BEC review Flashcards
Strategic Planning
setting long-term overall goals and policies. Guides the org’s long-term ops.
Tactitcal planning
focuses on ST objectives and termporary techniques
First step in strategic planning
Creating a mission statement
Mission statement
identifying and org’s purpose and values
Second step in strategic planning
identify goals and objectives that flesh out the org’s mission
Performance measures
measures how well the org is meeting their goals and objectives
Tactics
specific actions to be used to meet goals
Master budget
a static budget (does not adjust for different levels of output) for the company as a whole
2 budgets the master budget summarizes
operating, financial
Operating budget
a projected income statement with its various supporting schedules
Financial budget
projected capital budget, cash budget, B/S, and statement of CFs
Static budgets
analyzes conditions for 1 level of activity. does not each time some volume changes (e.g., sales). These are usually set up for long periods and made for a whole company or each division within a comp
Kaizen budgeting
make cost projections that incorporate expectations for future improvements. If improvements don’t happen, then the budget is not met. Focuses on continous small improvements rather that huge structural changes
Steps in making a master budget
1) Estimate future sales volume 2) Use sales volume to est. revenues 3) Use collection histories to est. collections 4) Est. the cost of sales based on the number of units sold 5) Use current FG inv., budgeted ending inv., and COGS to est. the number of units to be manufactured 6) Use units to be manufactured to est the org’s material needs, labor costs, and overhead costs 7) Use material needs, current RM inv., and budgeted ending inv. to budget future purchases 8) Use purchases to est payments 9) Analyze expense and payment patterns to complete operating and cash flow budgets
Budgets must be prepared in what order?
Sales, production, direct/RM purchases, cash disbursements
How do you determine something like budgeted RM purchases?
Work backwards from budgeted unit sales (sales budget is 1st step in budgeting)
Flexible budgets
Can be adjusted for changes in volumes. This budget is prepared according to how costs behave (variable v. fixed). Thus flexible budgets use variable costing/direct costing
What is the flexible budget equation?
Y = a + Bx……“a” is the intercept or FC……“B” is slope or VC…..”x” is the cost driver….”Y” is TC
What is the slope?
Shows the effect on Y for a change in X. So it shows the effect a change in the cost driver has on the change in Y
What is the advantage to flexible budgeting?
Can be easily adapted to changes in variable costs that result from changes in sales levels. Will show how TC changes when sales levels change.
Correlation analysis
Calculates the correlation coefficient between an independent and a dependent variable.
Range of correlation coefficient
-1 to 1.
What does -1 show?
perfect negative correlation
What does +1 show?
perfect positive correlation
What does 0 show?
neglible relationship
Regression analysis
Shows the relationship btwn a dependent variable and several independent variables (multiple/multivariate regression). Or a dependent variable and only one independent variable (univariate/simple regression)
What does regression analysis do?
Tests what independent variables are the best predictor of the dependent variable
Coefficient of determination
R squared. Percentage of variation in the dependent variable explained by the percentage of variation in the independent variable. Btwn 0 and 1.
F-statistic
measure of the statistical significance of a regression model (model specification)
Model specification
Applying many different combos of independent variables to a dependent variable to see which combo fits best.
p-value
Attached to F-statistic. Probability that the overall predicted relationship (R squared) occurred by chance. P-value is for the overall fit of the model specification.
t-statistics
Attached to p-value. Shows each independents variable’s statistical significance in predicting the dependent variable. So t-statistic is for 1 indep. var. in the model specification.
What is a range of p-values that is very reliable?
.01 - .05. (i.e., there’s only a 1% to 5% chance that the overall predicted relationship of the model occurred by chance.
Responsibility accounting
Helps companies to evaluate manager’s or division’s performance by assigning them to centers of responsibility. This helps to reduce costs/increase efficiency in manufacturing.
Cost center
Manager here is responsible only for the costs incurred in the center
Profit center
responsible for both the revenues and costs of a center
Investment center
Responsible for the revenues, costs, and capital investments of a center
What’s the general rule for responsibility accounting?
Manager’s should not be held responsible for the costs/revenues/investments that they can’t affect
What is the benefit of using ABC for regression?
Yields a greater number of potential cost drivers (b/c costs are seperated into different activities…MOH is not just a single allocation to all products based on a single cost driver). Generally, the more potential cost drivers, the better the regression model.
Value adding costs
Those that actually make the product better. Improvements that the customer will value.
Non-value adding costs
Those that increase the cost of a product but that customers don’t specifically value. (depreciation, storing, handling)
Does ABC seperate costs into value adding and non-value adding?
YES
Service departments
incur OH providing support to the production/manufacturing departments. Under ABC, firms allocate the service department OH to appropriate production departments
2 methods to allocate service department OH costs
Direct: Allocates costs from each service department directly to production departments. Step allocation: firm allocates costs from a service department both to production departments and temporarily to the other service departments
Step-Allocation (service department costs –> production departments)
1) Rank service departments by amount of services performed to the other service departments 2) Costs of 1st service dep. are allocated to remaining service deps. and production deps. Once all of the 1st service dep. costs are allocated, that dep. is removed from process. 3) Costs of next service dep. are allocated to the remaining service and production deps. Process is repeated until the costs of the last service dep have been allocated to production deps.
Econometric models
Regression analyses that incorporate company data AND industry/economy-wide measures to estimate future sales and costs
Time series analysis/models
Subset of regression that forecasts data for a SINGLE firm over time (sales/costs)
Delphi method
The use of experts in different areas when there’s little historical info to use to predict future conditions. Expert opinions are examined and sent back as a whole to each expert until a consensus.
What does the Delphi method avoid when properly used?
Experts simply agreeing with each other if they meet to discuss their opinions. Avoids GROUPTHINK.
Probability distribution
gives the likelihood of possible outcomes occurring from a single action
How do you get the expected value of a probability distribution?
Multiply each of the possible outcomes by its chance of happening and sum the amounts
Gordon Growth Model
Total Return = Distribution Rate + Growth Rate
What does the gordon growth model assume?
Reinvested assets will increase distributions by the amount of reinvestment. Ex. Investment with 3% dividend and 7% growth rate: The dividends will grow 7% each year. Growth rate of assets will be the growth rate of future dividends
Portfolio
A group of investments
Expected return of a portfolio
weighted-average of the expected return of the individual investments
Arithmetic average return rate
Add returns for several periods and divide by the number of periods. Does NOT take into account compounding
Geometric average return rate
Single annual compound rate of return needed to turn the initial value of a investment into its final value over the number of intervening periods.
When single period return rates are different over several periods, which method of average return gives a lower return?
Geometric gives a lower return. This is because compounding is included in the calculation, so a lower return is needed to get the investment to the same value (compared to arithmetic average return).
How do you calculate a geometric average return?
(value one period later - initial value) / initial value
Standard deviation
Measure of the volatility of an investment. Square root of the variance of the investment. Measure of the dispersion of a set of data from its mean.
What is a shortcoming of standard deviation?
SD gives disproportionate weight to big differences from average return (i.e., outliers skew the SD in 1 direction)
Coefficient of variation
Standard deviation / Expected Return
Modern Portfolio Theory
SD of portfolio of investments will generally be smaller than the SD of the individual investments. This is b/c each investment is unlikely to move up and down at exactly the same time.
Correlation coefficient
1: when one investment goes up, the other investment goes up proportionally the same amount. -1: when one investment goes down, the other investment goes up proportionally the same amount. 0: There is no relationship btwn the investments
T/F: Correlation coefficient < 1 means SD of the portfolio is < the average SD of the individual investments
TRUE; the diffs. in the investmens’ price fluctuations somewhat offset each other
NOTE:
A high covariance means the investments move in similar directions. A low covariance means the investments move in different directions.
How do investors try to eliminate unsystematic risk?
By combining investments that have low covariance with each other.
Unsystematic risk
risk that pertains to only one investment. When a portfolio of investments have very low covariance, unsystematic risk is greatly reduced b/c as one investment goes up, the others go down.
Systematic risk
Unavoidable risk that cannot be diversified away. This is the risk of the market as a whole. Results from economy-wide factos like GDP, inflation, interest rates, etc.
What do investors expect from bearing systematic risk?
The market’s expected returns.
What would investors bearing unsystematic risk have to expect?
Expected (average) returns less than the market’s b/c they are bearing risks that may be avoided.
Mean-variance optimization
Gives the portfolio with the highest expected return for a particular level of volatility. This portfolio is known as the efficient portfolio for that level of variance.
Efficient frontier
Plots the combo of assets that yield the most efficient portfolios for various risk levels
Beta
Measures how the changes in the value of an individual investment compares with changes in the value of a market-wide portfolio. Thus, it compares the volatility of an individual investment relative to the volatility of the market.
What does a beta of 1 indicate? .5?
1: The investment changes in value exactly at the rate that the market does. .5: the investment changes in value at half the rate that the market does
CAPM
Suggests that investments with higher betas should have higher expected returns to compensate for the extra risk
Alpha
Measures how much better an investment performs than the return predicted by its beta.
Efficient Market Hypothesis
States that stock prices already have all existing info. Thus, an alpha greater than 0 is just luck. The best portfolio invests in all the stocks in the market (thereby eliminating unsystematic risks).
Bull market (charge)
A period during which prices have risen > 20% from their previous trough
Bear market (hibernate)
A period during which prices have fallen > 20% from their previous peak
When referring to credit risk, who has the risk?
The borrower has credit risk. (i.e., risk of nonpayment)
Sector risk
fraction of a borrower’s credit risk due to being in a particular industry
Concentration of credit risk
credit risk from lending to only a few borrowers or those only in a specific industry
Market risk
risk that economy-wide conditions will tank the value of all pre-existing assets (this is INDEPENDENT OF CREDIT RISK)
Interest rate risk
risk that rising interest rates will tank the value of pre-existing bonds/loans
Yield Curve
Shows U.S. Treasury rates for differing maturities (usually 3 months to 30 years). The shape of this curve is important b/c most bonds and loans are priced based on this curve.
Normal yield curve
interest rates increase as maturities increase
Liquidity preference theory
Interest rates should normally be higher for longer terms than for shorter terms b/c investors demand higher compensation for investments that are more subject to various risks (the longer the term, the more shit that could happen) Ex. interest rate risk is more of a concern for a 30 year bond than for a 2 month bond
Inverted yield curve
interest rates decrease as maturities increase
Expectations theory
LT int. rates reflect expected future ST int. rates. Ex. if the economy expects ST int. rates to go down in the future, then a 30 year bond today will pay low interest (to match the expectation of low interest in the future)
Flat yield curve
int. rates are similar across terms.
Market segmentation theory
B/c participants in bond/loan markets focus on lending for different terms, the change in conditions for these individual markets (e.g., depsitory institution) will result in a change in interest rates for the particular term the market uses for loans
Humped yield curve
B/c of changing expectations, rates for intermediate term loans may be higher than rates for ST and LT loans
What does the yield curve commonly look like when the gov’t is using expansionary policy?
Normal (increasing rates over time to maturity)
When is a project deemed to have been managed effectively?
Meets its objectives within the planned time and costs
Effective mangement of projects requires 4 elements:
Resources, time, money, scope
The 5 seperate process of projects:
1) Initiation 2) Planning 3) Execution 4) Monitoring and Control 5) Closure
Project initiation involves what?
Selecting most promising projects w/in the firm’s contraints, approval and support of the project by officers, selecting a project mngr or committee
Project planning
What tasks are to be done, by whom, and when
Statement of work
describes in narrative form the work that’s to be done
SOW includes what?
Project specifications, milestone schedule, work breakdown structure
Program evaluation and review technique
PERT: used when the project’s completion time is hard to predict. PERT schedules and controls these projects. Tries to identify the critical path, or the shortest time in which a project may be finished.
What are the time estimates that PERT computes?
optimistic, most likely, pessimistic. These times are used to gauge how long it’s likely for something to take place. (can use expected value here)
Slack time
difference btwn a task’s expected time and the latest it can be finished w/o delaying other overall project
What does slack time assume?
tasks are completed simultaneously. project consists of tasks a and b. b takes 10 hrs and a takes 4 hours. a has 6 hours of slack time.
Critical path method
similar to PERT. Uses only ONE time estimate. How long the task usually takes. Use this method when task’s time are easier to predict.
Graphical evaluation and review technique
GERT. permits tasks to be looped or branched out. Some tasks can be done many different ways.
ABC analysis
ranks tasks based on importance A = urgent and important B = important but not urgent C = neither urgent nor important
Project crashing
adding more resources than usual to a task to speed it up. Crash time is the time it takes for a task to be done with more resources.
How do you manage project risks?
Use controls similar to ERM or enter into contracts (e.g., insurance/derivatives)
What are 3 problems encountered during project execution?
Organizational uncertainty, uncommon decision-making conditions, lack of mgmt support
Organizational uncertainty
failure by the firm’s mgmt to describe the relationships btwn the firm’s mngrs and the project leaders. (Who has power over who?)
Uncommon decision making conditions
Many projects are ST and need quick decisions and employ leaders from 1 part of the firm that have no info on other parts.
Lack of mgmt support
Manager’s may delay/refuse requests from the project team for resources or cooperation
Monitoring and control
How is the project doing? Do we need to adjust it?
Closure
Have all tasks been completed? Complete all project related contracts/financial docs
How are derivatives settled?
Through cash transfers taking into acct how the prices of the asset evolved relative to the terms set in the contract
What 3 characteristics do derivatives have?
No net investment, and underlying and a notional amount, net settlement (NUNS)
Notional amount
amount of some financial asset that you agree to buy/sell in the future
Underlying price
the underlying price of the asset on which the derivative is based. This determines the derivative’s price.
What are the types of derivatives?
options, futures, forwards, swaps
Option
allows holder to call (buy) or put (sell) an underlying asset at a pre-specified price during a pre-specified period (american) or at a specified date (euro) THIS IS NOT A CONTRACT.
Forwards
2 parties agree to buy and sell an underlying asset at a pre-specified price at a future date
Futures
std. versions of forwards for std. amounts
Swaps
2 parties agree to swap certain streams of payments
Currency swap
2 parties agree to swap CFs in 2 currencies. If effective, this removes exchange risk for both parties
What are the purposes of derivatives?
Speculation, hedging
Speculation
Trying to profit from derivatives. Profits are made when you’re on the side of the transaction for which the predicted action actually occurs.
Hedging
Use derivs. to reduce their risk exposure
Risks associated with derivatives
Credit, market, legal, basis
Market risk
adverse changes in economy will affect the FV of the derivative. Only applicable for speculation
Legal risk
regulatory changes may alter or void the derivative contract
basis risk
Changes in the value of the derivative may not exactly match changes in the value of the asset that’s being hedged
FV Hedge
hedge against changes in the value of an aseet or liability that the firm has or expects to have
Cash flow hedge
hedge against fluctuations in future CFs
foreign currenct hedge
hedge against the effects of fluctuations in the value of a foreign currency on the value of assets, liabs., or CFs
What value should derivatives be reported at?
Fair value. But a change in the FV of the derivative, if effective, will be matched by a change in the value of the hedged asset in the opposite direction
FV hedges
only the net effect of the changes in the value of the derivative and the value of the hedged asset is reported in earnings. Nothing will be reported if the derivative completely offsets a change in the value of the asset
CF hedges
Effective part of derivative value change is reported in OCI on B/S. Ineffective part of derivative value change is reported in earnings on I/S
Measuring hedge effectiveness
The degree to which a change in the value of the asset is matched by an opposite change in the value of the hedge. Thus, the ineffective portion is a loss and should be included in NI. The effective portion is a gain and should be reported in OCI (on B/S) b/c it’s an asset.
Ways to value derivatives
Black-Scholes: stock options. Monte carlo sims, binomial trees. Zero-coupon method: interest rate swaps.
Balanced scorecard
Allows performance measures to be grouped into 4 perspectives
4 perspectives of the balanced scorecard
internal processes, financial, customer, learning and growth
Internal process perspective
measuring averages and variances in the cost, time, and number of defects involved in producing and delivering a product or service
Customer perspective
measuring customer satisfaction
Financial perspective
measures profitability, revenue, asset growth, soundness (debt equity ratios)
Learning and growth perspective
ensure that the key drivers of a orgs’ LT ability to achieve their mission are not neglected in pursuit of ST objectives. Focuses on employees and technology
What does the balanced scorecard commonly include?
strategic objectives, performance measures, baseline performance, targets, strategic initiatives
Strategic objectives
firm’s goals and what is need to achieve them
performance measures
quantitative methods determining how well the strategic objectives are being met
baseline performance
how well the firm is doing under each performance measure
targets
amount of improvement being sought for each baseline performance measure
strategic initiatives
changes the firm will make to achieve its strategic objectives
Cause and effect linkages
Firms try to identify how initiatives are effecting their performance measures. This can help to identify which measures are actually performance drivers and which are performance measures
Sunk costs
These are irrelevant to future decisions
Strategy maps
diagrams that help to find cause and effect linkages
decision trees
Graphical aid that highlights chains of decisions that will/will not happen under various scenarios. If X happens, then Y. If Z happens, then A.
Value Based Management
Measures all aspects of a company to identify the economic value added (EVA) that different activities contribute. This focuses on the financial scorecard in the balanced scorecard
Disadvantages to VBM
May focus on activities that increase profitability in the ST or have direct cost-to-profit linkages. Ex. cost cutting boosts profit in the ST but not LT. But, R&D boosts profit in the LT
Value chain
sequence of processes through which a product becomes more valuable
Competitive benchmarking
Cross sectional: 1 time period for multiple firms. Time-series: data from 1 firm over time. Panel data analysis: data for multiple firms over time
Generic benchmarking
Track performance of 1 firm against all firms, even if outside of industry. This may not be very useful.
Pareto Principle
80% of quality problems result form only 20% of the possible causes. Focus on most important causes first
Six sigma quality
percentage of products that are in acceptable form. 1 sigma = 68% of products are acceptable. 6 sigma = 99.99999% of products are acceptable. 6 sigma = 3.4 defects per million
Theory of constraints
helps to max profitability and overcome production bottlenecks by focusing production on those products with the highest CM/unit
Bottleneck resource
Demand exceeds capacity for resource
Nonbottleneck resource
Capacity exceeds demand for resource
Throughput contribution
Revenues - DM COGS….a CM for direct materials.
