Business Forecasting

Why forecast?:
aid in planning and control
forecasts often critical to both short- and longterm decision making
techniques offer advantages over blind
guessing
Basis of forecasting here is the time series:
set of time-ordered observations on a variable
during successive and equal time periods
techniques for analysis of variation in time
series are called time series methods

Methods of forecasting
1. Qualitative Methods
1. Subjective estimates Survey
2. Delphi

2. Causal Methods
1.
2.
3.
4.
5.

Chain Ratio
Consumption level
End use
Leading Indicator
Econometric

3. Time Series methods

Time Series Methods of

forecasting
1. Moving averages:
extrapolative technique based on mean of past
observations
short range applications for inventory control,
scheduling, pricing
Can predict only one period ahead
2. Exponential smoothing:
extrapolative, uses weighted (more weight on more
recent) combination of past and forecast values
short range applications as above

Time Series Methods of

forecasting
4. Regression analysis
assumes relationship between dependent
variable and one or more explanatory
variables (e.g. spot price)
linear regression, multiple regression
short & intermediate term forecasts for
established products, production, marketing
personnel, financing

Time Series Methods of

forecasting
3. Decomposition:
assumes relationship between time and
forecast variable
time series assumed to have systematic &
non-systematic components
used for both long term (new products,
capital) and short term (advertising, inventory,
financing, production)

Smoothing methods
To forecast, one may take the following steps:
1 Choose a forecasting method based on forecasted
knowledge about the observed pattern of the time
series.
2 The forecasting method is used to develop a fitted
value of the data.
3 Forecast error is calculated.
4 A decision is made about the appropriateness of
the model based on the measure of forecast error.

Forecasting Using Moving Averages

Month
Observed 3 month 5 month
Values
Moving Moving
Avg
Avg
1
262.8
2
262.9
3
262.6
4
263.2
262.8
5
263.9
262.9
6
265.4
263.2
263.1
7
266.5
264.2
263.6
8
267.1
265.3
264.3
9
268.5
266.3
265.2
10
269.7
267.4
266.3
11
270.4
268.4
267.4
12
269.4
269.5
268.4

Moving Averages Forecasting

272
270
268
266
264
262
260
258
1

Months
Observed Values
5 month Moving Avg

10

11

3 month Moving Avg

12

Single Parameter Exponential Smoothing

Month
Observed
0.2
0.5
Values
1
262.8
2
262.9
262.8
262.8
3
262.6
262.8
262.9
4
263.2
262.8
262.7
5
263.9
262.9
263.0
6
265.4
263.1
263.4
7
266.5
263.5
264.4
8
267.1
264.1
265.5
9
268.5
264.7
266.3
10
269.7
265.5
267.4
11
270.4
266.3
268.5
12
269.4
267.1
269.5

0.8

262.8
262.9
262.7
263.1
263.7
265.1
266.2
266.9
268.2
269.4
270.2

values

Single Parameter Exponential Smoothing

272
270
268
266
264
262
260
258

values
1

Observed Values

Months
0.2

10

0.5

11

12

0.8

Sales Data For 28 Quarters

1991

Q1

289

1993

Q1

293

1995

Q1

347

1997

Q1

444

1991

Q2

410

1993

Q2

441

1995

Q2

520

1997

Q2

592

1991

Q3

301

1993

Q3

411

1995

Q3

540

1997

Q3

571

1991

Q4

213

1993

Q4

363

1995

Q4

521

1997

Q4

507

1992

Q1

212

1994

Q1

324

1996

Q1

381

1992

Q2

371

1994

Q2

462

1996

Q2

594

1992

Q3

374

1994

Q3

379

1996

Q3

573

1992

Q4

333

1994

Q4

301

1996

Q4

504

Decomposition of Time Series

Components
DEMAND Y = T*C*S*R
TREND (T)
The long term growth / decline in demand

BUSINESS CYCLE (C)

Deviation from trend because of environmental
factors

SEASONAL COMPONENT (S)

Annually repetitive demand fluctuations

RANDOM COMPONENT ( R)
Irregular, unpredictable residual component

Sales Forecast for 1998

1998 Q1 ( 29)
Extrapolating the given data values gives
Forecast for Q1 as 570.15.
Forecast for Q2 as 580.7
This doesnt take care of the seasonal effect
and the business cycle impact

Sales Forecast for 1998

Q1(29)
T = 570.15, C = 0.95, S = 0.8
TCS = 433.3
Q2 (30)
T = 580.7, C = 0.94, S = 1.17
TCS = 638.65

Evaluating the Error in

Forecasting
(e )

MSE
t

(X

|e|

MAD
n

- Ft )

Evaluating the Error in Forecasting

Tracking Signal

e / MAD

Ideal Value is 0
Large + value indicate pessimistic
approach
Large - value indicate optimistic
approach

Comments on smoothing constant

Small values reduce impact of remote values
slowly, build in slow response to changes
Large values dampen remote values quickly,
can cause forecast to over-respond to
irregular movements
General principle: values between 0.05 and
0.30 work well for exponential smoothing
Values > 0.3 suggest another method better

Forecasting Summary
Empirical studies show that the accuracy of Qualitative methods
is much worse compared to Quantitative methods
Too much mathematical focus will limit the accuracy of
Quantitative methods also
Combining forecasts produce better results
Time horizon is very crucial
Study among 150 fortune 500 companies (1990)
Forecasting method
use %
% who are satisfied
Moving Average
85
58
Trend line
82
32
Jury method
81
54
Regression
72
67

 Copper prices for 3 yrs

Copper prices for 10 years

Copper prices for 100 years