3.3 Making Business Decisions Flashcards
Sales figures can be collected at consistent time intervals and presented in in time order - this is time series data. Time series analysis is used to reveal underlying patterns within this data. Time series data can be difficult to interpret with fluctuations so businesses can take moving averages to smooth out fluctuations.
Must know how to calculate 3 period and four quarter moving averages. A period is any fixed amount of time and a quarter is a three month time period. 4 quarter moving averages are taken across the 4 quarters of a year so can remove seasonal variation.You put the value between the second and third value or a further 8 quarter moving average can be taken putting the found figure against the 3rd value.
Sales data can be displayed as a scatter graph to see if there are any obvious trends. For example the sales of a particular product over a certain number of years. A line of best fit through the data points should be as close to all the points as possible this may show an overall trend.
Line of best fit can be used to look for a correlation between two variables, the closer the line of best fit is to the data points the stronger the correlation. A strong correlation however does not prove cause and effect, this means spending money on promotion may not be the only factor increasing sales there may be an external factor such as what competitors are doing.
Extrapolation can be used to predict future sales, trends in past sales data can be continued into the future useful to set sales targets and manage performance. You can extrapolate without a line of best fit if a line has a curve you carry this on from the most recent trend. Unlike line of best fit this type of extrapolation focuses on most recent changes and it is hard to know how long a short term trend will continue.
Extrapolation relies on the assumption that past trends will remain true however past performance is no guarantee of the future - a firms sales performance relies on external factors which may mean extrapolations from the past don’t predict very accurately. It is useful in fairly stable environments in dynamic ones it is best to only extrapolate a few steps at a time.
Some businesses will see their see their sales figures fluctuate in a regular cycle for example a business might release a new product every five years seeing rapid growth one year followed by declining sales over the next four. Although moving averages might show the long term trend the actual sales can differ quite allot from the moving averages depending on where in the cycle the business is.
The difference between the actual sales figure and moving average for a period is called the cyclical variation. Firms can calculate this to get more accurate sales forecast through Actual sales figure - Moving average = cyclical variation. Adjusting forecasts using cyclical variations assumes this will stay the same however this could change over time.
Businesses need to invest in order to achieve their objectives. In any situation where you have to spend money in hope of making money in the future is risky because there is always the possibility you wont achieve as much return as stated businesses want low risk with high returns. When a firm is making strategic decisions they gather as much data as possible to work out the risk and reward involved.
There are two main deciders: How long will it take to get the money back and how much money will be generated from the investment. there are three main methods to determine these answers: payback period, average rate of return and discounted cash flows. All of the methods are only as good as the data used to calculate them, incorrect predictions can lead to making the wrong choice.
Pay back measures how long it takes to receive the initial investment. To calculate you need aqnnual net cash flow which how much is generated each year minus how much it will cost. With a consistent cash flow you can use: Amount invested / Annual net cash flow. However when not so straight forward a business may need to look more closely at the cash flow forecast to work out the payback period. Managers can compare this figure with other projects.
Positives and Negatives: \+Easy to calculate and understand \+Good if a firm knows it is not a long term project and needs quick payback. -It ignores cash flow after payback -It ignores the time value of money
Average rate of return (ARR) compares net return with investment. The net return is the income of the project minus costs including the investment. The higher the ARR the more favourable a project will appear. ARR is a percentage expressed like this:
Average Net Return / Investment X 100
Positives and Negatives:
+Easy to calculate and understand
+It takes account of all the project’s cash flows
-It ignore the timing of the cash flow a firm may value quicker return
-It ignores time value of money
Discounted Cash flows consider the present value of returns. This is an investment appraisal tool that considers the time value of money it adjusts future cash flows to work out their present value. To calculate present value the net cash flow each year is multiplied by a discount factor. Discount factors depend on what the interest rate is predicted to be. High interest rates may need high discount factors to give correct present values this is to reflect the opportunity cost of not investing the money into a bank.
The net present value (NPV) is the sum of present values minus the initial investment. A negative NPV may suggest a better return just by putting the money into a bank. The downside of discounted cash flow is that its hard to calculate with appropriate discount factors as they don’t know future interest rates. The longer the project the harder to predict the discount factor. Return = NPV / Investment X 100 to see the percentage of return against investment.
Decision trees combine probability with expected pay off. A business will often know the cost however not the uncertain outcome. Probability is the likelihood of an event occurring managers must base this estimate on past data or experience. probability is usually expressed in decimals and both outcomes added must equal 1. The expected monetary value (EMV) is the probability times the expected pay off. The EMV of a course of action is tye EMV’s of different outcomes added together.
Features:
>A square is a decision node the lines from this are possible courses and costs of each action.
>A circle shows a chance node which shows alternate outcomes by lines coming out the circle with probabilities
>The value in £’s represents pay off
Net gain is the financial gain after initial costs have been subtracted: Net gain = EMV - initial costs.
Advantages:
+Decision trees force managers to work out and think about the probability and pay off rather then creating vague statements
+They’re a nice visual representation.
+Decisions can be compared objectively and quantitatively.
+They’re useful in familiar situations where accurate estimates of probabilities and returns can be calculated.
Disadvantages:
- Decision tree’s ignore valid quantitative data such as employee opinions and rely on qualitative figures.
- Probabilities and pay offs are hard to predict accurately so carry a degree of uncertainty
- The tree depending on who created may be biased towards a particular outcome to achieve that option
- In reality there is a wider range of outcomes such as long vs short termism.
Critical path analysis identifies the most efficient and cost effective way of completing a complex project. First all activities are identified and the order is worked out. secondly the duration for each is estimated. These activities are then arranged from start to finish and which ones can be completed simultaneously. The shortest time from start to finish can be identified the tasks that have to be done with no gaps in between is called the critical path. Any delays in these delay the whole project.
The circles on the network are called nodes and show when one activity stops and another begins. A node is split into three the left half represents which number node it is. The top right quarter is the earliest start time. The bottom right quarter is the latest finish time of the previous activity which is the latest time that it can finish without having a knock on effect. If LFT = EST the this node is on the critical path.
Earliest start time: An activity cant start until the prior activity has been completed. its worked out by adding the duration of the previous activity to its EST.
Earliest Finishing time: Is the time an activity will finish if started at the EST.
Latest finishing time: Is the latest time an activity can finish without holding up the rest of the project. This is calculated by working back from the final node the LFT of the final node = EST of final node.
Latest start time: The latest time an activity can start and still be finished by its LFT. To calculate you subtract the duration of the activity from its LFT.
Float time: The length of time you can delay an activity without delaying the completion of the project. It can be worked out with: Total float = LFT-Duration-EST. This only goes fro non critical activities.
CPA can be used fro time management of strategies. It allows businesses to work out when they’ll need resources to be available. IN many cases the critical path can be shortened by allocating additional resources to an activity sometimes ones from the float time. Resources can be switched between activities. CPA also helps with decision making knowing the LFT makes it easier to know when to launch ads or become public.
Advantages of CPA:
+CPA allows critical activities to be identified and thus show which activities must meet their deadlines.
+Resources can be transferred from activities with float time to critical activities if needed.
+If different functions can start at the EST this will make the operation run smooth and cost effective.
+CPA helps firms forecast their cash flow which allows accurate budgeting.
More CPA Advantages:
+CPA find the shortest possible times sometimes giving a competitive advantage.
+Its an excellent visual aid
+The network can be amended
+Allows everything to be covered with a systematic approach to ensure things aren’t forgotten.
+Can be used to review individual task progression.
Disadvantages of CPA:
- CPA relies on estimates which carries inaccuracy.
- Constructing and amending the network requires a significant amount of planning and time.
- CPA sets tight deadlines so employees could cut corners to meet deadlines harming quality.
- Doesn’t tell about costs or how good the project is.
- CPA doesn’t factor in external setbacks such as weather or staff illness.
