Forecasting

Types of Forecasts
 Qualitative (Judgmental)

 Quantitative
 Time Series Analysis
 Causal Relationships

2
Time Series Analysis
 Time series forecasting models try to
predict the future based on past data
 You can pick models based on:
 Time horizon to forecast
 Data availability
 Accuracy required
 Size of forecasting budget
 Availability of qualified personnel

4
Simple Moving Average Formula

 Assumes an average is a good estimator

of future behavior
 Formula is:

A t-1 + A t-2 + A t-3 +...+A t- n

Ft =
n

Ft = Forecast for the coming period

n = Number of periods to be averaged
A t-1 = Actual occurrence in the past period for up to “n”
periods

5
Simple Moving Average Problem (1)

A t-1 + A t-2 + A t-3 +...+A t- n

Ft =
Week Demand n
1 650
2 678 Question: What are the 3-
3 720
4 785
week and 6-week
5 859 moving average
6 920 forecasts for demand?
7 850 Assume you only have 3
8 758 weeks and 6 weeks of
9 892
10 920
actual demand data for
11 789 the respective forecasts
12 844
6
 7
Calculating the moving averages gives us:

Week Demand 3-Week 6-Week

1 650 F =(650+678+720)/3
4

2 678 =682.67

3 720 F =(650+678+720
7
+785+859+920)/6
4 785 682.67
=768.67
5 859 727.67
6 920 788.00
7 850 854.67 768.67
8 758 876.33 802.00
9 892 842.67 815.33
10 920 833.33 844.00
11 789 856.67 866.50
12 844 867.00 854.83
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©The McGraw-Hill Companies, Inc., 2004
 Plotting the moving averages and comparing them shows how
the lines smooth out to reveal the overall upward trend in this
example

950
900
850
800
Dem an d

750
Demand
700
650 3-Week
600 6-Week
550
500
1 2 3 4 5 6
Week 7 8 9 10 11 12

Note how the 3-Week is

smoother than the Demand,
and 6-Week is even smoother
8
Simple Moving Average Problem (2) Data

Question: What is the

3 week moving
average forecast for
Week Demand
this data?
1 820 Assume you only
2 775 have 3 weeks and 5
3 680 weeks of actual
4 655 demand data for the
5 620 respective forecasts
6 600
7 575

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Simple Moving Average Problem (2)
Solution
Week Demand 3-Week 5-Week
1 820 F4=(820+775+680)/3

2 775 =758.33
F6=(820+775+680
3 680 +655+620)/5
4 655 758.33 =710.00

5 620 703.33
6 600 651.67 710.00
7 575 625.00 666.00

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Weighted Moving Average Formula
While the moving average formula implies an
equal weight being placed on each value that is
being averaged, the weighted moving average
permits an unequal weighting on prior time
periods
The formula for the moving average is:
Ft = w 1 A t-1 + w 2 A t- 2 + w 3 A t-3 + ...+ w n A t- n
n
wt = weight given to time period “t”
occurrence (weights must add to one)
w
i=1
i =1

11
Weighted Moving Average Problem (1)
Question: Given the weekly demand and weights, what is the forecast
for the 4th period or Week 4?

Week Demand
Weights:
1 650
2 678 t-1 .5
3 720 t-2 .3
4 t-3 .2

Note that the weights place more emphasis on the most

recent data, that is time period “t-1”

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Weighted Moving Average Problem (1)

Week Demand Forecast

1 650
2 678
3 720
4 693.4

F4 = 0.5(720)+0.3(678)+0.2(650)=693.4

13
Weighted Moving Average Problem (2)
Question: Given the weekly demand information and weights,
what is the weighted moving average forecast of the 5th period
or week?

Week Demand Weights:

1 820 t-1 .7
2 775 t-2 .2
3 680
t-3 .1
4 655

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Weighted Moving Average Problem (2)

Week Demand Forecast

1 820
2 775
3 680
4 655
5 672

F5 = (0.1)(775)+(0.2)(680)+(0.7)(655)= 672

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Exponential Smoothing Model

Ft = Ft-1 + a(At-1 - Ft-1)

Where :
Ft  Forcast value for the coming t time period
Ft - 1  Forecast v alue in 1 past time period
At - 1  Actual occurance in the past t tim e period
  Alpha smoothing constant
 Premise: The most recent observations might
have the highest predictive value
 Therefore, we should give more weight to the
more recent time periods when forecasting
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Exponential Smoothing Problem (1)
Question: Given the
weekly demand data,
Week Demand what are the exponential
1 820 smoothing forecasts for
2 775
periods 2-10 using
3 680
a=0.10 and a=0.60?
4 655
Assume F1=D1
5 750
6 802
7 798
8 689
9 775
10
17
The respective alphas columns denote the forecast values. Note
that you can only forecast one time period into the future.

Week Demand 0.1 0.6

1 820 820.00 820.00
2 775 820.00 820.00
3 680 815.50 793.00
4 655 801.95 725.20
5 750 787.26 683.08
6 802 783.53 723.23
7 798 785.38 770.49
8 689 786.64 787.00
9 775 776.88 728.20
10 776.69 756.28
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Exponential Smoothing Problem (1)
Plotting
Note how that the smaller alpha results in a smoother line in this
example

850
800
750 Demand
700
Demand

650 0.1
600 0.6
550
500
1 2 3 4 5 6 7 8 9 10
Week

19
Exponential Smoothing Problem (2)

Question: What are

Week Demand
the exponential
1 820
smoothing forecasts
2 775 for periods 2-5 using
3 680 a =0.5?
4 655
5
Assume F1=D1

20
Exponential Smoothing Problem (2)
F1=820+(0.5)(820-820)=820 F3=820+(0.5)(775-820)=797.75

Week Demand 0.5

1 820 820.00
2 775 820.00
3 680 797.50
4 655 738.75
5 696.88
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 Forecasting Error: MAD
n
1 MAD  0.8 standard deviation
A
t=1
t - Ft
1 standard deviation  1.25 MAD
MAD =
n

 The ideal MAD is zero which would

mean there is no forecasting error

 The larger the MAD, the less the

accurate the resulting model

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MAD Problem Data

Question: What is the MAD value

given the forecast values in the
table below?

Month Sales Forecast

1 220 n/a
2 250 255
3 210 205
4 300 320
5 325 315
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MAD Problem Solution

Month Sales Forecast Abs Error

1 220 n/a
2 250 255 5
3 210 205 5
4 300 320 20
5 325 315 10

40

n
Note that by itself, the
A
t=1
t - Ft
40 MAD only lets us know the
MAD = = = 10 mean error in a set of
n 4 forecasts

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 Tracking Signal
 The Tracking Signal or TS is a measure that
indicates whether the forecast average is keeping
pace with any genuine upward or downward
changes in demand
 Depending on the number of MAD’s selected, the
TS can be used like a quality control chart
indicating when the model is generating too much
error in its forecasts
 TS formula is:

RSFE Running sum of forecast errors

TS = =
MAD Mean absolute deviation
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Tracking Signal

Deman Sum
Mont d devia Abs of
Actual RSFE MAD TS
h foreca tion Dev Abs
st dev
1 1000 950 -50 -50 50 50 50 -1
2 1000 1070 70 20 70 120 60 0.33
3 1000 1100 100 120 100 220 73.3 1.64
4 1000 960 -40 80 40 260 65 1.23
5 1000 1090 90 170 90 350 70 2.43
6 1000 1050 50 220 50 400 66.7 3.3

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Tracking Signal

27
Tracking Signal

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