COURSE MODULE ON

PRODUCTION PALNNING AND

CONTROL
Forecasting
(UNIT II)

1
Forecasting
1.0 Introduction
Forecasting is a basic tool to help managerial decision making. Managerial decis
ions are
seldom made in the absence of some form of forecasting. Every day, managers have
to take
decisions in the face of uncertainty, without knowing what would happen in
the future.
Managers strive to reduce this uncertainty and make better estimates of what i
s likely to
happen in the future. This is what forecasting aims to accomplish.

1.1 Forecasting:

An important and essential part of effective planning.

It refers to the systematic analysis of past and present circumstances.

It provides key information and pertinent facts relating to the future.

The success of a business greatly depends upon the efficient forecasting and pre

paring for
future events.
1.2 Definition:
It is defined as the estimation of future activities i.e., the estimation of type,
quality and
quantity of future work.

A systematic attempt to probe the future by inference from known facts. The

purpose is to
provide management with information on which it can base planning decisions.

It refers to the statistical analysis of the past and current movements in the given

time series
so as to obtain clues about the future pattern of these movements.

It is also defined as a technique of translating past experience into prediction of

things to
come.

It tries to evaluate the magnitude and significance of forces that will affect future

operating
conditions in an enterprise.
2.0 Sales Forecasting:
Sales forecast is the task of projecting the future sales of the firm. It indicates h
ow much
of a product is likely to be sold during a specified period in a specified market, at specifie
d prices.
Sales forecast is an estimate based on some past information, the prevailing situat
ion and
prospects of future. It is based on an effective system and is valid only for some specifi
c period.
Due to dynamic nature of market phenomenon sales forecasting has become a continuous
process
and requires regular monitoring of situation.
Sales forecasting has been defined by the American Marketing Association
as Sales

forecast is an estimate of sales in dollars or physical units for a specified future period
under a

2
proposed marketing plan or programme and under an assured set of economic and ot
her forces
outside the unit for which the forecast is made.
In the words of Philip Kotler, the company sales forecast is the expecte
d level of
company sales based on chosen marketing plan and assumed marketing environment.
3.0 Types of Forecasting:
There are two types of forecasting.
1. Short-term forecasting
2. Long-term forecasting
Short-term Forecasting:
The forecasting which covers a period of three months, six months or o
ne year is
generally called as short-term forecasting. The period for which forecasting is done
depends upon
the nature of business. Forecasting is done only for a short period when the demand f
luctuates
from one month to another.
Long-term Forecasting:
This type of forecasting usually covers a period of 5-10 years, and in some cases
even 20
years. However, beyond 10 years, the future is assumed to be uncertain. But in many
industries
like ship building, petroleum refinery, generation of electricity etc. along term fore
casting is
needed as the total initial investment cost of equipment is quite high.
4.0 Objectives of Forecasting:
4.1 Objectives of Short-term Forecasting:
(i) Formulation of suitable production policy: Forecast helps to formulate a suitable pr
oduction
policy so that problems of under production or over production may not arise.

(ii) Regulate supply of Raw Material: It is possible to evaluate the requirements of raw
materials
in future so as to ensure regular and continuous supply of materials on the basis of esti
mated
sales and also to control the sizes of inventory at economic level.
(iii) Best utilization of Machines: The operations can be so planned that the machines are
utilized
to its maximum capacity.
(iv) Regular availability of labour: One of the objectives of sales forecasting is also to arr
ange for
trained personnel and non-technical workers so that they might not experience any
shortage of
personnel and at the same time they dont remain idle when the production is curtailed
.
(v) Price policy formulation: Sales forecast enable the management to formula
te some
appropriate pricing mechanism, so that the level of prices does not fluctuate too muc
h in the
periods of depression or inflation.

3
(vi) Forecasting of short-term financial requirements: On the basis of sales forecast it is
possible
to determine the financial requirements of the enterprise for the production of desired
output,
and arrange it accordingly much in advance.
(vii) Setting the Sales target:

Sales forecasts are (forecasted) calculated for differe

nt market
segments and then the sales targets for various territories are fixed accordingly. This
later on
becomes the basis to evaluate and control sales performance.
4.2 Objectives Long-term of forecasting:
(i) Deciding Plant Capacity: The long run objectives of sales forecasting is to plan plant
capacity
in accordance with the demand. The size of the plant can be determined such that th
e output
confirms with sales requirements. Too small or too large size of the plant may not
be in the

economic interest of the enterprise. By studying the demand pattern for the product
and the
forecast for future; the enterprise can plan for a plant with output of desired capacity.
(ii) Manpower Planning: Reliable and accurate forecast can help the management to
assess the
appropriate manpower requirements. This can ensure best manpower facility to carry
out the
production in the long run without any hindrances.
(iii) Estimating Cash inflows: Cash inflows from sales can well be estimated throu
gh sales
forecasting to determining the cash and credit sale ratio.

It can also help to plan

for credit
policy of the firm.
(iv) Determining Dividend Policy:

The profits can also be forecast on the basis of g

ross profit
ratio on sale and dividend policy can be determined.
(v) Planning of Long-run production:

Long-run production planning also depends u

pon sales
forecasting.

In the long-run product has to be adjusted to the market demand

and other
conditions.
(vi) Long-run Financial Requirements:

Sales forecasting also helps to determine the

long-run
financial requirements of the organization for working capital as well as
for capital
expenditure.
(vii) Budgetary Control over Expenditure:
are to be

In forecasting the sales, all the activities

forecast and for this purpose budget is to be prepared for the income and expenditur
e of the
organization. The budgeting figures for income and expenditure may then be compar
ed with
the actual performance and any variation is removed.
ntrol over,
expenditure becomes possible.

Thus budgetary co

4
5.0 Importance of Forecasting:
According to Henry Fayol,
nt tool of

Business

Forecasting is the most

importa

management. The success of the business depends upon the skill of the man
agement in
forecasting.
Importance in planning: Provides a basis to plan the future requirements for men,
machines,
time, money, etc.

Accuracy in managerial decisions: It enables the management to arrive at accurate

decisions
relating to the various aspects of the business.

Facilitates Control: It is essential for efficient managerial control as it can disclose

the areas
where control is lacking.

It is a must in order to control the costs of production and the productivity of

personnel.

It helps in anticipating the areas where there is a great need to be attentive to control

the costs.

Formulating future policies: From the analysis of the past and estimation future it

assists in
formulating business policies.

Co-ordination is developed: It is common effort of many persons working in the

concern, it
may facilitate in creating team spirit, unity and co-ordination in the efforts of
subordinated.
- the act of forecasting is a great benefit to all who take part in the process.
- it is the best means of ensuring adaptability to changing circumstances.

Helps in preparing budgets: Business activities are governed and regulated by budget

such as
sales budget, production budget, cash budget, material budget, man power budget, etc.

Helps in taking decisions relating to financial and expansion policies.

Sales forecasts:
-

provides a basis for business growth, diversification and expansion.

Accurate forcast of probable demand for companys products helps the company in
production planning & control, fixing prices etc.

 It contributes to business success:

enefits by

It enables the enterprise to obtain maximum b

better utilization of resources. It contributes to the overall success of business.

6.0 Steps in Forecasting:
The steps involved in forecasting may vary from company to company because th
e nature
of the business and of the product is not similar for each enterprise. Market conditions a
lso vary
from company to company and from product to product.

However, the following

steps are
generally followed by most of the industries in ordinary circumstances.
The following are the main steps in demand forecasting:

5
1. Determining the objective of forecast:
Certain points in this respect should be very clear before taking up the forec
asting test
such as period of forecasting (short term, long term) areas of sales forecasting, unit
of sales
forecasting (i.e., in quantities or values); the time, labour and money to be e
mployed on
forecasting.

All these points are determined taking into account the objectives

of sales
forecasting.
2. Sub-divide the task of forecasting:
Sub-divide the forecasting the programme into homogeneous groups acc
ording to
product, area, activities or customers. The total sales forecast of the company will be
the sum
total of all the groups.
3. Determine the relative importance of factors:
So that due weightage may be given to different factors affecting forecast.
4. Select the method to be used for forecasting:
The method is to be selected by the appropriate authority taking into accou
nt all the
relevant situations, purpose of forecasting and the degree of accuracy required.
5. Collect and analyze the data:

By applying the appropriate method, the necessary data for forecast are
collected,
tabulated and cross-checked. The data are interpreted by using statistical techniques.
It may
be called as the preliminary sales forecast which forms the basis for final sales forecast.
6. Study the correlation b/w sales forecast & sales promoting plans:
Making the forecast reliable, sales promotion plans such as advertising policy, pe
rsonnel
selling and other policies should be reviewed with reference to the preliminary sales for
ecast.
7. Study of competitors activities:
Volume of sales of a company is largely affected by the activities of compet
itors and,
therefore, it is essential to study the competitors activities, policies, progra
mmes and
strategies and also their effects on the market and adjust the forecasting accordingly.
8. Prepare final sales forecasts:
The preliminary sales forecast results and converted into final sales forecast re
lating to
the products and territories involved. The aggregate of sales forecasts of different prod
ucts, or
territories or customers or activities may from the sales forecasts of the enterprise.
9. Evaluation and adjustments:
The actual sales performance in the coming period should be reviewed and
evaluated
from time to time. The evaluation may be made monthly, quarterly, half yearly or year
ly. The
forecast figures may be revised in the light of difficulties experienced during the
course of
actual operations. On the expiry of forecasts period the actual sales and forecast sale
s should
be compared and causes of variation found out which may help to improve the n
ext period
sales forecasts.

6
7.0 Advantages of Sales Forecasting:
Helps in effective planning: Forecasting helps in effective planning by providing a s
cientific

and reliable basis for anticipating future operations such as sales, production, inventory,
supply
of capital etc.

Helps in removing the weaknesses of organization structure: Since it leads to ration

alization
of various procedures for the achievement of organizational objectives.

Helps in better co-ordination of various resources which leads to better utilization of

resources
and reduction in waste and inefficiencies.

Achieves Co-operation in the Enterprises: Various executives at different levels

participate in
the process of forecasting. This creates a sense of belongingness among them.

Provides a basis for effective control: Forecasting provides a basis for effective

control by
providing information where higher degree of control is to be exercised. The manag
ers can
predict the weaknesses of their departments through forecasting.

Importance at the national level: Economic forecasts of various factors at the nati

onal level
help in planning for economic development.
8.0 Limitations of Forecasting:
Forecasts are only estimates of future condition. They can never be actual positio
n. They
can only give a best estimate of future course of events, but they can never be hundred
percent
accurate and reliable the following are some of the limitations of sales forecast.

Forecasting is based on postulations and assumptions and hence it is subject to s

ome guess
work and possibility of error.
Forecasting is usually based on past data but future may not be a copy of the past.

Changes in consumers need, taste fashion, style, etc. may cause inaccuracy in forecast.

There may be lack of history in case of a new product.

Forecasts are not full proof and condition proof and if there are chances in

the general
economy of the country; they may not materialize.

Development of new products, materials methods may introduce error in the sales fore

cast of a
particular product.

There may be lack of efficient and experienced sales force.

Lack of sales history in case of a new product makes the forecast difficult.

Short term forecasting is more accurate than long term forecasting and hence its usef

ulness is
limited to short-term purposes.

7
9.0 Forecasting Techniques:
Forecasts can be obtained using a variety of techniques / models. The forecasting
models
fall into one of the two categories: qualitative models and quantitative models.
The qualitative models use personal judgment and involve qualities like intu
ition and
experience as the bases of forecasts, and are subjective by their very nature. On the oth
er hand,
quantitative models are objective in nature and they employ numerical information as the
basis of
making forecasts. The quantitative models include time series models and casual models.
9.1 Qualitative Models of forecasting:
Some of the Qualitative methods of forecasting are discussed below.
Delphi Method: Perhaps the most important method of forecasting involving judgments i
s called
the Delphi method. The method is an iterative group process and it employees
a group of
experts, not an oracle, to obtain forecasts. The experts are usually not known to each o
ther and
their interaction takes place through a coordinator. The other participants in the Delhi pro
cess are
the staff and respondents. The staff personnel assist the experts by preparing,
distributing,
collecting and summarizing and tabulating the data, while the respondents are the subjects
whose
judgments are valued and are being sought. In this method, the coordinator obtains the f
orecasts

from the experts and then assimilates each of their forecasts. Based on this additional infor
mation,
each of the experts may revise his / her original forecast. After repeating
this process
appropriately, the experts tend to reach a consensus forecast.
Sales Force Composite: In this method of demand forecasting, each of the members com
prising
sales force of a company are asked to estimate the likely sales in their respective a
reas.

The

estimates are then reviewed to ensure that they are realistic.

After this, the estimate

s are then
reviewed to ensure that they are realistic. After this, the estimates are combined at the
district,
regional and national level to obtain the overall forecast.
Consumer Panel Survey:

Some marketing research methods employ consumer pa

nels for
making forecasts. Here, a consumer needs panel to be maintained and consumers on such
a panel
are questioned about their purchase plans. The goal here is to forecast demand for prod
ucts and
services on the basis of the subjective judgments of the subjects involved, abo
ut possible
purchases. This method works on a strong assumption that the consumers on the panel
are truly
representative of the ultimate purchasers.
9.2 Quantitative Models of Forecasting:
9.2.1 Time Series Models of Forecasting:
These are the demand characteristics over time. In this, time series analysis is
done by
analysts who plot demand data on a time scale, study the plots and look for consistent s
hapes or
patterns.

These time series data are analyzed for forecasting future activity levels. Ti

me series

8
data refer to set of values of some variables measured at the equally spaced time intervals
such as
monthly inventory levels, quarterly sales or monthly production levels.
emand has

The d

following patterns:
1.

Constant Pattern: In this pattern demand remains constant throughout the period.

2. Trend Pattern: It refers to the long-term growth or decline in the average level of
demand.

3. Seasonal Pattern: It refers to the annually repetitive demand fluctuation that may b
e caused
by weather, tradition or other factors.
4.

Cycle Pattern: Business cycle refers to the large deviation to actual demand value

s due to
complex environmental influences.

These are similar to the seasonable component

s except
that seasonality occurs at regular intervals and is of constant durations whereas it
varies in
both time and duration of occurrence.
5.

Combination of Different Patterns:

In long term forecast (more than 2 years)

seasonal
factors are ignored and focus is given on trend component with a minor emphasis on
business
cycle.

In medium term forecasts (few months to 2 years), the trend factor be

comes less
important and the seasonal and random factors are given more importance for short
duration
(one week to 3 months) main concern is random fluctuations.
a business

Generally when

concern is in operation, combination of trend and seasonal variations are given imp
ortance.
Such a pattern is shown in below figure. Some data plotted in the figure, do not fa
ll on the
combined pattern of trend with seasonal variations, but they are all cluster around it.
Some

SA 1

points fall very close to the pattern, while some lie relatively far away from the patter

n.

9
9.3 Average Methods
9.3.1 Simple Average Method:
Forecast is obtained by considering the average of all the past data available.

D D D D
n
9.3.2 Moving Average Method:
A moving average forecast is obtained by summing the data point over a desired
number
of past periods in years, months, weeks. This number usually encompasses 3 years, 5 ye
ars or 8
years. Extending the moving average to include more periods increases the smoothenin
g effect
but decreases the sensitivity of forecasts to more recent data.
A simple moving average is a method of a specified number of the most r
ecent data
values in a series.

SMA M t 1 D t n1 D t n2 .... D t 2 D t 1 D t
n

Mt = Simple moving average at the end of period (t); it is to be used as a forecast for per
iod (t+1).
Dt = actual demand in periodt.

n = number of periods included in each average.

Advantages:

The moving average gives a very good picture of the general long term movement in

the data,

if the data contains uniform cycles and if the trend in the data, if any,
is linear or
approximately so.

This method is simpler as compared with the method of least square.

It is a flexible method of trend measurement. By flexibility we mean that if a few

years are
added the entire calculations are not changed.

This method is not affected by the personal prejudice and bias of the computer.

If the period of moving average method has the value equal to the period of the

cycle, the
cyclical fluctuations are completely eliminated.

The moving average method has the merit of flexibility to adaptation of new

conditions and is
often a more effective measure of scalar trend than the curves fitted with great labo
ur. The
fitting of mathematical curves frequently involves the breaking up of a period into 2
or more
(three) subdivisions and the fitting of a separate curve to each of them.

The

use of this
method removes this difficulty.

W
10
Disadvantages:

It is sensitive to treatise movement in the data.

It does not result in a mathematical equation which may be used for forecasting.

There is a tendency to cut corners which results in the loss of data at the ends.

In case of the sharp turns in the original graph, the moving average trends to

reduce the
curvature.

The trend values cannot be computed for all items of the series.

The longer the

period of
moving average, the greater the number of years for which trend value cannot be com
puted.

The selection of the period of moving average requires a great deal of care for, i

f a wrong
period is selected a correct picture of trend cannot be obtained.

This method can represent trend accurately only if the cyclic and irregular fluctu

ations are
uniform both in duration and amplitude.
9.3.3 Weighted moving average method:
Equal weights were assigned to all periods in the computation of the simpl
e moving
average.

The weighted moving average assigns more weight to some demand valu

es than to
others.
n
i

i 1
n
i
i 1

i = 1, 2, 3 if we use three periods moving averages.

i = 3 corresponds to the most recent time period.
i = 1 corresponds to the oldest time period.
Wt : Weight for the time period (t).

9.3.4 Double Moving Average Method:

Let the moving average period = n.
First single moving average = M1

D1 D2 ....

(n)

Dn

Subsequent single moving average for any period = M1(t )

D(t ) D(t n)
M1(t ) M1 t
n
1

First double moving average = M2 2n 1

M (1) M (2) ...
1 1
n

M1 2n 1

11
Subsequent double moving average = M2(t )
M 2(t
1)

M 1(t
n)
M 1(t )
n

Forecast for any future period Z from period

t F Z

2M1(t ) M2(t ) (n2Z M1() M2(t )

M2(t )

1)

Example 1:
Demands of an item in a firm has been 180, 160, 170, 190 items in each of the
last four
quarters. Forecast the demand for this item for the current quarter based on SA method.
t
Forecast
for current quarter based on SA would be

180 160 170 190

4
Example 2:
A XYZ television supplier found a demand of 200 sets in July, 225 sets in August
and 245
175
item forecast for the month of October using SA Method.
setsin September. Find the
demand
200 225 245
3
Average demand for the month of October is 224 sets.
Example 3:
SA
223.33 224 units
Demand for generating sets of a particular size in the past six months, in a fir
m was as
follows:
January

300

February

350

March

400

April

400

May

450

June

500

Forecast the demand for July based on

(i)

6 months MA

(i)

6 months MA

4 months and MA

(iii)

3 months MA
400

500450
450400
400400

350 440
300
4 months M500
437.5
400
A=
4

(ii)

(iii)

(ii)

3 months M 500 450 4 450

00
A=
3

Example 4:
A XYZ refrigerator supplier has experienced the following demand for refrigerator during p
ast five
months.Find out demand forecast for the month of July using 5 period MA and 3 period M
A using
SMA method.

12

(i)

Month

Demand

February

20

March

30

April

40

May

60

June

45

Using 5 period MA, demand for

July
(ii)

45 60 40 30 29 units
20
5

45 60
48.33 49 units
40
.... Dt2 3Dt1 Dt

Using 3 period MA, demand for

July

Dt(n1) Dt(n2)

Average is moving, Time period is moving but fix the period.

F 1 or M 1
n
t
Example 5:
Three months MA
MA M(t)

Forecast Ft

Time for Month (t)

Demand for Month (t)

95

100

87

94.00

123

103.33

94.00

90

100.00

103.33

96

103.00

75

87.00

78

83.00

106

86.33

10

104

96.00

11

89

99.67

12

83

92.00

99.67
92.00

Example 6:
The Manager of a restaurant wants to make a decision on inventory and overall c
ost. He
wants to forecast demand for some of the items based on weighted MA method.
r the past
three months he experienced a demand for Pizzas as follows:
Month

Demand

October

400

November

480

Fo

December

550

Find the demand for the month of January by assuming suitable weights to demand data.
WMA CiDi

13
n

Ci = Weights for periods; Di = Demand for periods

i 1

Assume C 1 0.2, C 2 0.3, C 3 0.5

WMA =.
Example 7:
Using the data given in Example 3 compute a weighted three months moving aver
age for
July where the weights are 0.5 for the latest month, 0.3 and 0.2 for the other months resp
ectively.
WMA forecast for July = 0.5 x 500 + 0.3 x 450 + 0.2 x 400 = 465
Example 8:
Three months weighted MA

MA3

Time for Month (t)

Demand for Month (t)

120

118

MA M(t)

Forecast Ft

130

110

118

140

129

118

110

119

129

130

126

119
126

0.2 120 0.3 130 0.5 110

0.2 0.3 0.5
Example 9:
The Manger of a company needs to be able to forecast accurately the demand for an ite
m. The
Manager has collected the following demand data for the pat 8 months.
(i)

Compute a 3 month MA forecast for months 4 through 9.

(ii)

Compute a weighted 3-month MA forecast for months 4 through 9.

Assign weights of 0.55, 0.33 and 0.12 to the months in sequence stacking with
most recent
month.
Month

Demand

MA

WMA

F(t)

12

8.77

9.33

8.7

8.77

15

10.33

12.06

8.7

11

11.67

12.08

12.06

10

12

10.93

12.08

12

11

11.22

10.93
11.22

14

Example 10:

M1(t )

Demand for Month (t)

60

70

85

71.66

60

71.66

88

77.66

73.66

85.66

68

72.00

73.77

68.44

71.66
106

87.33

79.00

104.00

75

83.00

80.77

87.44

86

89.00

86.44

94.11

95.00

89.00

94.11

110.66

98.22

107.00

111.00

105.55

135.55

M 1(3) 7

10
71.66
11

124
71.66
122

12

87

Assume n = 3
D1 D2 D3 60 70 85

3
3
M1(4) M1(t 1)

73.66

Dt Dtn
n
60 60
3

DMA

M1(2)
M 1(3)
M1(4)
M 1(5)
M1(1)
M 2(2n 1) M 2(5)
3

71.66 71.66 77.66

3

M2(t ) M 2(t 1)

M2(t )

Time for Month (t)

M 1(t
n)
M 1(t )
n

M1(3)
M1(6)
M2(6) M2(5)
3

F(t)

 73.66

73.77

F6 F51 2M 1(5) M2(5 2 M 1(5) M2(5)

2
)
3M 1(5) 2M 2(5)
3 x 77.66 2 x 73.66 = 232.98 147.32 = 85.66
F10 F91 2M 1(9) M2(9 2 M 1(9) M2(9) 94.12
2
)

F t 1 t 1 t 1 1 t 2
.....
15

9.4 Exponential Smoothing:

This is another time series forecasting technique where the forecast for the next p
eriod is
calculated as weighted average of all the previous value. It is based on the premise that
the most
recent value is the most important for predicting the future value. Also, it presumes tha
t values
prior to the current value are also relevant but in declining importance as we go back in ti
me.
Symbolically,
1 1 1 ... 1

1
2

F 1 = forecast for the next period

value for the current period.

F 1 t =actual
t 1 t 1 1 t 2 ....................... Eq
.(1) t1, t2,....
are the values of successive preceding periods.
Fractional value between 0 & 1.
0 1 (Smoothing constant)
72 71.66
From this expression,
two points may be noticed.

1. Weights are declining since 1, successive weights of preceding time period

values) are
declining since each weight is obtained by multiplying previous weight by 1 , which
is also a
fraction.
2. Summation of weights is equal to unity.

1 2 .....

1
2

 1 1

Making forecasts while the calculation of the forecast seems a difficult proposition in term
s of the
t

equation given earlier, it can be simplified as shown below.

2

F 1 t 1 1 t 2 ...........................................

Eq.(2)

Multiply both sides of the eq. (ii) by 1 we get

1 F

Subtracting eq. (iii) from eq. (i) we have

F 1 1 F t

F 1 t 1 F
F 1 F t F .
t actual value of period (t).

16
Ft forecast value for the same period.

error in previous forecast

Current Forecast = Last period's Forecast + Last period's actual value - Last Period's

forecasted value

The choice of smoothing constant :The exponential smoothing ap

proach to
forecasting is easy to use but choosing an appropriate value of the smoothing constan
t t1 is an
t

important matter. This is because the choice of this value can make the difference
between an

1
t 1
t 2forecast.
.................................
Eq.
accurate
forecast
and an
In selecting an appropriate
value of the
1inaccurate
t
(3)
smoothing

constant the objective is to obtain the most accurate forecast. The overall ac
t

curacy of a

forecasting
model is determined
by comparing the actual values with the forecasted v
t
t
alues. The
t

difference between an actual value and a forecasted value is called forecast error.
9.5 Trend Adjusted Exponential Smoothing:
The simple exponential smoothing and moving averages methods fail to res
pond to the

presence of trend. The method of exponential smoothing, however, can be modifi

ed so that it
makes adjustment for trend. It involves computing a simple exponential smoothing f
orecast and
then adjusting for positive or negative trend.
In a constant level model, the forecast made for period (t+1), on the basis of
3

week assuming the subsequent demands as 465, 434, 420, 488 and 462 units.

the past (t)

periods, data also provides the best current forecast for time periods t + 1 + m, for
m = 1, 2, 3,
.. The method of forecasting, when linear trend is assumed, is given below.
Yt observed actual value of time series at time (t), then first obtain the smoothed leve
l St at time

(t) as follows.

S t Y 1 S t 1 B t 1

Bt St St 1 1 Bt 1.
In the above equations,
St : smoothened level at time (t)
: smoothing constant as defined earlier
Bt : Smoothed value of the slope at time (t)
: Smoothing constant, like , , for obtaining smoothed value of the slope, with va

lues ranging
between
0 & 1.
t
Forecasted values for m periods as :
F m S t M B t

17
t

Example 11:
A firm uses simple exponential smoothening with 0.02 to forecast dem
and.
The
forecast for the first week of January was 400 units whereas actual demand turned out to
be 450

units.(i) Forecast the demand for the 2

nd

week of January. (ii) Assume that the actual d

emand
during the 2
February
rd

0.02

nd

week of January turned out to be 460 units. Forecast the demand up to

D t
January 1

st

Old Forecast Forecast Error Correction New Forecast

Dt F 1
F 1
Dt F 1
F 1 ( )

450

400

50

10

410

nd

460

410

50

10

420

rd

465

420

45

429

th

434

429

05

430

February 1

st

420

430

-10

-2

428

nd

498

428

70

14

442

rd

462

442

20

446

Demand smoothing technique, compute the forecast from the following dat
Using the Exponential
Week
t
t
t
t
a under
th

do you accept? Give reasons.

Old Forecast Correction
Foreca error
=0.3

Correction

Month
st

Demand

27

27

27

27

30

27

0.9

27.9

2.1

29.1

32

27.9

4.1

1.23

29.13

2.87

31.13

=0.7

4 when 31
29.13
1.87 the forecast
0.56
the situations
=0.3 and
=0.7. Compute
for 29.69
the 11
ast
5
28
29.69
-1.69
-0.507
29.18

1.309
period.
-1.183

31.039forec
Which
28.912

27

29.18

-2.18

-0.654

28.53

-1.526

27.57

30

28.53

1.47

0.441

28.97

1.029

29.271

33

28.97

4.03

1.209

30.179

2.821

31.88

33

30.179

2.821

0.846

31.02

1.979

32.664

10

31

31.02

0.02

0.006

31.499

31.014
Example 12:
One of
ut

usually

the

two

wheeler manufacturing company experience

irregular

increasing demand for three products. The demand was found to be 420 bikes for June
and 440

Ft1
t
bikes for July. They use a forecasting method which takes average of past year to foreca
st future
demand. Using SA method demand forecast for June is found as 320 bikes. (Use a s
moothing
coefficient 0.7 to weight the recent demand most heavily) and find the demand f
orecast for
average.

18

January 1 week Previous Average

Week
Ft1

Actual
Demand Dt

Smoothed
Average Ft

Smoothed
Trend Tt

Next period
projection
Ft1

st

600

650

605

1.00

606.00

nd

605

600

605.4

0.88

606.38

rd

605.4

550

600.65

-0.246

600.40

th

600.65

650

605.36

0.742

606.10

605.36

625

607.99

1.120

609.11

nd

607.99

675

615.70

2.440

618.14

rd

615.70

700

626.33

4.080

630.41

th

626.33

710

638.37

5.670

644.04

January 1
2

February
st
1
2

644.04 644 units

st

March 1

Month

Dt

D t

F 1

Dt

F 1

Ft

June

420

320

100

70

390

July

440

390

50

35

425

425
Example 13:
Compute adjusted exponential forecast for the 1
m with the
following data.

st

week of March for a fir

Assume the forecast for the 1 st week of January

F0

as

600 and the

corresponding initial trend T0

as 0. Let 0.1and 0.2.

January

February

Week

Demand

650

600

550

650

625

675

700

710

st

F 0.1 650 0.9 600

=605

Tt 0.2 605 600

0.8 0 1.0

Tt1 0
nd

F 0.1 600 0
.9 605 1

= 605.4

Tt 0.2 605 600 0.8 0 1.0

19
9.6 Trend Projections:
We now consider the last of time-series forecasting techniques, in the for
m of trend
projections. For this method, a trend line is fitted to the given time series data and then pr
ojections
2 Week

are made into future using this line. The trend line may be linear (straight line0 or curvilinear in
nature. There is a wide variety of curvi-linear trend lines possible to draw, but our
= 0.88

focus in this
chapter is on linear trend only. For obtaining the trend line, the given historical dat
a are first
plotted on the graph, representing time scale on the x-axis then a line is drawn thr
ough these
points in such a way that (i) the sum of deviations above the line is equal to the sum of d
eviations
below the line so that the sum of deviations is equal to zero (ii) sum of squares of these
(vertical)
deviations is the minimum. In essence, the trend line is drawn on the basis of the pri
nciple of
least squares. Such a line, like any other straight line, is represented by the equation.

Yt a bX
Yt : trend value

a: Y-axis intercept; b: slope of trend value

X : the independent variable, the time
Parameters a & b of the trend line drawn on the principle of least squares are obtained
using the
following pair of normal equations

na b X.

XY
b X

a X

XY nXY ; a Y bX.

Alternatively b

Here,

Summation of the values of dependent variable

Summation of the values of independent variable

XY

Summation of the products of the X and corresponding Y-values

Summation of squares values of independent variable.

n = number of data points

The value of b in the equation indicates the change in the variables under consi
deration
per unit of time.
Year

1988

1989

1990

1991

1992

1993

1994

1995

1996

Sales (in lakhs)

11

23

29

34

40

45

56

nX

20
Example 14:
A firm believes that its annual profit depends on its expenditures for resea
rch.
The
information for the preceding six years is given below. Estimate the profit when the expen
diture is
6 units.
Year

Expenditure for Research (X)

Annual Profit (Y)

1989

20

1990

25

1991

34

1992

30

1993

11

40

1994

31

1995

Solution:
X

XY

1989

20

40

1990

25

75

1991

34

170

25

1992

30

120

16

1993

11

40

440

121

1994

31

155

25

Total
X

Y
n

30

180

30
6
5
180
6
30

1000 6 5 30
X Y n X
b

X n X
2
200 6 5
Y

2
2

Year

1000

200

b
Solution:
Year (X)

Solution: 1988
0
1989
l
+
0
w
n

Sales (Y) in lakhs

x = X - 1992

xY

-4

-24

16

-3

-24

1990

11

-2

-22

1991

23

-1

-23

1992

29

1993

34

34

1994

40

80

1995

45

135

56

224

16

380

60

1996
6 y y
2
y y1 Total
1

252

aY
X 30
2 5 2
The mode
is y = a
bX=2
+ 2X
The profit
hen expe
diture is
units.
Y = 20 +

2 x 6 = 32 units of rupees.
x
Example15:
0
Alpha company has the following sales pattern during 1988 to 1996. Compute th
e sales
y

28

n x

6.33

21

n
x

252
9
b

xy n x y
2

380 0
60 9 0 0

forecast for 1997.

a y bx 28 6.33 0 28
Model is Y = a + bx
= 28 + 6.33 x
= 28 + 6.33 (x-1992)
The forecast of sales for the year 1997 is computed by substituting x = 1997
Y = 28 + 6.33 (1997-1992) = 28 + 6.33 x 5 = 59.65 60 units
Establishment of Trend Method:

(i) Simple Average Method:

ups and a

Historical data are divided in this method, into two gro

mean is computed for each group and position at the centre of each sub period.
Year
Sales (Rs. in Lak
Semi Average
1991

When the

400

1992
number of periods
is odd, the middle 420
one is not considered while430
dividing data into
1993

two equal

470

1994
Notthe
considered
parts. A line drawn
through the two semi480
averages then constitutes
trend.
1995
Example16 : Sales
turnover of a firm in520
the last seven years is as follows.

Year

1996

Year

550

1997

1991

610

1990

x 1
Sales x 39

1991
48
Year

1992

Sales (Rs. in Lakhs) 560

400

1993

1994

1995

1991

65
78
95
Sales (Rs. in Lakhs)
1992
420
39
1993
470
48
1994
480

1992

1995

65

520

1993

1996

78

550 -

1994

1997

95

610

1990

1996

91
112
Semi Total

Semi Average

152

50.67

Not considered

Not considered

}
}

1995 semi average method

91 and determine the sales
298 for 1998.
Compute the trend through
1996

112

99.33

22

x2 x 1

y 430 560 43 1998 1992

0

4
Y = 625
Example 17:
96 are

The details of sales turnover of a fertilizer company for the period 1990

Year

1988

1989

Sales (Rs. in Lakhs)

1990

45

56

1991

78

1992

46

75

1995 1991
2
y 50.67 (X)
Salessquares,
(Y) in find theX trend values
xY the five years.
x
By adoptingYear
the method of least
for each of
so
khs 45
1988
1
1
45

Al

y 123.66
1989 124 crores 56
2
4
112
Solution:
1990
78
3
9
234
9.7 Least Square Method:
1991
46
4
16
184
In this method, a line y = a + bx is identified which fits the data best, by examining the su
1992
75
5
25
375
m of their
300with the smallest sum
15 of squared55errors is950
and the line
squared Total
deviations,
determined.
A least
square line is determined using data from N periods and known parameters a and b. This
is done
Year
1990
1991
1992
1993
by solving a set of two linear equations.
110
130
150
160
b x
y na Sales
2

y
na
b
x
-----(1)
xy
a
x
--------140
(ii)
Demand Index

100
110

150
b xthe estimate sales for the year 1997.
given in the following table. Compute
2
Year
Index X in 0
Sales Y in 0
X

Solution:

1990

10

1991

11

23

20

x 70
estimate the annual sales for 1993.

99.33 50.67

x 1991;

xy
b x

a x

Solving (1) and (2),

x 1997

950 15a 55 (1)

(2)
b

a = 45, b = 5

The trend equation is Y = 45 + 5x

180
200
xy

11

100

110

13

121

143

196

210

225

240

400

360

1992
14
15
Example 18: The annual sales of an enterprise are as follows:
1993
15
16
1994

1994

18

73

1042

xy

1063

Now trend values are

y 1988 = 45 + 5(1) = Rs.50 lakhs; y 1989 = 45 + 5(2) = Rs.55

lakhs
y 1990 = 45 + 5(3) = Rs.60 lakhs; y 1991 = 45 + 5(4) = Rs.65 lak
hs
y 1992 = 45 + 5(5) = Rs.70 lakhs; y 1993 = 45 + 5(6) = Rs.75 lak

b 0.66

hs

Example 19:

Suppose a firm is manufacturing automobiles and finds a relationship b/

w sale of
0.66demand

5.36
automobile
and
Index
for cars. The sales for the last five years are

year 1995. Supposing the demand index nse to 210. Use least square method.

24

na b

73 5a 70b

xy
b x

a x

(1)

r1063 70a 1042 (2)

b

a 5.3
Find the relation b/w the demand index and sale of automobile. Further make a forecast for the
6
Trend equation will be y = 5.36 + 0.66 x
Solution:
The y and x in the equation are 1/10 f actual y and x
y
x
10

10

This is the relation b/w demand index and sales.

Forecasting for the year 1995 with demand index 210

y = 53.6 + 0.66 (210) = 192 automobiles.

9.8 Casual Models of Forecasting:

Casual forecasting models consider situations where the variable to be forecasted,
called

the dependent variable, is related to some variable(s), known as independent variable(s

). For
example, the sales of a company depend on, and is related to, price changed, pr
ices of the
substitute goods, competitors prices, level of economic activity and soon. Similarly, agri
cultural
production depends upon the amount of rainfall, grade and amount of seeds used, use of f
ertilizers
and the like.

The forecasting for the dependent variable is done by developing

a statistical
relationship between it and the independent variable(s).

This is done in terms of

regression
analysis. Here, we consider simple regression analysis and then have some idea about
multiple
regression analysis.
9.8.1 Simple Regression Analysis:
The simple regression analysis is employed where there is one inde
pendent or
explanatory variable.

Here, an estimate of the dependent variable is made correspon

ding to a
given value of the independent variable, by placing the relationship between the two vari
ables in
the form of a regression line The regression line is obtained on the basis of the
given data,
involving paired observations of the X and Y variables. The given paired data are plot
ted on a
graph by means of points.

The line is obtained on the basis of the principle of le

ast squares,
discussed earlier in this chapter.

The regression line is represented by the following

equation,
which is obviously called the regression equation.
YC a bX.

a: Y-intercept of the regression line

b: Slope of the regression line
X: independent variable
YC : predicted value of the dependent variable

As in case of trend line, the value of a and b are obtained as follows:

25

XY

nX

and a Y bX
X
Y nX
2
2

b: Regression coefficient
9.8.2 Correlation Analysis:
Correlation analysis is an additional technique which may be employed to sales f
orecast.
Since all forecast methods are subject to error, a firm is wise to employ more than one me
thod. A
forecast based on time series analysis trends to be substantiated if a similar forecast is obt
ained by
correlation analysis.

Significantly different results cast doubt on each forecast and ind

icate the
need for further analysis. It is recognized fact that certain lines of business or economic
activity
generate business in other fields. For example, sales of building material supplies fluctu
ate with
change in the number and value of building permits issued. Furniture sales follow the p
attern of
new home purchases. Population, employment, income, climate, and distribution
of age,
education, sex and nationality are among other factors which may be used to forecast sales
.
Correlation Defined:
A statistical tool used for expressing the relationship between two or more var
iables in
one single figure is known as correlation. Correlation is simply as averaging process by
which an
average relationships between two or more variables is established.
Measurement of Correlation:
Correlation can be known by
(i)

Graphic Methods: (a) Simple graph,

(b) Scatter diagrams or Scattergrams

(ii)

Mathematical methods: (a) Pearsonian method or Sum product method, (b)

concurrent
or concomitant deviation method, (c) Ranking method, (d) Regression equation or least
squares
method, (e) Difference method.

Pearsonian method:
To render comparison possible a coefficient of correlation is calculated.

Karl

Pearson,

the great biologist, has devised a coefficient of correlation which varies with is 1.1 re
presents
perfect correlation. Positive correlation is given by (+) sign and negative correlation by
xy

(-) sign.

x y
N

Zero indicates
of any
or independence of variables. Limited degrees

correlation
xabsence
y

.N y

of are

given
by intermediate
values lying within
+1.
N

Karl Pearsons coefficient of correlation is given by the formula

xy or r xy y
r

N x x2 N y
3
4
Sales (Rs.1
2

Consumption of goods
9 8
10
12
11
2
2
2x x x
X
Y

x
300 5a 15b

N x y

1
9
-4
16

16
2
y

15
xy

-3

12

-3

-4

16

12

10

-2

-2

12

-1

11

-1

13

26 1

14

16

12

X = standard deviation of x series

8
Y = standard
deviation 16
of y series

13
14
y y y

N = Number of observations

R = Karl Pearsons coefficient of correlation

xy

9
3
The
sum of the 15
product x and 4y columns, 16
x and y denotes
deviation9of x and y. 12

y
y

x0 x

108

60

60

xy

Series from their respective means

When the deviations are taken from the assumed mean the formula takes the following for
m.

22
2

However, we may compute r, if sufficient data are available by the following formula

N xy xx
yy

2
2

xy = the sum of product x and y columns of x and y series

= the sum of x column of y series

57

= the sum of x column of x series

N = number of observations

0.95

y
x 20:
Example

Given below are the sales pattern of ABC company, manufacturing consumer goods
Required equation : x X l y Y
trends of

consumption of consumer goods of similar goods in the market is also depicted. Fi

nd out xthe 2.58
y 2.58
correlation b/w sales of the company and consumption of goods in the market. Also com

pute the

Demand (Y)

XY

105

105

108

216

112

336

116

464

16

Determine5 the forecasted120

demand in 11 600
period

(ii)

130

x 21

691

780

xy

2501

27

xy

Period (X)

25
36
2

91

57

60 60
estimates of sales where consumption in the market will rise to 20 lakhs.
2

X 5
Solution:
Y 12
l 0.95

x 5 0.9
5

x
y

2x2
N

2.58
(y 12)
2.58

X = 0.95 y 6.4
Y = 20, then x = 0.95 x 20 6.4 = 12.6
Example 21: The demand for six consecutive period for a product is as follows:
105, 108, 112, 116, 120, 130
(i)

Establish a linear forecaster

th

(iii)
Calculate the coefficient of determination and standard deviation for the line of the
best fit.
Solution:

N 6 21

N 6 691
Y

xy N. X.
b
4.714
Y

(i)

N=6

3.5
115.167

N X

(iii)

a Y bX 98.668
x X X
Y
Y = 98.668 + 4.714 X
th
1
105
-2.5
6.25

XY

103.37

25.42

2 Y 98.668
108
-1.5 11 150.522
2.25
4.714
11
3
112
-0.5
0.25

-7.167

51.365

10.75

-3.167

10.03

1.58

116

0.5

0.25

0.833

0.694

0.42

120

1.5

2.25

4.833

23.36

7.25

130

2.5

6.25

14.833

220.02

37.08

x0 x
Correlation Coefficient r

Standardized Cost

28

17.5

xy

x y

3.05

91

xy

408.84

3
3.25

2.98

0.97

5
2.93

6
3.91

7
2.58

2.44

2.37
2

Year (X)

Standardized Cost (Y)

XY

3.25

3.25

3.05

6.1

2.98

8.94

2.93

11.72

16

3.91

19.55

25

2.58

15.48

36

2.44

17.08

49

2.37

18.96

64

(ii)

y Y Y

-10.167

Year

36

Forecasted demand in the 11

23.51

period:

XY

101.08

204

82.5

82.5

82.5

17.5 408.84

17.5
6

Standard deviation of x series

x

4.5
x.

N2

of4.5
Standard deviation
y series
y .

84.6

408.84
6

y
N

Required equation X X
r.

x
Y Y
y

X 3.5 0.9
7

X 3.5 = 0.2 (Y 115.17)

1.7 Y 115.17

1
8.2
5

0.2 Y = 19.53 + X

Example 22:
The cost per standardized long distance phone call has been decreasing over time
using the

(ii)

1.71
8.25

Using above equation, predict the standardized cost for year 10.

following data for the last 8 years.

(i)

Use linear regression to compute an expression for cost as a linear function of time.

Solution:

29

(i)

X 36
X
8
N
X

X
N

36
8

a Y b X 3.4452
Y = 3.4452 0.1125 X

(iii)

Standardized Cost for year 10:

Y10 3.4452 0.1125 x 10 = 2.320
Y10 2.320

10.0 Measures of Forecast Accuracy:

Different types of errors which are generally computed are

Mean Absolute Deviation (MAD)

Mean Square Error (MSE)

Mean Forecast Error (MFE)

Mean Absolute Percent Error (MAPE)

Forecast error, Ft = Dt - Ft

Where, Dt Demand for the period t

Ft - Forecast demand for the period t
et - Forecast error for the period t
Mean Absolute Deviation (MAD):

Mean of absolute deviations

oft forecast demands from the actual demand values. It is als
Dt F
o called

as mean absolute error.

n

n: number of time periods

MAD n
1

Mean Square Error (MSE)

Mean of the squares of the deviations of the forecast demands from the actual demand val
ues.

These errors may be smoothed out by inventory or overtime work.

Dt

tF

30

MSE

t 1

Percentage
error

Absolute
Percentage
Error

Dt

Forecast,
Ft

Deviation
(Dt - Ft)

Absolute
Deviation
Dt Ft

Squared
error
2
(Dt Ft)

150

165

-15

15

225

-10.000

10.000

160

165

-5

25

-3.125

3.125

165

165

175

165

10

10

100

5.71

5.71

180

165

15

15

225

8.33

8.33

Time
period

Demand,

Dt Ft
X 100 Dt Ft
X 100
Dt
Dt

Mean Forecast Error (MFE):

It is the mean of the deviations of the forecast demands from the actual demands.
n

MFE

t1

Mean Absolute Percentage Error (MAPE):

t
t
Mean of the forecast deviations of theforecast
demands
from the actual demands.

Year
Sales

1
96

2
116

3
119

n
Dt
1
M
X 100
Ft
An
t1 t

4
P

127
E

5
146

6
145

7
153

8
158

9
160

10
165

11
177

12
190

Wins
6
6
8
For the
data given in4table, calculate
the forecast
errors.
Attendance
Problem:

36,300

40100

41200

53000

6
44000

7
45600

5
39000

7
47500

MAD = 45/5 = 9
MSE = 575/5 = 115
MAPE = 27.165/5 = 5.433%
MFE = 5/5 = 1

31

Questions from previous papers:

1.

Alpha company has the following sales pattern during 1988 to 1996

.Compute the
sales forecast for 1997:

13
205

(a) Show that in exponential smoothing method, weightage to the past dat
a declines
exponentially.
(b) Compare exponential smoothing forecast for different values of smooth
ing
constant.
2.

A computer software firm has experienced the following demand for its P

ersonal
Finance software package:

(a) Develop an exponential smoothing forecast using = 0.4 and an adjust

ed
exponential smoothing using = 0.4 and = 0.20
(b) Compare the accuracy of two forecasts using MAD and cumulative err
or.
3.

The sales particular of a company for 13 years of operation is furnished be

low

a) Fit simple regression for the above data

th

b) Forecast the sales for the 14 year of operation

4.

(a) List out various qualitative methods of forecasting. Explain any one.
(b) The State university athletic department wants to develop its budget for

the
Coming year using a forecast for football attendance. Foot ball attendan
ce
accounts for the largest portion of its revenues and athletic director beli
eves
attendance is directly related to the number of wins by the team. Busine
ss

Develop a simple regression equation for this data to forecast attendance

for this
success. for research (X) Annual Profit(Y)
Yearlevel ofExpenditure
information for the preceding six years is given below.
1989
2
20
32
1990
3
25
1991
5
34
1992
4
30
5. A firm
believes
that
its
annual
profit
depends
on
its
expenditures
for research. Th
1993
11
40
e
1994
5
31
1995
6

Month 1
Sales 96

3
106

92

4
5
6
114 108 98

7
99

8
115

9
106

10
91

11
102

12
99

(a) Develop a linear regression model for these data and determine the
strength of the linear relationship using correlation
b) Estimate the profit when the expenditure is 6 units
6.

(a) Classify forecasting based on its use and explain them briefly.
(b) The following table represents the sales data for liters of milk sold by a
milk booth
th

Use single exponential smoothing and forecast demand for 10 month with
=0.2 and an initial forecast of 100.0

manager has accumulated total annual attendance figures for the past 8 years.

33