65 terms

Study Unit 8 - ANALYSIS AND FORECASTING TECHNIQUES

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Forecasts
- are the basis for business plans and budgets
- are used to project product demand, inventory levels, cash flow, etc.
Qualitative methods of forecasting
rely on the manager's experience and intuition.
Quantitative methods of forecasting
use mathematical models and graphs
Correlation analysis
- is the foundation of any quantitative method of forecasting
Correlation
- is the strength of the linear relationship between two variables, expressed mathematically in terms of the coefficient of correlation (r).
- It can be graphically depicted by plotting the values for the variables on a graph in the form of a scatter diagram.
Values for the coefficient of correlation (r)
Perfect direct relationship: r = 1
Perfect indirect relationship: r = -1
Strong direct relationship: r = 0.7
No linear relationship: r = 0

Note:
coefficient of correlation of zero does not mean there is no relationship at all between the two variables, only that the relationship they may have cannot be expressed as a linear equation.
Coefficient of determination (r2), or the coefficient of correlation squared
is a measure of how good the fit between the two variables
Regression analysis (least-squares analysis)
- is the process of deriving the linear equation that describes the relationship between two variables with a nonzero coefficient of correlation.
- is particularly valuable for budgeting and cost accounting purposes.
Simple regression
is used when there is one independent variable
Simple regression formula
y = a + bx

Where:
y = the dependent variable
a = the y intercept
b = the slope of the regression line
x = the independent variable
Multiple regression
- is used when there is more than one independent variable
- allows a firm to identify many factors (independent variables), and to weight each one according to its influence on the overall outcome
Multiple regression analysis Formula
y = a + b1x1 + b2x2 + b3x3 + b4x4 + etc.
Notes of Regression analysis
- The linear relationship established for x and y is only valid across the relevant range. The user must identify the relevant range and ensure that (s)he does not project the relationship beyond it.
- A negative y intercept in the simple regression equation usually indicates that it is outside the relevant range
-
Ceteris paribus assumption
- Regression analysis assumes that past relationships can be validly projected into the future.
Limitation of the regression method
is that it can only be used when cost patterns remain unchanged from prior periods.
Homoscedasticity or constant variance
The distribution of y around the regression line is constant for different values of x
Learning Curve
- analysis reflects the increased rate at which people perform tasks as they gain experience.
- The curve is usually expressed as a percentage of reduced time each time cumulative production doubles.

NOTE: See example in the book (Study unit 8 page # 6
Two methods of applying learning curve analysis
1) The cumulative average-time learning model
2) The incremental unit-time learning model
Cumulative average-time learning model
projects the reduction in the cumulative average time it takes to complete a certain number of tasks.

Calculation:
1) Cumulative total time = units produced x cumulative average time per unit
2) Time spent on most recent unit = Cumulative total time of 1st product - Cumulative time of the next product

See example in the Gleim book - Study unit 8 page # 6
Incremental unit-time learning model
projects the reduction in the incremental time it takes to complete the last task.

Calculation:
1) Incremental unit total time = cumulative average time per unit of a product(s) + the next cumulative average time per unit of a product(s)
2) Average time spent on most recent unit = Incremental unit total time/ # of units produced on each level

See example in the Gleim book - Study unit 8 page # 6
Expected value
is a means of associating a dollar amount with each of the possible outcomes of a probability distribution.

Note:
- The decision alternative is under the manager's control.
- The state of nature is the future event whose outcome the manager is attempting to predict.
- The payoff is the financial result of the combination of the manager's decision and the actual state of nature.
State of nature
is the future event whose outcome the manager is attempting to predict.
Payoff
is the financial result of the combination of the manager's decision and the actual state of nature.
Expected value calculation
1) Probability of each outcome x its payoff = Expected value

Note: Add all if there are more than State of nature and probability

See Gleim book for example
Criticism of expected value
is that it is based on repetitive trials, whereas in reality, most business decisions involve only one trial.
Perfect information
- is the certain knowledge of which state of nature will occur
-
Expected value of perfect information (EVPI)
- is the additional expected value that could be obtained if a decision maker knew ahead of time which state of nature would occur
- the difference between this amount and the best choice without perfect information
Calculation of Expected value of perfect information (EVPI)
Expected value of perfect information (EVPI) = Expected value with perfect information - Expected value without perfect information

Note:

The maximum anyone should be willing to pay for perfect information is the expected value of perfect information.

See Gleim book for example
Sensitivity analysis
- reveals how sensitive expected value calculations are to the accuracy of the initial estimates.
- is useful in determining whether expending additional resources to obtain better forecasts is justified.
Strategic management
sets overall objectives for an entity and guides the process of reaching those objectives. It is the responsibility of upper management.
Strategic planning
is the design and implementation of the specific steps and processes necessary to reach the overall objectives.
Five-stage process of strategic management
1) Drafting of Mission and goals by the board of directors
2) SWOT (strength, weakness, opportunity, threats) analysis
3) Strategies on how to achieve the mission
4) Implementation
5) Monitoring the progress - involves results of controls and feedback
Mission statement
- summarizes the entity's reason for existing.
- It provides the framework for formulation of the company's strategies.
- tend to be stated in general terms
- describes what a company wants to achieve now
- concentrates on the present; it defines the customers and critical processes, and it explains the desired level of performance.
Vision statement
- outlines what a company wants to achieve in the future.
- focuses on the future; it is a source of inspiration and motivation. It often describes not just the future of the organization, but the future of the industry or society in which the organization operates.
- It answers the question, "Where do we want to be in the future?"
Situational analysis
is most often called a SWOT analysis because it identifies the entity's strengths, weaknesses, opportunities, and threats.
Porters five competitive forces that determine long-term profitability
1) Rivalry among existing firms - will be intense when an industry contains many strong competitors.
2) Threat of new entry - The most favorable industry condition is one in which entry barriers are high and exit barriers are low.
3) Threat of substitute - limits price increases and profit margins
4) Threat of buyers' bargaining power
5) Threat of suppliers' bargaining power - Buyers' best responses are to develop favorable, mutually beneficial relationships with suppliers or to diversify their sources of supply.
Stage of the industry life clycle
1) Rapid growth
2) Growth
3) Maturity
4) Decline or rapid decling
The intensity of rivalry and the threat of entry vary with the following factors:
1) The stage of the industry life cycle
2) The distinctions among products (product differentiation) and the costs of switching from one competitor's product to another
3) Whether fixed costs are high in relation to variable costs - High fixed costs indicate that rivalry will be intense
4) Capacity expansion - If the size of the expansion must be large to achieve economies of scale, competition will be more intense
Structural considerations affecting the threat of substitutes are
a) Relative prices,
b) Costs of switching to a substitute, and
c) Customers' inclination to use a substitute.
Suppliers' bargaining power is greater when:
a) Switching costs are substantial.
b) Prices of substitutes are high.
c) They can threaten forward (downstream) vertical integration.
d) They provide something that is a significant input to the value added by the buyer.
e) Their industry is concentrated, or they are organized.

Note:
Vertical integration is a strategy where a company expands its business operations into different steps on the same production path, such as when a manufacturer owns its supplier and/or distributor.
Strategies with a Broad Competitive Scope
1) Cost leadership - is the generic strategy of entities that seek competitive advantage through lower costs and that have a broad competitive scope.
2) Differentiation - is the generic strategy of entities that seek competitive advantage through providing a unique product and that have a broad competitive scope.
Strategies with a Narrow Competitive Scope
1) Cost focus - is the generic strategy of entities that seek competitive advantage through lower costs and that have a narrow competitive scope (a regional or smaller market).
2) Focused differentiation - is the generic strategy of entities that seek competitive advantage through providing a unique product and that have a narrow competitive scope (a regional or smaller market).
Five Operations Strategies:
1) Cost strategy - is successful when the entity is the low-cost producer. However, the product (e.g., a commodity) tends to be undifferentiated in these cases, the market is often very large, and the competition tends to be intense because of the possibility of high-volume sales.
2) Quality strategy - involves competition based on product quality or process quality.
3) Delivery strategy - may permit an entity to charge a higher price when the product is consistently delivered rapidly and on time. An example company is UPS.
4) Flexibility strategy - involves offering many different products. This strategy also may reflect an ability to shift rapidly from one product line to another.
5) Service strategy - seeks to gain a competitive advantage and maximize customer value by providing services, especially post-purchase services such as warranties on automobiles and home appliances.
Product quality
- relates to design, for example, the difference between a luxury car and a subcompact.
Process quality
- concerns the degree of freedom from defects.
Dogs (under the Growth-Share matrix)
- (low RMS, low MGR) are weak competitors in low-growth markets.
- Their net cash flow (plus or minus) is modest.

Note:
RMS - Relative market share
MGR - Market growth rate
Question marks (under the Growth-Share matrix)
- (low RMS, high MGR) are weak competitors and poor cash generators in high-growth markets.
- They need large amounts of cash not only to finance growth and compete in the market, but also to increase RMS.
- If RMS increases significantly, a question mark may become a star. If not, it becomes a dog.
Cash cows (under the Growth-Share matrix)
- (high RMS, low MGR) are strong competitors and cash generators.
- ordinarily enjoys high profit margins and economies of scale.
- Financing for expansion is not needed, so the strategic business units (SBU's) excess cash can be used for investments in other SBUs. However, marketing and R&D expenses should not necessarily be slashed excessively. Maximizing net cash inflow might precipitate a premature decline from cash cow to dog.
Stars
- (high RMS, high MGR) are strong competitors in high growth markets. Such an SBU is profitable but needs large amounts of cash for expansion, R&D, and meeting competitors' attacks.
- Net cash flow (plus or minus) is modest.
Strategic Business Unit (SBU)
- Portfolio of SBUs should not have too many dogs and question marks or too few cash cows and stars.
- Each SBU should have objectives, a strategy should be formulated to achieve those objectives, and a budget should be allocated.
- SBU Strategy:
a) Hold strategy - is used for strong cash cows.
b) Build strategy - is necessary for a question mark with the potential to be a star.
c) Harvest strategy maximizes short-term net cash inflow. Harvesting means zero-budgeting R&D, reducing marketing costs, not replacing facilities, etc.
d) Divest strategy - is normally used for question marks and dogs that reduce the firm's profitability. The proceeds of sale or liquidation are then invested more favorably.
- The progression of a life cycle of a successful SBU is from question mark to star, cash cow, and dog.
Balanced scorecard
- is an accounting report that connects the firm's critical success factors to measurements of its performance
- is a goal congruence tool that informs managers about the nonfinancial factors that top management believes to be important.
- It measures financial or nonfinancial, internal or external, and short term or long term.
- facilitates best practice analysis
Trend in performance evaluation
is the balanced scorecard approach to managing the implementation of the firm's strategy.
Key performance indicators (KPIs)
- are specific, measurable financial and nonfinancial elements of a firm's performance that are vital to its competitive advantage.
- Firm identifies this by means of a SWOT analysis that addresses internal factors (its strengths and weaknesses) and external factors (its opportunities and threats).
Strengths and weaknesses
are internal resources or a lack thereof
Opportunities and threats
arise from such externalities as government regulation, advances in technology, and demographic changes.
SWOT analysis
tends to highlight the basic factors of cost, quality, and the speed of product development and delivery.
PEST analysis
- is an analysis of certain factors in the external environment of an organization, which can affect its activities and performances.
- It is used to identify KPIs
PEST analysis includes
1) Political factors,
2) Economic factors,
3) Social factors, and
4) Technological factors.

- PEST analysis may also include environmental, legal, and ethical considerations, among others.
four perspectives under KPIs
1) Financial
2) Customer satisfaction
3) Internal business processes
4) Learning and growth
Lagging indicators
such as output and financial measures
Leading indicators
such as many types of nonfinancial measures
Development & functionality (Importance of balance scorecard)
The active support and participation of senior management are essential.

Note:
1) The scorecard should contain measures at the detail level that permit everyone to understand how his or her efforts affect the firm's results.
2) In order for the balanced scorecard to be useful, the organization must be able to identify a cause-and-effect relationship between an action that could be taken (or avoided) and an effect on a KPI.
Strategy map
- the chaining of objectives and perspectives
To achieve its objectives, the organization must establish the following (balance scorecard):
1) Relevant criteria to measure outcomes - This requires the use of lagging indicators which measure the results of actions.
2) Relevant performance drivers - This requires the use of leading indicators which are used to determine how an outcome can be met.

Note:
When measuring results and planning actions to take, the organization must stay focused on the cost-effectiveness of any action taken (or not taken).
The following are problems in implementation of the balanced scorecard approach:
1) Using too many measures, with a consequent loss of focus on KPIs
2) Failing to evaluate personnel on nonfinancial as well as financial measures
3) Including measures that will not have long-term financial benefits
4) Not understanding that subjective measures (such as customer satisfaction) are imprecise
5) Trying to achieve improvements in all areas at all times
6) Not being aware that the hypothesized connection between nonfinancial measures and ultimate financial success may not continue to be true