Chapter Six Forecasting Tools and Techniques Learning Objectives
Chapter Six Forecasting Tools and Techniques
Learning Objectives • Demonstrate the importance of sales forecasting. • Describe the role of cost drivers in estimating costs. • Demonstrate the use of graphical and statistical forecasting techniques. • Demonstrate the use of cost estimates in cost-volume-profit (CVP) analysis. • Discuss qualitative factors that affect costs. Copyright © Houghton Mifflin Company. All rights reserved. 2
Sales Forecasting • Sales forecasting is the foundation of budgeting. • Companies forecast customer demand use this data to estimate sales revenue. – Established companies often use historical trends to predict future sales. – Startup enterprises rely on surveys, industry data, and regional economic and demographic data to forecast revenues and costs. Copyright © Houghton Mifflin Company. All rights reserved. 3
Forecasting Costs • Identifying Cost Drivers – Cost estimation requires that companies identify the factors affecting costs. These activities commonly are known as cost drivers. – Cost drivers vary across industries and business processes. – Managers must understand the relationships between business activities and related costs to determine the amount of fixed and variable costs that a company will incur. Copyright © Houghton Mifflin Company. All rights reserved. 4
Differences in Cost Drivers Across Business Sectors Copyright © Houghton Mifflin Company. All rights reserved. 5
Forecasting Techniques • Companies use graphical and statistical techniques to forecast revenues and costs. • A common graphing technique is the scatter plot method. • Today’s technology allows managers to use statistical techniques, such as correlation and regression analysis, to formulate quantitative revenue and cost predictions. Copyright © Houghton Mifflin Company. All rights reserved. 6
The Scatter Plot Method • The scatter plot is a graph with dollar revenue or cost volume plotted along the y-axis and business activity reflected along the x-axis. • Scatter plots provide managers with a picture of the relationship between two variables. Copyright © Houghton Mifflin Company. All rights reserved. 7
Correlation Analysis • Correlation analysis is a common statistical technique used to measure the degree of relationship between variables. • A correlation expresses the extent to which changes in one variable are associated with changes in another. – A high correlation is a correlation approaching 1. 0. – A correlation of 1. 0 (a perfect correlation) indicates that variables change together in an identical manner. – A correlation of – 1. 0 (an inverse relationship) suggests that variable changes move in opposite directions. Copyright © Houghton Mifflin Company. All rights reserved. 8
Regression Analysis • Regression analysis determines the bestfitting line among a set of data points, yielding an equation that can be used to estimate costs. – The Y variable is known as a dependent variable because its data values rely on (or are a function of) other variables. – The X variable is known as an independent variable because the variable drives (or affects) the dependent variable. Copyright © Houghton Mifflin Company. All rights reserved. 9
Coefficient of Determination • The coefficient of determination, R 2, represents the extent the variation in the dependent variable can be explained by the variation in the independent variable. – A high R 2 is preferred in cost estimation as it suggests that managers can predict total costs using a single variable. 2 R Copyright © Houghton Mifflin Company. All rights reserved. 10
Using Statistical Techniques • Statistical techniques yield estimates for fixed and variable costs. These results can be incorporated in a firm’s total cost equation, which in turn can be used in costvolume-profit and breakeven analyses. Copyright © Houghton Mifflin Company. All rights reserved. 11
Qualitative Cost Considerations • When making business decisions, managers must recognize that environmental, industry, and other strategic factors may impact cost estimation. • Companies must also recognize how technological innovation and a phenomenon known as the learning curve increase efficiency and lower costs over time. Copyright © Houghton Mifflin Company. All rights reserved. 12
Environmental Factors • Environmental risks can affect business decisions. • Changes in market forces (e. g. , the economy, competition, and regulation) impact both the manner and extent to which managers rely on cost data. – For example, if the government mandates an increase in the minimum wage, assumptions about employee labor costs based on historically based quantitative analyses will no longer be valid. • New competition, regulatory developments, weather changes, and natural disasters can also affect costs. Copyright © Houghton Mifflin Company. All rights reserved. 13
Industry Structure • Since business processes drive profitability, the manner in which an industry conducts business directly impacts costs. – For example, in a manufacturing industry, production quantity, direct labor hours, and machine hours are common activities that drive costs. • In some industries, the activity that drives costs may not be obvious. – For example, in the airline industry, the cost driver could be one of at least three activities: air miles flown, passengers flown, or passenger miles flown (transportation of a passenger for one mile). Copyright © Houghton Mifflin Company. All rights reserved. 14
Technology Considerations • Technology has a considerable effect on the scale and scope of a company’s costs. – It can be a major structural force, such as automation and robotics or it can be used as a marketing and information device, such as using it to sell products and services via the internet. • As technology is introduced, managers must consider the following: – Effects on employee morale like computers or automation replacing workers – Effects on customer perception as services are shifted toward automation (e. g. , telephone inquiries) Copyright © Houghton Mifflin Company. All rights reserved. 15
Learning Curve and Cost Behavior • As workers become more experienced, efficiency increases. Thus, as cumulative outputs increase, the average labor time required and costs per unit usually decrease. In other words, as employees become more familiar or adept at executing a particular process, their experience creates efficiencies that reduce costs. Copyright © Houghton Mifflin Company. All rights reserved. 16
Business Strategy • A firm’s strategy also affects cost. Managers must be aware of which business commitments are most important to the company. – For example, a business may choose to dedicate time and resources to a particular product line or subset of customers. While such strategic decisions are likely based upon detailed analysis of the firm’s operating environment, managers must consider how such initiatives will affect future sales and costs. • Making sales or cost decisions without considering this broader context may ultimately jeopardize strategy execution. Copyright © Houghton Mifflin Company. All rights reserved. 17
Cost Controllability • Controllable costs are costs over which managers have some discretion or degree of control. – For example, a food and beverage manager at a hotel can select vendors, manage purchases on a weekly basis, and set procedures for stock usage. • Recognizing which costs are controllable allows managers to determine how much flexibility they have to adapt to changing business conditions. Copyright © Houghton Mifflin Company. All rights reserved. 18
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