8. Analysis And Forecasting Techniques (Correlation, Learning Curve, Balance Score Card)

Question 1

Correlation And Regression

Answer 1

• Forecasting is the basis for business plans and budgeting
• Correlation analysis is the foundation of any quantitative method of forecasting. Correlation is the strength of the linear relationship between 2 variables (Independent and dependent) expressed mathematically in terms of coefficient of correlation (r)
• The value of (r) ranges from 1 (perfect direct relationship) to -1 (prefect inverse relationship)
• If (r) is Zero, it does NOT mean that there is no relationship between variables, only the relationship CAN’T be expressed as a linear equation
• Coefficient of determination (r2) measures how good the fit between 2 variables. Is the proportion of total variation in the dependent variable that is accounted for by independent variable - Measures % of total variance in cost that is explained in regression equation
• Regression Analysis also called least square analysis is the process of deriving the linear equation that describes the relationship between two variables with a nonzero coefficient of correlation
• Regression analysis is based on assumptions and prediction that future CAN’T provide certainty
• Regression analysis determines the extent of dependence
• Types of regressions:
  1) Simple regression where ONE independent variable is used
  2) Multiple regression where MORE than independent variable is used - It is NOT used to determine fixed and variable costs because it have more than ONE independent variable (only used to estimate variables)
• Simple regression equation:
  Y = A + Bx
  Y: Dependent variable - A negative Y intercept indicates that it is outside the relevant range
  A: The Y intercept - Fixed cost, it also means that it is the minimum amount regardless of level of independent variable
  B: The slope of regression - Variable cost
  X: Independent variable
• Simple regression, high low method and graphic method are used to estimate fixed and variable costs
• The linear relationship established for X and Y is only valid across the relevant range
• Regression analysis assumes that PAST relationships can be validly projected into the future
• A limitation of regression analysis that it can ONLY be used when cost patterns remain unchanged from prior periods
• Regression analysis is valuable for budgeting and cost accounting.

Question 2

Learning Curve Analysis

Answer 2

• Learning curve reflects the increased rate at which people perform tasks as they gain experience
• The time required to perform given task becomes progressively shorter during early stages of production
• Is best used to predict unit DL cost (quantitative technique)
• Learning cure methodology is appropriate when submitting a bid for a product which the firm already has experience
• The learning curve is usually expressed as a % of REDUCED TIME each time cumulative production doubles.
• The time listed in cumulative average time per unit is an average of ALL units produced UP TO that point
• Learning curve methods:
  1) Cumulative average time learning model - time it takes to complete CERTAIN number of tasks
  2) Incremental unit time learning model - time it takes to complete the LAST tasks
• Limitation of learning curve in practice that it is difficult in knowing the shape of the learning curve
• If the question states that the company is required to submit the minimum bid for manufacturing additional quantities we need to exclude the fixed cost from the total cost. But in case the question was to submit the maximum bid we will include the fixed cost

Question 3

Expected Value

Answer 3

• Expected value is the weighted average of probable outcomes
• The outcome yielding the highest expected monetary value is the optimal alternative
• Expected value components:
  1) The decision - alternative is under the manager control
  2) State of nature - is the future event whose outcome the manager is attempting to predict. Also is uncontrollable future event that can affect the outcome of decision
  3) The payoff - is the financial result of the combination of the manager decision and the actual state of nature
• The expected value of an event is calculated by multiplying the probability of each outcome by its payoff and summing the products - payoff comes in the form of profit
• The difficult aspect of constructing a payoff table is determination of all possible outcomes of decisions and their probabilities.
• Another approach is called deterministic approach that assumes a value is known with certainty. - If the question states deterministic instead of probabilistic approach then we choose the highest probability i;e hot 25K 10%, warm 10K 15% and cold 20K 20% we go with the highest probability which is 20%. Example, we will take the 20K and multiply directly to sales or price based on question
• The expected value criterion is likely to be adopted by manager who is RISK NEUTRAL.
• Perfect information is the difference between expected value under CERTAINTY and the expected value under best act under UNCERTAINTY - best act means highest outcome from all probabilities. It is also the additional expected value that could be obtained if a decision maker new ahead of time which state of nature would occur

Question 4

Sensitivity Analysis

Answer 4

• Is the process of evaluating the effect of changes in variables- can be used in determining the outcome of variety of decisions.
• is useful to determine whether expending additional resources to obtain better forecast is justified
• The benefit of it that manager can see the effect of changed assumptions on the final objective
• A trial and error method INHERENT in sensitivity analysis is facilitated by the use of computer software.
• The major use of sensitivity analysis is an capital budgeting

Question 5

Strategic Management

Answer 5

• Strategic management sets overall objectives for an entity and guides the process of reaching those objectives. It is the responsibility of UPPER MANAGEMENT
• Steps in Strategic management: MSSIC
  1) Mission statement - drafted by BOD
  2) SWOT analysis - also called situational analysis
  3) Strategy to be developed by upper management
  4) Implementation of strategy
  5) Controls and feedback - monitor progress, isolate problems and take corrective actions
• Mission statement tends to be most effective when they consist of single statement - in GENERAL terms
• Mission statement describes what a company wants to achieve NOW, Vision statement describes what a company wants to achieve in the FUTURE - mission describes how the company will achieve its vision
• SWOT analysis tends to highlight the basic factors of cost, quality and speed of product development
• Strength and Weaknesses are INTERNAL environment
• Opportunities and Threats are EXTERNAL environment
• Implementing the chosen strategies involves every employee at every level of the entity
• Porter model includes an analysis of the five competitive forces that determine long term profitability as measured by long term ROI
• Five porter competitive forces:
  1) Rivalry among existing firms - will be affected by many factors like stage of industry life cycle, capacity expansion, higher fixed costs indicates that competition will be intense and distinction among products. During growth stage a new product models and features are introduced
  2) Barriers to entry - Factors that increase threat of entry such as economic of scale is NOT significant, brand identity, cost of switching to substitute is low, exit barrier is low, government policy to encourage new entrants. The MOST favorable industry is one in which entry barriers are HIGH and exit barriers are LOW - increase the threat of new barrier
  3) Threat to substitutes - limit price increases and profit margins. Substitutes are TYPES NOT BRANDS of goods and service. Considerations affecting the threat of substitute:
  a. Relative prices
  b. Cost of switching to a substitute
  c. Customer inclination to use a substitute
  4) Threat of buyer bargain power - high switching costs decrease buyer bargaining power, buyers are in a stronger position when supplier products are undifferentiated, the more important the supplier is to the buyer the less bargaining power they have.
  5) Threat of supplier bargain power - buyer best response are to develop favorable, mutually beneficial relationships with supplier or to diversify their source of supply.
• Generic competitive analysis model:
  1) Broad competitive scope
  a. Cost leadership
  b. Differentiation
  2) Narrow competitive scope
  a. Cost focus - Regional or smaller market
  b. Focused differentiation - Regional or smaller market
• Five operation strategies:
  1) Cost strategy - competition tends to be intense because of the possibility of high volume sales
  2) Quality strategy
  3) Delivery strategy
  4) Flexibility strategy - involves offering many different products
  5) Service strategy
• Growth Matrix Share - frequently used for competitive analysis was created by Boston Consulting Group. It contains Market Growth Rate (MGR) which reflect the MATURITY and ATTRACTIVENESS of the market and the need for CASH to finance expansion and Relative Market Share (RMS) which reflects the SBUs competitive position in the market
• The growth matrix have 4 quadrants, the firm SBU are commonly represented by circles. The SIZE of the circle is directly proportional to the SBU SALES VOLUME
• The growth matrix quadrants:
  1) Question marks - (Low RMS, High MGR) - weak competitors and they net large amount cash flow not only to finance growth but also to increase RMS
  2) Stars - (High RMS, High MGR) - strong competitors and their net cash flow are MODEST
  3) Cash Cows - (High RMS, Low MGR) - strong competitors, financing for expansion is not needed so excess cash can be used for investments in other SBU
  4) Dogs - (Low RMS, Low MGR) - weak competitors and their net cash flow are MODEST
• The matrix starts with QUESTION MARKS and ends with DOGS
• A portfolio SHOULDN’T have too many LOW RMS or too few HIGH RMS
• Growth Share Matrix strategies:
  1) Hold Strategy - strong cash cows
  2) Build Strategy - A question mark with potential star
  3) Harvest Strategy - Weak cash cows an possibly questions marks and dogs
  4) Divest Strategy - Question marks and dogs (Low RMS)
• Managers may find it difficult to measure market share and growth or even define SBU. Thus, Growth share matrix may have LIMITED strategic value

Question 6

Balance Scorecard

Answer 6

• The trend in performance evaluation is balance scorecard approach
• Balance scorecard is:
  1) Tool for communication - measure financial and non financial
  2) Goal congruence tool - internal or external, short term or long term
• Strength & Weaknesses are INTERNAL resources, Opportunity & Threats are EXTERNAL resources
• Balance scorecards facilitates BEST PRACTICE ANALYSIS - the whole concept of benchmarking is aimed of identifying best practice
• PEST analysis is an analysis for certain factors in the EXTERNAL environment:
  1) Political factor
  2) Economic factor
  3) Social factor
  4) Technological factor
• The scorecard should include Lagging indicators (financial measures) and Leading indicators (nonfinancial measures).
• Balance scorecard de-emphasize short term financial results and focuses attention on KPI
• An ERP system is almost a necessity
• Balance score cards KPI & measures: FLIC
  1) Financial
  2) Customer satisfaction - Economic value added is NOT customer satisfaction measure
  3) Internal business process - Cycle time is an internal process measurement, it’s the manufacturing time to complete an order
  4) Learning and growth
• The active support and participation of senior management are essential
• A high level of management judgment and intuition are required to successfully implement a balanced scorecard.
• The scorecard should contain measures at the DETAIL LEVEL.
• Problems in implementation of balance scorecard:
  1) Using too many measures
  2) Failing to evaluate personnel
  3) Including measures that will not have long term financial measures
  4) Trying to achieve improvement in ALL areas
  5) Not being aware that connection between nonfinancial measures and ultimate financial may not continue to be true

Question 7

Strategic Planning

Answer 7

• Planning is the determination of WHAT to be done, HOW, WHEN, WHERE and by whom
• Outcome of strategic planning is broad management statement of concept that emphasizes the implementation of organizational objectives over the long term
• During planning, no transactions occur during the planning cycle that must be recorded in the general ledger
• Forecasting is the basis of planning because it projects the future.
• Strategic planning steps:
  1) Setting objectives
  2) Setting premises
  3) Setting policies, procedures and rules
• Strategic plans are translated into measurable and achievable intermediate operational plans
• Contingency planning - Involves having alternative strategies in place
• Scenario planning - Involves projecting plausible future events
• Premises are the underlying assumptions about the expected environment in which the strategic plan will be carried out
• Conflict among an organizations objective is COMMON
• Effectiveness is doing the right thing, efficiency is doing things right. Trade offs are frequently made between efficiency and effectiveness
• Intermediate and operational plans are translated into policies, procedures and rules.
• Policies and procedures provide feedforward control because they anticipate problems and provide guidance
• Policies are general statement
• Procedures define how work is to be done
• Rules are detailed guides that restrict behavior
• Management By Objectives (MBO) is a Behavioral, COMMUNICATIONS oriented - it is a comprehensive management approach. MBO is a set of QUANTITATIVE terms
• MBO is based on philosophy that employees: they should participate in setting their objective
  1) Want to work hard if they know what is expected
  2) Like to understand what their job actually entail
  3) Are capable of SELF DIRECTION and SELF MOTIVATION
• Goal Congruence ensures harmonization of objectives, procedures and work as a team in order to realize company goals
• Characteristic of successful strategic plans: CMDL
  1) Clarity of purpose and realistic goals
  2) Monitoring, measurement and feedback
  3) Discipline and commitment
  4) Leadership