to use as a basis for
comparison, when choosing among different techniques.

Forecast Accuracy
Forecasting error is defined as the difference between actual and forecast,
i.e.,
.
Two commonly used measures are

Mean absolute deviation (MAD)

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, and

Mean squared error (MSE)

.
The difference between these two measures is that MAD weights all errors
evenly, and MSE weights errors according to their squared values.
For the usage of these measures, either MAD or MSE, a manager could
compare the results of exponential smoothing with values of .1, .2, and .3, and
select the one that yields the least MAD or MSE for a given set of data.

Forecasting Control
It is necessary to monitor forecast errors to ensure that the forecast is
performing adequately over time. This is generally accomplished by comparing
forecast errors to predefined values, or action limits, as illustrated below.

Possible sources of forecast errors:

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the omission of an important variable,

a sudden or unexpected change in the variable (causing by severe

weather or other nature phenomena, temporary shortage or breakdown,
catastrophe, or similar events),

appearance of a new variable,

being used incorrectly,

data being misinterpreted, and

random variation.

Two

common

methods

in

forecast

control

monitor

are tracking

signal and control chart.

Tracking Signal
A tracking signal focuses on the ratio of cumulative forecast error to the
corresponding MAD:

The tracking signal often ranges from

limits of

to

. For the most part, we shall use

, which are roughly comparable to three standard deviation limits.

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Values within the limits suggest --- but do not guarantee --- that the forecast is
performing adequately.
MAD can be updated using the following exponential smoothing equation:

Control Chart
The control chart sets the limits as multiples of the squared root of MSE. Basic
assumptions are

Forecast errors are randomly distributed around a mean of zero, and

The distribution of errors is normal.

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The square root of MSE is used in practice as an estimate of the standard

deviation of the distribution of errors. That is,

.
For a normal distribution, 95% of the errors fall within
approximately 99.7% of the errors fall within

, and

. Errors fall outside these limits

should be regarded as evidence that corrective action is needed.

Plotting the errors with the help of a control chart can be very informative.
A plot helps you to visualize the process and enables you to check for possible
patterns, nonrandom errors, within the limit that suggests an improved forecast is
possible.

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The control chart approach is generally superior to the tracking signal

approach. The major weakness of the tracking signal approach is its use of
cumulative errors: individual errors can be obscured so that large positive and
negative errors cancel each other.

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Using Forecast Information

A manager can take a reactive or proactive approach to a forecast. A
reactive approach views forecast as probable descriptions of future demand, and
a manager reacts to meet the demand. Conversely, a proactive approach seeks
to actively influence demand.
Generally speaking, a proactive approach requires either an explanatory
model or a subjective assessment of the influence of the influence on demand. It
is possible that a manager might use two forecast: one to predict what will
happen under the status quo and a second based on a what if approach, if the
result of the status quo forecast are unacceptable.

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Bibliography
Books
W. J. Stevenson. Operations Management. 2002
URL
https://ids355.wikispaces.com/Ch.+3+Forecasting
http://mcu.edu.tw/~ychen/op_mgm/notes/part2.html

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