Projection and Forecasting Techniques Flashcards
What is sensitivity (“what-if”) analysis?
it is the process of experimenting with different parameters and assumptions regarding a model and cataloging the range of results to view the possible consequences of a decision; sensitivity models often use probabilities to approximate reality
What is scenario analysis?
in preparing models for future periods, managers may prepare multiple different scenarios which represent alternative possible outcomes; budgets will be prepared under each scenario and then probabilities may be assigned in order to come up with weighted totals
What is regression analysis?
linear regression is a method for studying the relationship between two or more variables; one use of linear regression is to predict the value of a dependent variable corresponding to given values of the independent variables
regression analysis explains variation in a dependent variable as a linear function of one or more independent variables; simple regression involves only one independent variable; multiple regressions involve more than one independent variable
y = a + bx
Y = the dependent variable (the variable we are trying to explain)
X = the independent variable (the regressor; the variable that explains Y)
A = the y-axis intercept of the regression line
B = the slope of the regression line
Statistical measures to evaluate regression analysis
the coefficient of correlation (r) - it measures the strength of the linear relationship between the independent variable (x) and the dependent variable (y)
perfect positive correlation = 1 (upward sloping line on x-y axis)
perfect inverse correlation = -1 (downward sloping line on x-y axis)
no correlation = 0 (horizontal line on x-y axis)
the coefficient of determination (r^2) - the proportion of the total variation in the dependent variable (y) explained by the independent variable (x); its value lies between zero and one
the higher the r^2, the greater the proportion of the total variation in Y that is explained by the variation in X; that is, the higher the r^2, the better the fit of the regression line
What is the high-low method?
it is a simple technique that is used to estimate the fixed and variable portions of cost, usually production costs
how to calculate:
divide the difference between the high and low dollar total costs by the difference in high and low volumes to obtain the variable cost per unit
use either the high or low volume to calculate the variable costs by multiplying the volume times the variable cost per unit
subtract the total calculated variable cost from total costs to obtain fixed costs
the flexible budget formula is below:
total cost = fixed cost + (variable cost per unit * number of units)
What is a learning curve?
this analysis is based on the premise that as workers become more familiar with a specific task, the per-unit labor hours will decline as experience is gained and production becomes more efficient
the calculation begins with the first unit/batch; as cumulative production doubles (ex. from 1 to 2, 2 to 4, 4 to 8, etc.) cumulative average time per unit falls to a fixed percentage (the learning curve rate) of the previous average time
What is cost-volume-profit (CVP) / breakeven analysis?
it is used by managers to forecast profits at different levels of sales and production volume; the point at which revenues equal total costs is called the breakeven point
some general assumptions are: all costs can be divided into variable or fixed, volume is the only relevant factor affecting cost, all costs behave in a linear fashion in relation to production volume, cost behaviors are anticipated to remain constant over the relevant range of production, costs show greater variability over time, the product mix remains constant, contribution approach (direct costing) is used rather than absorption approach, and selling prices remain unchanged
Absorption approach vs contribution approach
the absorption approach, which is required for financial reporting under U.S. GAAP, does not segregate fixed and variable costs
the contribution approach uses variable costing (aka direct costing); although it does not represent GAAP, the contribution approach is extremely useful for internal decision making
variable costs include DM, DL, variable MOH, shipping and packaging, and variable selling expenses while fixed costs include fixed overhead, fixed selling expenses, and most general and admin expenses
the contribution ratio formula is as follows: contribution margin ratio = contribution margin / revenue
the difference between the absorption approach and the contribution approach is the treatment of fixed factory overhead; SG&A expenses are period costs under both methods
treatment of fixed factory overhead:
under the absorption approach, all fixed factory overhead is treated as a product cost and is included in inventory values; COGS includes both fixed and variable costs
under the contribution approach, all fixed factory overhead is treated as a period cost and is expenses in the period incurred; inventory values include only the variable manufacturing costs, so COGS includes only variable manufacturing costs
treatment of SG&A expenses:
under the absorption approach, both variable and fixed SG&A expenses are part of operating expenses and are reported on the income statement separately from COGS
under the contribution approach, the variable SG&A expenses re part of the total variable costs for the contribution margin calculation
if all production is sold every period, both methods produce the same operating income figures; however, if the number of units sold is more or less than the number of units produced, the operating income figures will be different
if units produced exceed units sold, then some units are added to ending inventory and income is higher under absorption costing than under variable costing
if units sold exceed units produced, then ending inventory is less than beginning inventory and income is lower under absorption costing than under variable costing
although absorption costing is required by GAAP, net income under this method is less reliable for performance evaluation purposes than variable costing because inventory levels (which include fixed costs) impact the bottom line
variable costing allows for the easy separation and tracing of variable and fixed costs; net income is more reliable because inventory levels do not impact net income, and contribution margin calculations are isolated; however, variable costing is not GAAP and cannot be used for external financial reporting
What is breakeven analysis?
it determines the sales required (in dollars or units) to achieve zero profit or loss from operations; in determining the amount in revenues required to break even, management must estimate both fixed costs overall and variable costs on a per-unit basis
the contribution approach to the income statement makes it easy to calculate the breakeven point in either units or sales dollars
breakeven point in units = total fixed costs / contribution margin per unit
breakeven point in dollars = unit price * breakeven point (in units)
breakeven point in dollars = total fixed costs / contribution margin ratio
breakeven analysis can be extended to calculate the unit sales or sales dollars required to produce a targeted profit
sales units = (fixed cost + pretax profit) / contribution margin per unit
sales dollars = variable costs + fixed costs + pretax profit
sales dollars = (fixed cost + pretax profit) / contribution margin ratio
after breakeven has been achieved, each additional unit sold will increase net income by the amount of the contribution margin per unit
setting selling prices based on assumed volume - this analysis also may be used to derive a per-unit selling price necessary to cover all costs and the desired pretax profit given a specific volume limit
sales price per unit = (fixed costs + variable costs + pretax profit) / number of units sold
the margin of safety is the excess of sales over breakeven sales, and generally is expressed as either dollars or a percentage
margin of sales (in dollars) = total sales (in dollars) - breakeven sales (in dollars)
margin of safety percentage = margin of safety in dollars / total sales
What is target costing?
it is a technique used to establish the product cost allowed to ensure both profitability per unit and total sales volume
the concept of target costing uses the selling price of the product to determine the production costs to be allowed
target cost = market price - required profit
in management commits to a target cost, serious measures must be employed to reduce costs; the firm may have to sacrifice quality (by reducing costs), which can result in loss of sales
firms competing in this type of environment may incur increased downstream costs in an attempt to differentiate their products and create brad loyalty (and a competitive advantage)
the product may have to be redesigned to provide for the reduction of costs throughout the life cycle of a product (referred to as the Kaizen method)
