Business Forecasting

Forecasting for Management Decisions

Importance of Business Forecasting

Allows organizations to improve profits
Essential in eliminating waste such as:
Inventory shortages
Missed due dates
Plant shut-downs
Lost sales
Lost customers
Expensive expediting
Missed strategic opportunities.

Financial and Strategic Importance

Better strategic information
Better marketing information
Better financial information
Better operating information
Increased customer service
Better allocation of resources
(Continued)

Financial and Strategic Importance

Increased manufacturing and operating efficiency
Higher productivity
Stability in planning
Reduced finished goods inventory
Elimination of waste
Increased profitability
Increased return on investment.

The Commonality of Forecasting

All organizations wish for excellence in management
(whether manufacturing or a hospital).
Demand for products, labor, materials, and other
resources must be estimated using either formal or
informal forecasting methods.

Business Forecasting Process

Managements
Question/Problem

Data Gathering

Feedback Loop

Model Formulation

Design the Forecasting Experiment

Analysis and Interpretation

No

Valid Results?

Yes
Report Results

The Forecasting Process

Business Forecasting
Data Patterns and Choice of Forecasting
Techniques

Topics
Data Patterns
Forecasting Methodologies
Technique Selection

Data Pattern and Choice of Technique

The pattern of data
The nature of the past relationship in the data
The level of subjectivity in making a forecast
All of the above help us in how we classify the forecasting
technique.

Data Pattern and Choice of Technique

Univariate forecasting techniques depend on:
Past data patterns.

Multivariate forecasting techniques depend on

Past relationships.

Qualitative forecasts depend on:

Subjectivity: Forecasters intuition.

Data Patterns
Data Patterns as a Guide
Simple observation of the data will show the way that data
have behaved over time.
Data pattern may suggest the existence of a relationship
between two or more variables.
Four Patterns: Horizontal, Trend, Seasonal, Cyclical.

Data Patterns
Horizontal

Forecast Variable

When there is no trend in the data pattern, we deal with

horizontal data pattern.

Mean

Time

Data Patterns
Trend
Long-term growth movement of a time series
Yt

Trend

Yt

Trend

t
Yt

Yt

Trend

Trend

Data Patterns
Seasonal Pattern

Forecast Variable

A predictable and repetitive movement observed around a

trend line within a period of 1 year or less.

Time

Data Patterns
Cyclical
Occurs with business and economic expansions and
contractions.
Lasts longer than 1 year.
Correlated with business cycles.

Other Data Patterns

Autocorrelated Pattern
Data in one period are related to their values in the previous
period.
Generally, if there is a high positive autocorrelation, the
value in the month of June, for example, is positively related
to the values in the month of May.

Measures of Accuracy in Forecasting

Error in Forecasting

et

Yt

Yt

Measures the average error that can be expected over time.

The average error concept has some problems with it. The
positive and negative values cancel each other out and the
mean is very likely to be close to zero.

Error in Forecasting
Mean Average Deviation (MAD)
n

MAD

et

t 1

Error in Forecasting
Mean Square Error (MSE)

MSE

2
(e t )

t 1

Error in Forecasting
Mean Absolute Percentage Error

MAPE
t 1

(et / Yt ) 100
n

Error in Forecasting
Mean Percentage Error

(et / Yt )
MPE

t 1

No bias, MPE should be zero.

Evaluating Reliability
Forecasters use the following two approaches to
determine if the forecast is reliable or not:
Root Mean Square (RMS)
n

RMS

et2

t 1

Evaluating Reliability
Root Percent Mean Square (R%MS)

R % MS

(et2 / Yt )

t 1

Forecasting Methodologies
Forecasting methodologies fall into three categories:
Quantitative Models
Qualitative Models
Technological Approaches

Forecasting Methodologies
Quantitative Models
Also known as statistical models.
Include time series and regression approaches.
Forecast future values entirely on the historical observation
of a variable.

Forecasting Methodologies
Quantitative Models
An example of a quantitative model is shown below:

Yt
Yt

1Yt

= Sales one time period into the future

Yt = Sales in the current period

Yt

2 Yt 1

1 = Sales in the last period

Forecasting Methodologies
Qualitative Models
Non-statistical or judgment models
Expert opinion
Executive opinion
Sale force composite forecast
Focus groups
Delphi method

Forecasting Methodologies
Technological Approach
Combines quantitative and qualitative methods.
The objective of the model is to combine technological,
societal, political, and economic changes.

Technique Selection
Forecasters depend on:
The characteristics of the decision making situation which
may include:
Time horizon
Planning vs. control
Level of detail
Economic conditions in the market (stability vs. state of flux)

Technique Selection
Forecasters depend on:
The characteristics of the forecasting method
Forecast horizon
Pattern of data
Type of model
Costs associated with the model
Level of accuracy and ease of application