Chapter 1: Forecasting

Forecasting is a technique that uses historical data as inputs to make informed estimates that are
predictive in determining the direction of future trends.

Businesses utilize forecasting to determine how to allocate their budgets or plan for anticipated
expenses for an upcoming period of time. This is typically based on the projected demand for the
goods and services offered.

How Forecasting Works

Investors utilize forecasting to determine if events affecting a company, such as sales expectations,
will increase or decrease the price of shares in that company. Forecasting also provides an important
benchmark for firms, which need a long-term perspective of operations.

Stock analysts use forecasting to extrapolate how trends, such as GDP or unemployment, will change in
the coming quarter or year. The further out the forecast, the higher the chance that the estimate will
be inaccurate. Finally, statisticians can utilize forecasting to analyze the potential impact of a change
in business operations. For instance, data may be collected regarding the impact of customer
satisfaction by changing business hours or the productivity of employees upon changing certain work
conditions.

Forecasting addresses a problem or set of data. Economists make assumptions regarding the situation
being analyzed that must be established before the variables of the forecasting are determined. Based
on the items determined, an appropriate data set is selected and used in the manipulation of
information. The data is analyzed, and the forecast is determined. Finally, a verification period occurs
where the forecast is compared to the actual results to establish a more accurate model for forecasting
in the future.

Types of Forecasting

Time Categories:

Long Term –for duration of 3-5 years or more (annual basis)

Medium Term –for duration of up to 3 years (usually quarterly or monthly basis.Short Term –the
duration is up to 1year, usually less than 3 months (on daily, weekly)Forecasts affect decisions and
activities throughout an organizationAccounting, financeHuman resources MarketingManagement
Information SystemOperationsProduct / service design

Two important aspects of forecasts

 the expected level of demand

 the degree of accuracy that can be assigned to a forecast

Time Categories

 Long Term

for duration of 3-5 years or more (annual basis)

  Medium Term

for duration of up to 3 years (usually quarterly or monthly basis.

 Short Term

the duration is up to 1year, usually less than 3 months (on daily, weekly)

Forecasts affect decisions and activities throughout an organization

Forecasts affect decisions and activities throughout an organization

 Accounting and finance

 Human resources
 Marketing
 Management Information System
 Operations
 Product / service design

Elements of a Good Forecast

 Timely
 Reliable
 Accurate
 Meaningful
 Written
 Easy to Use

Steps in the Forecasting Process

Choosing Forecasting Technique

 No single technique works in every situation

 Two most important factors
 Cost
 Accuracy

Other factors include the availability of:

 Historical data
 Computers
 Time needed to gather and analyze the data
 Forecast horizon

Approaches in forecasting

 Qualitative - refers to methods consist mainly of subjective inputs, which often defy precise
numerical description. It involves either the projection of historical data or the development
of associative models that attempt to utilize causal (explanatory) variables to make a
forecast.

Qualitative approach is used for:

 Executive(s) Opinion / Jury of executive Opinion

A method of forecasting using a composite forecast prepared by a number of individual
experts. The experts form their own opinions initially from the data given, and revise their
opinions according to the others' opinions. Finally, the individuals' final opinions are combined.

 Sales Force Opinions

A method commonly used by companies for short-term forecasts is to take advantage of their
field staff's intimate knowledge of customers' needs and market conditions by asking them to
forecast the company's sales for their respective areas for the coming season or year.

 Consumer Surveys

A method of demand forecasting involves direct interview of the potential consumers.

Consumers are simply contacted by the interviewer and asked how much they would be willing
to purchase of a given product at a number of alternative product price levels.
  Delphi Method

The Delphi method is a forecasting process framework based on the results of multiple rounds
of questionnaires sent to a panel of experts.

o The Delphi method is a process used to arrive at a group opinion or decision by

surveying a panel of experts.
o Experts respond to several rounds of questionnaires, and the responses are aggregated
and shared with the group after each round.
o The experts can adjust their answers each round, based on how they interpret the
"group response" provided to them.
o The ultimate result is meant to be a true consensus of what the group thinks.

The following steps outline how to undertake a Delphi study:

 Design the questionnaire

 Invite participants to take part
 Send out first round of questionnaire- a typical question

 Quantitative - it consists mainly of analyzing objective, or an uninterrupted set of data

observations that have been ordered in equally space intervals (unit of time). It is based on
identification of variables (factors) that can predict values of the variable in question.

Types of quantitative forecasting method:

 Time-series model

A time series is a sequence of data points that occur in successive order over some period of time. This
can be contrasted with cross-sectional data, which captures a point-in-time.

o A time series is a data set that tracks a sample over time.

o In particular, a time series allows one to see what factors influence certain variables from
period to period.
 o Time series analysis can be useful to see how a given asset, security, or economic variable
changes over time.
o Forecasting methods using time series are used in both fundamental and technical analysis.
o Although cross-sectional data is seen as the opposite of time series, the two are often used
together in practice.

Understanding Time Series

A time series can be taken on any variable that changes over time. In investing, it is common to use a
time series to track the price of a security over time. This can be tracked over the short term, such as
the price of a security on the hour over the course of a business day, or the long term, such as the
price of a security at close on the last day of every month over the course of five years.

Time series analysis can be useful to see how a given asset, security, or economic variable changes
over time. It can also be used to examine how the changes associated with the chosen data point
compare to shifts in other variables over the same time period.

Sample Table:
  Associative model

The associative model is also called the casual models and, in this method, the to be forecasted
variable is dependent on other variables in the environment. They are based on the assumption that

the past relationship between “dependent” & “independent” variables will remain the same in future
and accordingly each independent variable is predictable.

o Unlike time-series forecasting, associative forecasting models usually consider several variables
that are related to the quantity being predicted. Once these related variables have been
found, a statistical model is built and used to forecast the item of interest.
o Associative models assume that there is a causational relationship between the variable of
interest and other variables called predictors

Example:
 Price of beef and price of chicken
 Crop yields and soil condition
 Crop yields & timing of water
 Profits and sales
 Price of products and energy cost
 Predictor variables - used to predict values of variable of interest
 Regression - technique for fitting a line to a set of points
 Regression Methods - Regression (or causal) methods that attempt to develop a
mathematical relationship between the item being forecast and factors that cause it to
behave the way it does.
Naïve Forecasts

The forecast for any period equals the previous period’s actual value.

Estimating technique in which the last period's actuals are used as this period's forecast, without
adjusting them or attempting to establish causal factors. It is used only for comparison with the
forecasts generated by the better (sophisticated) techniques.

 Simple to use
 Virtually no cost
 Quick and easy to prepare
 Easily understandable
 Cannot provide high accuracy
 Can be a standard for accuracy

Types of Naïve Forecast / Approach:

 Stable series

the last data point becomes the forecast for the next period.

 Seasonality

the forecast for this season is equal to the value of the series last season.

 Trend

the forecast is equal to the last value of the series plus or minus the difference between the last two
values of the series.
Sample Table:

The following data shows the daily sales in kilos for each of the three products of fruits. Determine
the products on the 8th day using the naïve approach. The data set shows the three products of
fruit.   

Problem:  
A. Looking at the data for grapes, what type of naïve approach will be used?   
B. Looking at the data for mango, what type of naïve approach will be used?   
C. Looking at the data for banana, what type of naïve approach will be used?   
D. What is the forecast value of the grapes on the 9th day?  
E. What is the forecast value of the banana on the 9th day?  

Solution:
Average Techniques

MOVING AVERAGE

 a technique that averages a number of recent actual values, updated as new values
become available.
WEIGHTED MOVING AVERAGE

 weights are based on experience on experience and intuition

 most recent values are given more weight in computing a forecast.
EXPONENTIAL SMOOTHING

 a method based on previous forecast plus a percentage of a forecasts error.

Linear Trend Equation
Sources/References

GNC - MBA Archive: Forecasting Presentation by Prof Catheryn Alberto, LPT MBA

https://www.indeed.com/

https://www.nasdaq.com/

https://corporatefinanceinstitute.com/
https://www.monash.edu/

Prepared by:

Lesley Allen D. Kabigting, MBA

College of Business Administration

Guagua National Colleges