3.3 Flashcards
Why does a business need or want to forecast sales?
Quantitative sales forecasting is a vital and common business planning activity - forms basis for: • HR plans • Production • Cash flow forecast • Profit forecasts and budgets
What is extrapolation?
Use of trends established by historical data to make predictions about future values
Basic assumption of expltrapation
That the trend will continue into the future unless evidence suggest other wise
Moving averages
a+b+c
———-
3
b+c+d
————-
3
Etc
What is volatile data?
See trends more easily
Purpose of moving average
Helps point out the growth trend (expresses as a percentage growth rate)
Benefits of extrapolation
- simple method of forecasting
- not much data required
- quick and cheap
Drawbacks of extrapolation
- unreliable if there are significant fluctuations in historical data
- assumes past trend will continue into the future
- ignores qualitative factors (e.g change in tastes)
investment appraisal overview
Spending now with the expectation of a return in the future e.g new machinery, mergers/takeovers
Invest appraisal definition
A series of techniques designed to assist businesses in judging the desirability of investing in particular projects
When may investment appraisal be necessary?
- introducing new product
- expansion
- new technology
- advertising campaigns
Types of investment appraisal
Payback
Average rate of return
Net present value
What is payback?
The length of time that I takes for an investment to pay for itself from the net returns provided by that particular investment
Formula for payback
No of full years + what you need / what you get x 12
Advantages of payback
- Easy to calculate
- Takes into account the cost of investment
- Focuses on short term cash flow
Disadvantages of payback
- ignores the overall return on a project
- ignores the time value of money
- encourages a short term approach
What is average rate of return (ARR)?
A method of investment appraisal which measures the net return per annum as a percentage of the initial spending
How to work out average profit?
Total profit or returns/ no. of years
ARR formula?
Average profit/ initial costs x 100
Steps to calculate ARR
1) calculate profit over life time
2) divide by the number of years of the investment project to give the average annual profit
3) apply the ARR formula
Higher or lower rate for ARR?
Higher
Higher or lower rate for payback?
Lower
Advantages of ARR
- measures profitability
- easy to compare % returns against other investments
- considers total revenue
Disadvantages of ARR
- ignores the timings of cash flows
- ignores the time value of money
- ignores the risk factor of having a long payback period
What is net present value?
The present value of future income from an investment appraisal, less the cost
Calculating NPV
1) multiply net cash flow x discount factor
2) add up all the present values
3) subtract the initial outlay
Advantages of NPV
- considers all cash inflows
- use of discounting reduces the impact of long term , less likely cash flows
- has a decision making mechanism- rejects projects with negative NPV
Disadvantages of NPV
- complex to calculate
- can not compare projects with different initial costs
- rate of discount is critical- if it is high, fewer projects will be profitable
What is a decision tree?
Mathematical models that set out all the options available for manager when making a decision, plus the possible outcomes of those decisions
Expected value formula
Estimated financial effect x probability
Net gain formula
Expected value of each outcome + deducting costs associated with decision
Advantages of decision trees
- highlight possibilities that had not previously been considered
- require numerical values to be placed upon decisions- improves results
- takes account risks involved and makes the decision maker aware of them
Disadvantages of decision frees
- probabilities are estimated
- do not take into account non- numerical factors
- time lags may make data out of date
- process can be time consuming
- diagrams can become unmanageable for complex decisions
ARR- formula for total profit over life time
Total net cash flow - investment outlay
What is critical path analysis?
Project management tool that uses network analysis to help project managers handle complex and time sensitive operations
Advantages of CPA
- helps reduce risk and costs of complex projects
- encourages careful assessment of requirements of each activity in a project
- help sport activities which have some slack and could therefore transfer some resources
Disadvantages of CPA
- baser on estimates and assumptions made
- CPA does not guarantee the success of a project
- resources may not actually be as flexible as management hope when they come to address the float
- too many activities make the network diagram too complicated
