3.3 decision making techniques Flashcards
What is the sales forecast ?
An important business planning tool that provides an estimation using past data and external factors
What are the three main methods in quantitative sales forecasting ?
- Moving averages
- Extrapolation
- Correlation
What is a moving average ?
A series of averages calculated from successive segments of a series of data to smooth fluctuations
What is extrapolation?
This is the prediction of future sales from past data done by extending the line of best fit
What is a correlation ?
When there is a link between two variables there is a correlation that may be positive or negative
How do you calculate moving averages ?
Add together sales for a specified number of periods
Divide the moving total by specified number of periods
What is a scattergraph ?
Allow businesses to compare two variables such as sales volume and advertising to see if there is any correlation
What are the types of correlation
Positive - as one increases so does the other
Negative - as one increases the other decrease
None - no connection
What are limitations of quantitative sales forecasting
Seasonality
Competition
Publicity
Market changes
Changes to legislation
How can you improve accuracy of sales forecasts?
Detailed market research
Employing experts with excellent market knowledge
Revising the sales forecasts frequently
Forecasting the short to medium term
What is investment appraisal?
Comparing expected future cash flows of an investment with initial outlay for that investment
What do they want to find out from the investment appraisal ?
How soon the investment will recoup initial outlay
How profitable the investment will be
What data needs to be collected for an investment appraisal ?
Sales forecasts
Fixed and variable costs
Pricing information
Borrowing costs
What methods are used to appraise value of an investment ?
The simple payback period
The ARR
The net present value of discounted cash flow
What is the simple payback period ?
The calculation of the amount of time it is expected an investment will take to pay for itself
How do you calculate payback period ?
Initial outlay / net cash flow per period = years/months
What is the benefit of payback period ?
- Simple
- Cash flow management
- Identify the point where it is paid back
What is the drawback of the payback ?
- No insight into profitability of investment
- Only considers total length of time to recover an investment
- Neither timing or future value is considered
- May encourage shortism approach
What is the average rate of return ?
Compares average profit per year generated by an investment with value of initial outlay
How do you calculate ARR ?
arr / initial outlay x 100
Creative Frames, a small artwork framing business, is considering an investment of £40,000 in new machinery. Megan, the business owner, believes that total cash inflows over a 6-year period will be £140,000 and total cash outflows will be £92,000.
Calculate the Average Rate of Return of the proposed investment. (4 marks)
140 000 (cash inflows) - 92000 (cash outflows) = 48000 total profit
48000 / 6 years = 8000
8000 /40000 =0.2
20%
What is the advantage of ARR
- considers all net cash flows
- easy to understand and compare
what is the disadvantages of arr
- ignores timing of cash flows
- The opportunity cost of the investment is ignored as values are nether expressed in real terms nor adjustments made for the impact of interest rates and time
What is net present value ?
A financial metric used to evaluate the value of an investment or a project
What does the NPV take into account ?
Effects of interest rates
Effects of time
What does the discounting method take into account ?
- The fact that that money received in the future is worth less than money received today due to inflation
- The opportunity cost of not having the money available for other uses
How do you work npv ?
Total discounted - initial investment
What are the advantages of NPV
- considers opportunity cost of money
- calculate forecast future values of net cash flow
- they can adjust discount to adjust to level of risk
What are the disadvantages of NPV
- complicated
- hard to accurately forecast
- hard to select an appropriate discount
- only looks at financial costs and not non financial eg environmental damage
What overall is the limitations of I.A.T ?
- relies on forecast
- external shocks
- does not consider objectives
What is a decision tree ?
A quantitative method of tracing the outcomes of a decision so the most profitable decision can be identified
What are the advantages of decision trees ?
- Reveal unconsidered options
- Consider risks
- Requires deep research
In a decision tree how do you calculate the expected monetary value ?
(Expected value of success x Probability) + (Expected value of failure x Probability)
What is a limitation of using decision trees ?
- Time and data
- Constructed on estimates
- Does not take into account qualitative elements
- Time lag between making and implementing decision will effect relaiability
What is a critical path analysis ?
project management tool that uses network analysis to plan complex and time-sensitive projects
What components are in a C.P.A ?
Activites
Duration
Dependent on each activity
What are some things the CPA shows ?
- The order in which activities must be completed
- Path of projects
- The earliest and latest that each project activity can start and finish without delaying completion of the project as a whole
- Activities within a project that can be carried out simultaneously are identified
- The critical project activities which if delayed will cause the project as a whole to over-run
What is the main drawings of a cpa ?
Node
- left half : activity number
- top right : EST
- bottom right : LFT
Activity
- line which link nodes
Duration
- below activity line
If the nodes are equal for est and lft what does that mean ?
Where if the critical activites are delayed the whole project will be
What is the float time ?
Float time exists where there is a difference between the Earliest Start Time (EST) and the Latest Finish Time (LFT)
What are the limitations of C.P.A ?
Very lengthy
Relies on estimates and forecasts
Not guaranetee success of project
