Chapter 5: Forecasting - statistical tehniques (Part 2) Flashcards
Expected Values
Outcome * probability then add up all of the results for an overall expected value (weighted average)
Limitations of using EV
-EV’s are not as relevant in one-off decision making situations since they represent a long run average value
-EV’s ignores the spread of possible returns (i.e risk) since it is averaging outcomes.
-EV relies on the accuarcy of the probabilities.
Sensitivity analysis
Sensitivity % = profit level/variable (revenue or cost) * 100%
For example = profit level / telephone costs * 100%
If telephone costs have a sensitivity % of 20%, that would mean if telephone costs increased my 20% you would not make a profit.
What does a lower sensitivity percentage mean?
A lower % means the more sensitive profit is to the variable
What does Index numbers measure?
Measures the relative change in the volume or the value of an item over time.
For example FTSE 100 index or Retail Price Index
Calculating index numbers
Index numbers requires a ‘base year’
This is the ‘starting point’
Subsequent periods = (current period figure / base period figure) * 100
What does The Retail Price Index (RPI) measure?
Changes in the prices of items of expenditure of the average household.
As prices can be expected to change over a period of time the RPI can be used to inflate or deflate costs at different points in time for more meaningful comparisons.
If costs are ‘deflated’ this means that the effects of inflation are removed so that the comparisons of costs can be made in ‘real terms’
‘Real terms’ - excluding inflation
Ways that we can try to reduce the impact of uncertainity?
-Flexible budgets
-Regular re-forecasting
-Planning models
-Rolling budgets
-Flexible budgets- preparing a variety of different budgets for several levels of activity. For example: strong sales demand and weak sales demand and a more middle-of-the-range budget.
-Regular re-forecasting - as conditions are likely to change as the year develops we could regularly re-visit our budgets and update them as likely outcomes become more certain. For example if the economy move into a recession during the year we could reduce our expectations for demand levels for the later months of the year.
-Planning models - various software and spreadsheet models could enable us to more accurately predict a range of possible outcomes.
-Rolling budgets - regular refreshing and updating of the budget to account for uncertainties as they change or become more certain.
The Product life cycle stages
Development
Introduction
Growth
Maturity
Decline
Product life cycle - Development stage
High costs with no revenue so negative cash flow
involves high research and development expenditure and high capital expenditure to set up production facilities.
Product life cycle - Introduction stage
High costs and low revenue so still negative cash flow
Market size and growth will be low which will lead to minimal revenue with high marketing and promotional costs
Highly unlikely that companies will make profits
Product life cycle - Growth stage
Falling unit costs and increasing revenue mean that products should start to become profitable.
Rapid growth in sales and cash flow. An increase in output volumes can lead to a fall in production cost per unit through economies of scale. At this stage products will still require heavy expenditure on advertising in order to continue gaining market share.
Product life cycle - Growth stage
High demand in sales but growth will have slowed. Reduced production costs per unit with economies of scale and increased efficiency (perhaps through automation). Product should be highly profitable.
Expenditure will be on further improvements to the product, continued marketing and perhaps improved production efficiency and quality.
Product life cycle - Decline stage
Falling demand and market share leading to the product becoming loss making.
Products will become loss-making eventually so should be replaced with another that is in the introduction/growth stage.
Uses of the product life cycle in forcasting
If a trend for increasing sales has been based on the growth stage but the product is now moving into the maturity stage for the period you are forecasting when sales are less likely to continue growing.
When the product reaches the decline stage the trend will have well and truly reversed and sales will start to fall.
