forecasting

trend extrapolation dialectical method

Definition
A planningtool that helps management in its attempts to cope with the uncertainty of the future, relying mainly on data from the past and present and analysis of trends. Forecasting starts with certain assumptions based on the management'sexperience, knowledge, and judgment. These estimates are projected into the coming months or years using one or more techniques such as Box-Jenkins models, Delphi method, exponential smoothing, moving averages, regression analysis, and trend projection. Since any error in the assumptions will result in a similar or magnified error in forecasting, the technique of sensitivity analysis is used which assigns a range of values to the uncertain factors (variables). A forecast should not be confused with a budget. See also backcasting.

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Forecasting
From Wikipedia, the free encyclopedia Jump to: navigation, search For other uses, see Forecast (disambiguation).

Forecasting is the process of making statements about events whose actual outcomes (typically) have not yet been observed. A commonplace example might be estimation of some variable of interest at some specified future date. Prediction is a similar, but more general term. Both might refer to formal statistical methods employing time series, crosssectional or longitudinal data, or alternatively to less formal judgemental methods. Usage can differ between areas of application: for example, in hydrology, the terms "forecast" and "forecasting" are sometimes reserved for estimates of values at certain specific future times, while the term "prediction" is used for more general estimates, such as the number of times floods will occur over a long period. Risk and uncertainty are central to forecasting and prediction; it is generally considered good practice to indicate the degree of uncertainty attaching to forecasts. In any case, the data must be up to date in order for the forecast to be as accurate as possible.[1] Although quantitative analysis can be very precise, it is not always appropriate. Some experts in the field of forecasting have advised against the use of mean square error to compare forecasting methods.[2]

Contents
[hide]

1 Categories of forecasting methods o 1.1 Qualitative vs. quantitative methods o 1.2 Nave approach o 1.3 Reference class forecasting o 1.4 Time series methods o 1.5 Causal / econometric forecasting methods o 1.6 Judgmental methods o 1.7 Artificial intelligence methods o 1.8 Other methods 2 Forecasting accuracy 3 Applications of forecasting 4 Limitations 5 See also 6 References 7 External links

[edit] Categories of forecasting methods

[edit] Qualitative vs. quantitative methods

Qualitative forecasting techniques are subjective, based on the opinion and judgment of consumers, experts; appropriate when past data is not available. It is usually applied to intermediate-long range decisions. Examples of qualitative forecasting methods are:[citation needed] informed opinion and judgment, the Delphi method, market research, historical lifecycle analogy. Quantitative forecasting models are used to estimate future demands as a function of past data; appropriate when past data are available. The method is usually applied to shortintermediate range decisions. Examples of quantitative forecasting methods are:[citation needed] last period demand, simple and weighted moving averages (N-Period), simple exponential smoothing, multiplicative seasonal indexes.
[edit] Nave approach

Nave forecasts are the most cost-effective and efficient objective forecasting model, and provide a benchmark against which more sophisticated models can be compared. For stable time series data, this approach says that the forecast for any period equals the previous period's actual value.
[edit] Reference class forecasting

Reference class forecasting was developed by Oxford professor Bent Flyvbjerg to eliminate or reduce bias in forecasting by focusing on distributional information about past, similar outcomes to that being forecasted.[3] Daniel Kahneman, Nobel Prize winner in economics, calls Flyvbjerg's counsel to use reference class forecasting to de-bias forecasts, "the single most important piece of advice regarding how to increase accuracy in forecasting.[4]
[edit] Time series methods

Time series methods use historical data as the basis of estimating future outcomes.

Moving average Weighted moving average Kalman filtering Exponential smoothing Autoregressive moving average (ARMA) Autoregressive integrated moving average (ARIMA) e.g. Box-Jenkins

Extrapolation Linear prediction Trend estimation Growth curve

[edit] Causal / econometric forecasting methods

Some forecasting methods use the assumption that it is possible to identify the underlying factors that might influence the variable that is being forecast. For example, including information about weather conditions might improve the ability of a model to predict umbrella sales. This is a model of seasonality which shows a regular pattern of up and down fluctuations. In addition to weather, seasonality can also be due to holidays and customs such as predicting that sales in college football apparel will be higher during football season as opposed to the off season.[5] Casual forecasting methods are also subject to the discretion of the forecaster. There are several informal methods which do not have strict algorithms, but rather modest and unstructured guidance. One can forecast based on, for example, linear relationships. If one variable is linearly related to the other for a long enough period of time, it may be beneficial to predict such a relationship in the future. This is quite different from the aforementioned model of seasonality whose graph would more closely resemble a sine or cosine wave. The most important factor when performing this operation is using concrete and substantiated data. Forecasting off of another forecast produces inconclusive and possibly erroneous results. Such methods include:

Regression analysis includes a large group of methods that can be used to predict future values of a variable using information about other variables. These methods include both parametric (linear or non-linear) and non-parametric techniques. Autoregressive moving average with exogenous inputs (ARMAX)[6]

[edit] Judgmental methods

Judgmental forecasting methods incorporate intuitive judgements, opinions and subjective probability estimates.

Composite forecasts Delphi method Forecast by analogy Scenario building Statistical surveys Technology forecasting

[edit] Artificial intelligence methods

Artificial neural networks Group method of data handling Support vector machines

Often these are done today by specialized programs loosely labeled

Data mining

[edit] Other methods

Simulation Prediction market Probabilistic forecasting and Ensemble forecasting

[edit] Forecasting accuracy

The forecast error is the difference between the actual value and the forecast value for the corresponding period.

where E is the forecast error at period t, Y is the actual value at period t, and F is the forecast for period t. Measures of aggregate error:
Mean absolute error (MAE)

Mean Absolute Percentage Error (MAPE)

Mean Absolute Deviation (MAD)

Percent Mean Absolute Deviation (PMAD)

Mean squared error (MSE)

Root Mean squared error (RMSE)

Forecast skill (SS)

Average of Errors (E)

Business forecasters and practitioners sometimes use different terminology in the industry. They refer to the PMAD as the MAPE, although they compute this as a volume weighted MAPE.[citation needed] For more information see Calculating demand forecast accuracy. Reference class forecasting was developed to increase forecasting accuracy by framing the forecasting problem so as to take into account available distributional information.[7] Daniel Kahneman, winner of the Nobel Prize in economics, calls the use of reference class forecasting "the single most important piece of advice regarding how to increase accuracy in forecasting.[8] Forecasting accuracy, in contrary to belief, cannot be increased by the addition of experts in the subject area relevant to the phenomenon to be forecast.[9] See also

Calculating demand forecast accuracy Consensus forecasts Forecast error Predictability Prediction intervals, similar to confidence intervals Reference class forecasting

[edit] Applications of forecasting

The process of climate change and increasing energy prices has led to the usage of Egain Forecasting of buildings. The method uses forecasting to reduce the energy needed to heat the building, thus reducing the emission of greenhouse gases. Forecasting is used in the practice of Customer Demand Planning in every day business forecasting for manufacturing companies. Forecasting has also been used to predict the development of conflict situations. Experts in forecasting perform research that use empirical results to gauge the effectiveness of certain forecasting models.[10] Research has shown that there is little difference between the accuracy of forecasts performed by experts knowledgeable of the conflict situation of interest and that performed by individuals who knew much less.[11] Similarly, experts in some studies argue that role thinking does not contribute to the accuracy of the forecast.[12] The discipline of demand planning, also sometimes referred to as supply chain forecasting, embraces both statistical forecasting and a consensus process. An important, albeit often ignored aspect of forecasting, is the relationship it holds with planning. Forecasting can be described as predicting what the future will look like, whereas planning predicts what the future should look like.[13][14] There is no single right forecasting method to use. Selection of a method should be based on your objectives and your conditions (data etc.).[15] A good place to find a method, is by visiting a selection tree. An example of a selection tree can be found here.[16] Forecasting has application in many situations:

Supply chain management - Forecasting can be used in Supply Chain Management to make sure that the right product is at the right place at the right time. Accurate forecasting will help retailers reduce excess inventory and therefore increase profit margin. Studies have shown that extrapolations are the least accurate, while company earnings forecasts are the most reliable.[17] Accurate forecasting will also help them meet consumer demand. Economic forecasting Earthquake prediction Egain Forecasting

Land use forecasting Player and team performance in sports Political Forecasting Product forecasting Sales Forecasting Technology forecasting Telecommunications forecasting Transport planning and Transportation forecasting Weather forecasting, Flood forecasting and Meteorology

[edit] Limitations
As proposed by Edward Lorenz in 1963, long range weather forecasts, those made at a range of two weeks or more, are impossible to definitively predict the state of the atmosphere, owing to the chaotic nature of the fluid dynamics equations involved. Extremely small errors in the initial input, such as temperatures and winds, within numerical models doubles every five days.[18]

[edit] See also

CPFR Forecasting bias Foresight (future studies) Futures studies Futurology Optimism bias Planning Strategic foresight Technology forecasting

[edit] References
1. ^ Scott Armstrong, Fred Collopy, Andreas Graefe and Kesten C. Green (2010 (last updated)). "Answers to Frequently Asked Questions". http://qbox.wharton.upenn.edu/documents/mktg/research/FAQ.pdf. 2. ^ J. Scott Armstrong and Fred Collopy (1992). "Error Measures For Generalizing About Forecasting Methods: Empirical Comparisons". International Journal of Forecasting 8: 6980. http://marketing.wharton.upenn.edu/ideas/pdf/armstrong2/armstrong-errormeasuresempirical.pdf. 3. ^ Flyvbjerg, B. (2008). "Curbing Optimism Bias and Strategic Misrepresentation in Planning: Reference Class Forecasting in Practice". European Planning Studies 16 (1): 321. http://www.sbs.ox.ac.uk/centres/bt/Documents/Curbing%20Optimism%20Bias%20and%20 Strategic%20Misrepresentation.pdf. 4. ^ Daniel Kahneman, 2011, Thinking, Fast and Slow (New York: Farrar, Straus and Giroux), p. 251 5. ^ Nahmias, Steven (2009). Production and Operations Analysis.

6. ^ Ellis, Kimberly (2008). Production Planning and Inventory Control Virginia Tech. McGraw Hill. ISBN 978-0-390-87106-0. 7. ^ Flyvbjerg, B. (2008) "Curbing Optimism Bias and Strategic Misrepresentation in Planning: Reference Class Forecasting in Practice." European Planning Studies,16 (1), 3-21.] 8. ^ Daniel Kahneman (2011) Thinking, Fast and Slow (New York: Farrar, Straus and Giroux) (p. 251) 9. ^ J. Scott Armstrong (1980). "The Seer-Sucker Theory: The Value of Experts in Forecasting". Technology Review: 1624. http://www.forecastingprinciples.com/paperpdf/seersucker.pdf. 10. ^ J. Scott Armstrong, Kesten C. Green and Andreas Graefe (2010). "Answers to Frequently Asked Questions". http://qbox.wharton.upenn.edu/documents/mktg/research/FAQ.pdf. 11. ^ Kesten C. Greene and J. Scott Armstrong (2007). "The Ombudsman: Value of Expertise for Forecasting Decisions i

What is Forecasting? Meaning

Forecasting is a process of predicting or estimating the future based on past and present data. Forecasting provides information about the potential future events and their consequences for the organisation. It may not reduce the complications and uncertainty of the future. However, it increases the confidence of the management to make important decisions. Forecasting is the basis of premising. Forecasting uses many statistical techniques. Therefore, it is also called as Statistical Analysis.

Image Credits TYanceyIV.

Features of Forecasting

Peculiarities, characteristics or features of forecasting are as follows:1. Forecasting in concerned with future events. 2. It shows the probability of happening of future events. 3. It analysis past and present data.

4. It uses statistical tools and techiques. 5. It uses personal observations.

Steps in Forecasting

Procedure, stages or general steps involved in forecasting are given below:1. Analysing and understanding the problem : The manager must first identify the real problem for which the forecast is to be made. This will help the manager to fix the scope of forecasting. 2. Developing sound foundation : The management can develop a sound foundation, for the future after considering available information, experience, type of business, and the rate of development. 3. Collecting and analysing data : Data collection is time consuming. Only relevant data must be kept. Many statistical tools can be used to analyse the data. 4. Estimating future events : The future events are estimated by using trend analysis. Trend analysis makes provision for some errors. 5. Comparing results : The actual results are compared with the estimated results. If the actual results tally with the estimated results, there is nothing to worry. In case of any major difference between the actuals and the estimates, it is necessary to find out the reasons for poor performance. 6. Follow up action : The forecasting process can be continuously improved and refined on the basis of past experience. Areas of weaknesses can be improved for the future forecasting. There must be regular feedback on past forecasting.

Importance of Forecasting

Merits, significance or importance of forecasting involves following points:1. Forecasting provides relevant and reliable information about the past and present events and the likely future events. This is necessary for sound planning. 2. It gives confidence to the managers for making important decisions. 3. It is the basis for making planning premises. 4. It keeps managers active and alert to face the challenges of future events and the changes in the environment.

Limitations of Forecasting

Demerits, criticism or limitations of forecasting involves following points:1. The collection and analysis of data about the past, present and future involves a lot of time and money. Therefore, managers have to balance the cost of forecasting with its benefits. Many small firms don't do forecasting because of the high cost. 2. Forecasting can only estimate the future events. It cannot guarantee that these events will take place in the future. Long-term forecasts will be less accurate as compared to short-term forecast. 3. Forecasting is based on certain assumptions. If these assumptions are wrong, the forecasting will be wrong. Forecasting is based on past events. However, history may not repeat itself at all times. 4. Forecasting requires proper judgement and skills on the part of managers. Forecasts may go wrong due to bad judgement and skills on the part of some of the managers. Therefore, forecasts are subject to human error.

Seven Steps inForecastingForecasting Determine the use of the forecast Select the items to be forecasted Determine the time horizon of theforecast Select the forecasting model(s) Gather the data Make the forecast Validate and implement results

Advantages and Disadvantages of Forecasting Methods of Production and Operations Management

by Brian Bass, Demand Media

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Organizations use forecasting methods of production and operations management to implement production strategies. Forecasting involves using several different methods of estimating to determine possible future outcomes for the business. Planning for these possible outcomes is the job of operations management. Additionally, operations management involves the managing of the processes required to manufacture and distribute products. Important aspects of operations management include creating, developing, producing and distributing products for the organization. Sponsored Link Online Business Docs Google offers online docs & spreadsheets for your business. www.google.com/apps/business

Advantages of Forecasting
An organization uses a variety of forecasting methods to assess possible outcomes for the company. The methods used by an individual organization will depend on the data available and the industry in which the organization operates. The primary advantage of forecasting is that it provides the business with valuable information that the business can use to make decisions about the future of the organization. In many cases forecasting uses qualitative data that depends on the judgment of experts.

Disadvantages of Forecasting
It is not possible to accurately forecast the future. Because of the qualitative nature of forecasting, a business can come up with different scenarios depending upon the interpretation of the data. For this reason, organizations should never rely 100 percent on any forecasting method. However, an organization can effectively use forecasting with other tools of analysis to give the organization the best possible information about the future. Making a decision on a bad forecast can result in financial ruin for the organization, so an organization should never base decisions solely on a forecast.

Advantages of Operations Management

Operations management can help an organization implement strategic objectives, strategies, processes, planning and controlling. One of the primary focuses of operations management is to effectively manage the resources of an organization

so that the organization can maximize the potential of the products or services produced or offered by the company. Depending on the organization, operations management can include managing human resources, materials, information, production, inventory, transportation, logistics, purchasing and procurement.

Disadvantages of Operations Management

Operations management depends on many different components within the organization working together to achieve success. Even if operations management implements an effective plan, if operations management does not carry out the plan properly, the plan will most likely fail. Within an organization, mistakes often occur during the chain of events from manufacturing to sale. Therefore, operations management requires the coordination of operation functions, marketing, finance, accounting, engineering, information systems and human resources to have success within the organization. This poses the primary disadvantage of operations management because if an organization's individual components do not work well together, operations management will have limited success within the organization. Sponsored Links

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References

Ekonomska Fakulteta: Exercises 3: Demand Forecasting "Future Ready": Steve Morlidge and Steve Player; 2010 "Business Forecasting"; John E. Hanke and Dean Wichern; 2008 Operations Management: Designing and Managing Business Operations

10 Advantages of Business Forecasting

written by: Sarah Lambert edited by: Jean Scheid updated: 5/18/2011

Business forecasting takes a lot of time and effort; however, it is definitely worth it. These 10 reasons will show you the advantages of forecasting in business and why you should take the time to implement great forecasting tools.
Introduction

Business forecasting is a critical step in the creation of any business plan. Forecasting is almost never completely accurate but it helps companies look at the big picture. Here we look at 10 advantages of forecasting in business. We will use the wine industry to provide examples of how forecasting can truly benefit a business.
1. Helps to Predict The Future

Forecasting does not provide you with a crystal ball to see exactly what will happen to the market and your company over the coming years, but it will help give you a general idea. This will provide you with a sense of direction which will allow your company to get the most out of the marketplace.

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Predicting the future in the wine industry can be very difficult. But by doing so, a winery can predict future trends and then change their company objectives to achieve success in this new environment.
2. Keep Your Customers Happy

In order to keep your customers satisfied you need to provide them with the product they want when they want it. This advantage of forecasting in business will help predict product demand so that enough product is available to fulfill customer orders. By using business forecasting to look ahead, wineries are able to make sure they always have product available for the customers to purchase. If the shelves are bare for any length of time, a customer is extremely likely to try another brand.
3. Learn From The Past

Looking at what has happened in the past can help companies predict what will happen in the future. Thus making the company stronger and most likely more profitable. Wineries look at past sales and trends and use that data future.
4. Keeps Companies Looking Ahead

to try and predict the

By forecasting on a regular basis, it forces companies to continually think about their future and where their company is headed. This will allow them to foresee changing market trends and keep up with the competition. Wineries have to keep looking ahead or else they will not be able to meet demand. Giving their competition even a slight advantage could be devastating.
5. Save on Staffing Costs

One of the advantages of forecasting in business is that it allows companies to predict how much product will need to be produced to meet customer demand. From here a company can use this data to accurately determine how many employees they will need to have on hand to meet the required level of production. Many wineries have fairly small profit margins, so it is important to make sure they have the correct amount of staff on hand and are not employing too many people.
6. Remain Competitive

A business that does not use forecasting techniques will likely succumb to their competition in a short time. Having a general idea of what sales to expect in the

following period is very important. This will help a company prepare to meet customer demand, otherwise the customer will look to fulfill their needs elsewhere. The wine industry is extremely competitive. There are literally thousands of different wineries fighting for the same shelf space. Attracting new customers with expensive advertising campaigns and flashy labels is very costly. That is why once a company gets a new customer, they want to do everything in their power to keep them.
7. Receive Financing

In order to receive financing for new startups or to fund an existing enterprise, a forecast will need to be completed. The lender needs an estimate on the number of sales you will have within a given time period before they will consider lending out large sums of money. Financing is a key component of success for most wineries. Most have loans on their buildings, equipment, and vineyards. Without this financing, they would more than likely not be able to operate so this is an essential advantage of forecasting in business.
8. Reduce Inventory Costs

Forecasting helps predict how much inventory should be on hand at any given time. By having the right amount of inventory, your company will be able to save on warehouse and transportation costs. There will also be less risk of incurring obsolescence costs or having to discount products because you have a large surplus. Having the correct amount of inventory on hand is very important for every winery. White wine can only be kept on the shelf for a couple of years. That is why it is extremely important to make sure there is not a large surplus of product.
9. Helps Prepare for a Drop in Sales

A drop in sales is never a good thing for a company, however, this advantage of forecasting in business reveals sales drops which in turn, can be recognized and dealt with quickly. Learn how to create a sales forecasting spreadsheet in Excel right here on Bright Hub. When a winery has forecasted a drop in sales they will slow down production. This means having less wine in their tanks or barrels at any given time, and also less finished goods inventory on hand at their various facilities.

10. Prepare for New Business

By forecasting demand, a company can see if an increase in sales is likely imminent. This will allow the company to prepare for this increase in business by providing extra staff or production facilities to meet this new level of demand. Wineries will increase wine production and bottling to meet this new demand and hopefully gain life long customers in the process.
References

IBF retrieved at http://www.ibf.org/index.cfm?fuseaction=showObjects&objectTypeID=87 Business Performance Analysis retrieved at http://www.businessperformanceanalysis.com/Business-Forecasting.html Image Credits: freedigitalphotos.net/renjithkrishnan freedigitalphotos/clarita