Please enable JavaScript.

Coggle requires JavaScript to display documents.

Financial analysis - Coggle Diagram

- - - - how much of a company's fixed overhead costs are allocated to products or services for the purpose of calculating the full cost of production -> for management reporting and inventory costing purposes.
      - There are several methods for calculating the absorption rate, such as based on units of output, direct labour hours, machine hours, or activity based costing
      - Step 2: Dividing the total overhead amount TO by an appropriate allocation base, depending on what makes sense for the business. Common allocation bases are:
        
        Activity-based costing:
        allocating overhead costs based on cost drivers
        
        Step 1:
        
        Identify the activities that consume resources and cause overheads.
        
        These activities should have a reliable cost driver that can be used to assign costs.
        
        Examples of activities are: setups, machine hours, number of transactions, etc.
        
        Step 3:
        
        Identify the cost drivers for each activity. Cost drivers represent the level of activity consumed by each cost object.
        
        Common cost drivers are: number of setups, machine hours, labor hours, units produced, etc.
        
        Step 2:
        
        Assign overhead costs to each activity based on the resources consumed.
        
        This gives you the cost of each activity.
        
        Step 4:
        
        Calculate the absorption rate per unit of the cost driver for each activity.
        
        This is the activity cost divided by the total cost driver units.
        
        Step 5:
        
        Assign overheads to cost objects based on their consumption of each activity.
        
        Multiply the relevant absorption rates by the cost driver units consumed by that cost object.
        
        Example:
        
        Setup activity cost = $50,000
        
        Number of setups performed = 500
        
        Absorption rate per setup = $50,000/500 = $100 per setup
        
        If a product requires 10 setups, its overhead allocation for setup activity will be $100 x 10 = $1,000
        
        Benefits:
        
        • Improve overhead costs accuracy and relevance by:
        
        Identifying the activities that drive overhead costs and the relevant cost drivers
        
        Assigning costs based on each activity's actual consumption
        
        • Provide more accurate product costs and profitability by:
        
        Allocating overheads based on each product's actual consumption of activities
        
        Enabling better product pricing decisions
        
        • Increase efficiency and focus on the main cost drivers by:
        
        Understanding which activities and cost drivers have the greatest influence on costs
        
        Identifying opportunities to reduce activities that do not add value
        
        • Determine the true profitability of customers and products by:
        
        -Assigning costs more precisely based on activity consumption
        
        Revealing which customers and products are truly profitable
        
        • Allow the organization to:
        
        Improve resource allocation by focusing on value-adding activities
        
        Make better decisions by understanding cost behavior
        
        Continuously reduce costs by managing activities more effectively
        
        • Reasons for development:
        
        to improve costing accuracy in changing production and market environment
        
        Drawbacks:
        
        Complex implementation:
        Implementing an activity-based costing system can be complex due to the need to:
        
        • Identify all relevant activities and cost drivers
        
        • Assign costs to each activity
        
        • Collect and analyze large amounts of cost and activity data
        
        • Implement new costing procedures and software systems
        
        Identification and update of activities and drivers:
        The activities and cost drivers need to be
        
        accurately identified and defined.
        
        continually monitored and updated as processes and products change. This can be an ongoing effort.
        
        Involvement of all departments:
        
        Since activities span multiple departments, the successful implementation of ABC requires coordination and involvement across the organization. This can be difficult to achieve.
        
        Resistance to change:
        
        Some employees may resist the changes required for implementing ABC due to reluctance to adopt new systems and procedures.
        
        Extensive training may be needed to overcome this.
        
        Loss of customers or market share:
        
        If introducing ABC results in significantly higher product costs for some customers, it could lead to those customers seeking alternative suppliers.
        
        This could result in losing market share.
        
        no impact on material and labour costs, complex and costly to implement and maintain, require reliable and timely data
        
        • Overhead absorption:
        
        Direct labor hours: total labor hours spent directly producing the products. Let's call this DL. The absorption rate is then: TO/DL.
        
        If total overheads were $150,000 and total labor hours were 30,000 hours,
        
        the overhead absorption rate per labor hour would be $5 ($150,000/30,000 labor hours)
        
        Machine hours: total hours that machines were used in production. Let's call this MH. The rate is then: TO/MH.
        
        If total overheads were $200,000 and total machine hours were 20,000 hours,
        
        the overhead absorption rate per machine hour would be $10 ($200,000/20,000 machine hours)
        
        Units produced: total number of products or services produced. Let's call this U. The rate is then: TO/U.
        
        If a company produced 10,000 units and total overheads were $100,000
        
        then the overhead absorption rate per unit would be $10 ($100,000/10,000 units).
        
        to absorb overhead costs into the cost of each unit, the company would
        
        add $10 to the direct cost of each unit produced.
        
        Sales dollars: total revenue from sales. Let's call this S. The rate is then: TO/S.
        
        Percentage of prime cost base:
        
        If total overheads were $300,000 and total prime cost (direct material + direct labor) was $2,000,000
        
        overheads would be absorbed at a rate of 15% ($300,000/$2,000,000) of prime cost
        
        Percentage of direct wages base:
        
        If total overheads were $400,000 and total direct wages were $1,000,000
        
        overheads would be absorbed at a rate of 40% ($400,000/$1,000,000) of direct wages.
      - Step 1: Calculating the total fixed overhead costs for the period. This includes costs like depreciation, rent, insurance, salaries of indirect staff, etc. Let's call this total overhead amount TO.
- - - - are constrained by the environment and internal dynamics
      - are interrelated and hard to commit to
      - should match business strategy and context
- - - - may be influenced by heated debate or personal biases.
      - The sensitivity of the outcome to slight changes in probabilities should be tested.
    - - if too many choices, outcomes and probabilities->hard to construct and understand
      - if too many criteria, constraints, dependencies, feedback loops -> not capture them adequately -> oversimplify reality, ignore important factors/ interactions
      - probabilities/ values of outcomes (the predicted returns) inaccurate/ uncertain/ unknown -> not reflect true situation, wrong decisions
        
        The basis of these estimates is not given.
        
        The sensitivity of the outcome to slight changes in returns should be tested.
      - • The decision tree is only one input into the decision making process. Other factors may also need to be considered.
      - negotiable prices -> affect the outcome
        
        The effect of different prices and structures should be experimented with.
  - - - Key performance indicators:
        • Non-financial metrics for customer satisfaction and sustainability • Standard hotel KPIs for balanced evaluation of performance : Occupancy, ADR, RevPAR for revenue Space utilisation Customer satisfaction Carbon footprint This will provide: • Insight into specific cost and revenue drivers • Measures that reflect wider business priorities • Comparable metrics to benchmark and improve performance • Alignment with external demands around sustainability and customer experience The KPIs should complement financial metrics to facilitate a holistic evaluation of business performance.
        
        Occupancy rates: efficiency of space utilisation
        
        ADR: measure of financial performance and profitability
        
        RevPAR: incorporates occupancy and rates, shows total room revenue performance
        
        Gross operating profit per square metre: efficiency of space utilisation for non-room revenue
        
        Customer satisfaction: critical for online reviews and repeat business
        
        Carbon footprint: meets external sustainability demands, attracts eco-conscious customers
        
        More balanced measures:
        
        • Customer satisfaction surveys
        
        • Measures for sustainability e.g. reduced food waste, energy usage
        
        • Non-financial metrics for customer satisfaction and sustainability
        
        • Standard hotel KPIs for balanced evaluation of performance :
        
        Occupancy, ADR, RevPAR for revenue
        
        Space utilisation
        
        Customer satisfaction
        
        Carbon footprint
        
        This will provide:
        
        • Insight into specific cost and revenue drivers
        
        • Measures that reflect wider business priorities
        
        • Comparable metrics to benchmark and improve performance
        
        • Alignment with external demands around sustainability and customer experience
        
        The KPIs should complement financial metrics to facilitate a holistic evaluation of business performance.
      - Critical success factors (CSFs):
        • CSFs identify areas most vital to success
        
        Areas where an organization must excel to succeed
        
        Focus on what customers value most
        
        Guide strategy and resource allocation
        
        Alternatively, CSFs can be defined as:
        
        • Features that customers highly value
        
        • Areas where the organization must excel to outperform competitors
        
        This definition is better because it focuses on:
        
        • Delivering what customers value most
        
        • Exceeding competitors' performance in key areas
        
        Benefits of focusing on CSFs:
        
        • Guides strategy development and resource allocation
        
        • Aligns the organization around what matters most to customers
        
        • Focuses efforts on areas that drive competitive advantage
        
        • Identify the most important areas for organizational success
        
        • Highlight what customers value most and where competitors are outperformed
        
        • Guide the allocation of resources to maximize value for customers
        
        • Drive strategic focus on areas that deliver competitive edge
        
        •Vary by market segment
        
        • Examples for rail: safety, punctuality, convenience, cleanliness, security
        
        Issues:
        
        •CSFs originally focused on the customer
        
        •Broader definitions exist including internal measures
        
        •Internal CSFs may not align with customers' needs
      - Performance indicators:
        
        Measure how well an organization is performing
        
        Financial metrics in profit-seeking organizations
        • Include financial metrics (profits, EPS, ROCE) for businesses
        
        Non-financial metrics in not-for-profit organizations
        • Include non-financial metrics (exam grades, waiting times, road conditions) for non-profits
        
        Key performance indicators (KPIs):
        Most important performance indicators
        Measure how well critical success factors are achieved
        • KPIs measure performance on these critical areas (CSFs)
        • Together, they focus efforts on what matters most to achieve strategic goals
        • But KPIs must be set carefully to avoid unintended consequences
        • Effective KPIs are closely aligned with organizational strategy and objectives
        Unlike other indicators, KPIs focus on:
        • The critical few factors that drive success
        KPIs in businesses:
        • Sales volumes, prices and costs needed for target profits
        KPIs in schools:
        • Pupil-teacher ratios, attendance and teacher experience to achieve literacy goals
        
        • KPIs measure performance on the critical success factors
        
        • KPIs focus on the most vital areas for achieving strategic goals
        
        • Other indicators support this but have less influence on success
        
        • KPIs guide resource allocation and management priorities to fulfill critical success factors
        
        KPIs:
        •Targets to measure CSFs
        • Examples for rail:
        
        • Arrival punctuality within set time (e.g. 5 or 10 mins)
        
        • Accidents/fatalities per km travelled
        
        • Complaints about litter/dirt
        
        • Criminal offences on railway
        
        •KPI examples:
        
        •Financial: return on capital employed
        
        •Internal process: asset utilisation hours
        
        •Learning: growth qualifications
        
        Risks of performance indicators:
        • Inadequate coverage of important areas
        • Unsuitable difficulty levels
        • Misalignment with strategic priorities
        • Short-term focus
        
        • Not enough indicators
        Employees only focus on measured areas.
        
        • Too many indicators
        Employees focus on easier, less important targets.
        
        • Wrong indicators
        Misalign with organizational strategy.
        
        • Indicators too tight/loose
        Loss of motivation or underperformance.
        
        • Short-term "hit and run" indicators
        Assume performance will sustain itself.
        
        To avoid risks:
        
        • Link a critical few KPIs to critical success factors
        
        • Benchmark and adjust KPIs against competitors
        
        Avoid complacency from internal benchmarks alone.
        
        • Integrate KPIs within longer-term management objectives
        
        Avoid short-termism.
        
        They measure results but not how those results were achieved.
      - Balanced Scorecard
        
        •Non-financial as well as financial measures
        
        •Perspectives: customer, financial, internal processes, learning and growth
      - In summary:
        
        •CSFs define features customers value most
        
        •KPIs measure achievement of CSFs
        
        •Balanced scorecard covers range of measures
        
        •CSFs should ultimately align with customers' needs
        
        •Safety and punctuality likely key for rail sector
        
        •Integrated track and rail model may best achieve CSFs
        
        Recommend focusing GET strategy on:
        
        •Identifying CSFs for key customer segments
        
        •Setting appropriate KPIs for those CSFs
        
        •Using balanced scorecard approach to cover range of measures
        
        •Ensuring measures ultimately align with customers' interests
    - - • Qualitative factors that are difficult or impossible to quantify, but affect the decision
      - • Examples are:
        
        • Uncertainty of some costs and benefits, such as penalties, reorganisation costs, or alternative contribution
        
        • Knock-on impact of closure, such as loss of customer loyalty, market share, or cross-selling opportunities
        
        • Social, legal, and ethical implications of closure, such as employee morale, contractual obligations, or environmental impact
        
        • Risk and uncertainty of closure, such as potential lawsuits, competitors' reactions, or market changes
    - - Cash flow is harder to manipulate than profit
      - Cash flow and profit differ in the short term due to:
        while cash flow and profit measure the same underlying economics, they differ in timing due to differences in accounting conventions and treatment of non-operating items. This causes short-term disparity between the two metrics.
        
        Capital items affect cash flow but not profit
        
        Depreciation reduces profit but not cash flow
        
        Working capital changes impact cash flow, not profit
        
        The differences are due to:
        
        Cash accounting records items when cash moves
        
        Accrual accounting records items when incurred or earned
        
        Required by law
        
        Reflects legally enforceable transactions
        
        Cash accounting is not acceptable practice
        
        Does not reflect unpaid transactions
      - Long term, sound decisions equalize cash flow and profit
      - However, profit still matters:
        Reporting and measures like EPS use profit
        Profit influences shareholder behavior and share price
      - Financial reporting implications:
        Profit impact on discontinued activities requires separate disclosure
        Reporting rules are an 'other factor' to consider in decisions
      - the key tax implications to consider as part of decision making:
        
        • Direct tax impact - Forecast profits and apply tax rates to determine taxes payable.
        
        • Change in tax bracket - A decision may move the business into a higher tax bracket, increasing tax costs.
        
        • Impact on tax reliefs - A decision could make the business eligible for (or ineligible from) certain tax reliefs and incentives.
        
        • Timing of tax payments - The decision could affect when taxes are actually paid, impacting short-term cash flow.
        
        • Timing differences - Due to differences between taxable profits and accounting profits, taxes paid may not match the profits recorded in a given period.
        
        • Impact on shareholders - Earlier tax payments can reduce profits, affecting shareholder distributions and wealth.
        
        • Separate tax disclosure - Tax effects related to a decision may need to be disclosed separately in financial statements.
- - - - • Benefits: Standard costing can provide data for income measurement and pricing decisions, and can help to improve the efficiency and quality of an organisation
      - • Limitations: Standard costing is more suitable for repetitive processes than for customised products or services, and can have a demotivating effect if the standards are set too high or too low
    - - • How to use a standard cost card to record the standard quantities and costs of materials, labour and overheads for a product or service
      - • How standard costing may not be suitable for the modern production environment due to various factors and challenges
    - - • Non-standard products: Standard costing assumes homogeneous and mass-produced products, but modern products are often customised and differentiated
        
        Standard costing applies to mass production of identical products, but modern products are often non-standard or customised to customer specifications
      - • Outdated standards: Standard costing assumes stable and predictable costs and quantities, but modern costs and quantities are often volatile and uncertain
        
        Standard costing requires frequent updating of standards due to shorter product life cycles, but this increases the cost and complexity of the system
      - • High automation: Standard costing relies on labour-based measures, but modern production is often highly automated and requires different measures
        
        tandard costing assumes that control can be exercised by measuring the efficiency of the workforce, but modern production is often controlled by the machinery rather than the workforce
      - • Ideal standards: Standard costing uses ideal standards that assume no waste or inefficiency, but modern production is more realistic and allows for some variation
        
        Standard costing uses ideal standards that assume no waste or inefficiency, but this may not reflect the reality and may generate adverse variances that are not meaningful
      - • Continuous improvement: Standard costing focuses on meeting the standards and maintaining the status quo, but modern production is more dynamic and seeks to improve the standards and processes
        
        Standard costing focuses on meeting the standards and maintaining the status quo, but this is inconsistent with the concept of continuous improvement that is applied in TQM and JIT environments
      - • Detailed information: Standard costing provides aggregated information that may not be relevant or timely, but modern managers need more detailed and accurate information
        
        Standard costing provides aggregated information that may not be relevant or timely for decision making, but modern managers need more detailed and accurate information for effective management control
      - • Real time performance: Standard costing compares actual results with budgeted results at the end of a period, but modern managers need real time performance measures that can be monitored and adjusted during the period
        
        Standard costing compares actual results with budgeted results at the end of a period, but modern managers need real time information about events as they occur
  - - - • Purpose: to identify and address the factors that affect the performance of the business and to improve planning and decision making
      - • Steps: compare actual results with budgeted or standard results, calculate variances, classify variances as favourable or adverse, analyse the causes of variances, report and communicate variances, take corrective or preventive actions
    - - • Sales variances: related to sales volume and sales price
      - • Sales volume variance: difference between original and flexed budget profit
        
        • Sales volume higher than budget, but profitability much lower
        • This indicates poor cost and revenue management
      - • Sales price variance: difference between actual sales revenue and actual volume at standard sales price
        
        • Sales price variance is adverse by $405,000, indicating lower selling prices than budgeted
        • Sales price variance: lower prices to boost sales or compete
      - • Materials variances: related to direct materials cost, usage and price
        
        • Material price variance is adverse by $108,000, indicating higher material costs than budgeted
        • Material price variance: higher costs due to inflation, supplier issues, quality issues, or poor purchasing decisions
        
        • Material usage variance is adverse by $90,000, indicating higher material consumption than budgeted
        • Material usage variance: higher consumption due to wastage, spoilage, rework, or poor quality control
      - • Total direct materials variance: difference between actual and budgeted direct materials cost
        
        • Materials variance: adverse by $1.08m, due to price or quality
        
        • Price: short lead time, customer demand, new technology
        
        • Short lead time for orders, requiring higher prices or non-economic ordering
        
        • economic order techniques: methods of determining the optimal quantity, and timing of inventory orders.
        
        aim to minimise the total inventory costs, such as holding costs, ordering costs, and shortage costs.
        
        One example of an economic order technique is the economic order quantity (EOQ) model, which calculates the order quantity that minimises the total inventory costs
        
        • Customer demand for more attractive products, requiring more advanced components
        
        • Dynamic industry with rapidly developing technology, increasing the cost of new materials
        
        • Quality: poor control, inaccurate costs, design changes
        
        • Poor quality control, leading to wastage, spoilage or rework
        
        • Inaccurate standard costs, not reflecting the actual material usage
        
        • Product design changes, requiring more or different materials than budgeted
        
        • Direct labour variance is adverse by $945,000, due to either rate or hours of labour
        
        • learning curve effect:
        
        the relationship between experience producing a good and the efficiency of that production.
        
        the more a worker produces a good, the more skilled and productive he or she becomes, leading to lower costs and higher market share.
        
        can increase competitive advantage over time
      - • Direct materials usage variance: difference between actual and budgeted usage for actual output, multiplied by standard materials cost
      - • Direct materials price variance: difference between actual materials cost and actual usage multiplied by standard materials cost
      - • Labour variances: related to direct labour cost, efficiency and rate
        
        • Labour variance: adverse by $945,000, due to rate or hours
        
        • Rate: overtime, wage increase, skill mix
        
        • Overtime payments, due to short lead time or special orders
        
        • Wage increase, due to inflation, union pressure or skill shortage
        
        • Skill mix, due to different levels of experience or qualification of workers
        
        • Hours: special orders, lower productivity, inaccurate hours
        
        • Longer hours, due to special or customer-specific orders that are not yet standardised
        
        • Lower productivity, due to idle time, absenteeism, turnover or lack of training
        
        • Inaccurate standard hours, not reflecting the actual labour efficiency
      - • Total direct labour variance: difference between actual and budgeted direct labour cost
      - • Direct labour efficiency variance: difference between actual and budgeted labour time for actual output, multiplied by standard labour rate
        
        • Labour efficiency variance is adverse by $54,000, indicating lower labour productivity than budgeted
        • Labour efficiency variance: lower productivity due to idle time, absenteeism, turnover, or lack of training
      - • Direct labour rate variance: difference between actual labour cost and actual labour time multiplied by standard labour rate
        
        • Labour rate variance is adverse by $72,000, indicating higher labour costs than budgeted
        • Labour rate variance: higher costs due to overtime, bonuses, wage increase, or skill mix
      - • Fixed overhead variances: related to fixed production overhead spending
      - • Fixed production overhead total variance: difference between actual and budgeted spending on fixed overheads
        • Fixed overheads variance is adverse by $3.2m, or 39% higher than budgeted
        
        • Reasons: incorrect absorption rate, lack of control, increased orders
        
        • Incorrect standard absorption rate of overheads, not reflecting the actual overhead costs
        
        • Lack of overhead control, leading to inefficiencies and wastages
        
        • Increased orders, requiring more overhead resources or activities
      - • Causes of variances: various factors such as negotiation, quality, market conditions, supplier availability, etc.
      - • Profit variance: adverse by $9.275m, or 84.9% lower than budgeted
        
        • Reasons: adverse variances in price, material, labour and overheads, unrealistic budget, increased competition and demand
        
        • Adverse variances in sales price, material, labour and overheads
        
        • Unrealistic budget based on historical information, not reflecting the current environment
        
        • Increased competition and customer demand, affecting the price and quality of products
    - - • Reasons: natural variation, poor budgeting, poor recording, operational issues, random factors, etc.
        • Reasons: natural variation due to random or seasonal factors, poor budgeting due to unrealistic or inaccurate assumptions or estimates, poor recording due to errors or omissions in data collection or processing, operational issues due to inefficiency, waste, quality problems, labour turnover, etc.
      - • Actions: prevent or repeat variances, bring results back on track, improve performance and efficiency
        • Actions: revise the budget if it is unrealistic or outdated, improve data quality and accuracy, monitor and control costs and revenues, improve operational efficiency and quality, motivate and train staff, negotiate with suppliers and customers, etc.
      - • Purpose: to understand the factors that influence the performance of the business and to take corrective or preventive actions to achieve the budgeted targets or to revise the budget if necessary
      - • Steps: identify the source and nature of variances, analyse the causes of variances using quantitative and qualitative methods, report and communicate variances to relevant managers and stakeholders, recommend and implement actions to prevent adverse variances or repeat favourable variances
    - - • Purpose: to understand the trade-offs and interactions between different aspects of performance and to avoid misleading interpretations of isolated variances
      - • Examples: cheaper materials may lead to lower quality and higher waste, more experienced labour may lead to higher productivity and wages, lower sales prices may lead to higher sales volume, etc.
    - - • Purpose: to ensure fairness and motivation in performance evaluation and to assign responsibility and authority appropriately
      - • Implication: variances should be reported to the managers who can influence or correct them
    - - • Purchasing team: They have an adverse materials variance of $315,000, which means they paid more for the components than budgeted. This could be bad or good depending on the long-term effects on sales or profits.
      - • Sales team: They have a neutral sales variance, which consists of a favourable price variance and an adverse volume variance. This means they sold at a higher price but lower quantity than budgeted. This could be bad or good depending on the factors affecting demand and competition.
      - • Evaluation skills: They can be shown by explaining the causes and consequences of the directors' actions and exploring alternative scenarios or outcomes.
    - - the drawbacks and challenges of using standard costing and variance analysis for decision making and performance evaluation
      - • Examples: discretionary spending, changing conditions, uncontrollable factors, unclear responsibility, lack of motivation, dysfunctional behaviour, etc.
      - • Details:
        
        • Discretionary spending: spending that is not directly related to the level or quality of output, such as advertising or human resource development. Difficult to set standards or measure variances for such spending.
        
        • Changing conditions: changes in the market, technology, environment, etc. that affect the costs and revenues of the business. Require frequent updating of standards, which can be costly and time consuming.
        
        • Uncontrollable factors: factors that affect the performance of the business but are not under the control of a specific manager, such as demand fluctuations, supplier prices, competitor actions, etc. Unfair to hold managers accountable for variances caused by such factors.
        
        • Unclear responsibility: difficulty in defining and assigning the responsibility and authority for different costs and revenues among managers. May lead to confusion, conflict or blame shifting among managers.
        
        • Lack of motivation: lack of incentive for managers to improve their performance beyond meeting the standards. May lead to complacency, inefficiency or waste.
        
        • Dysfunctional behaviour: behaviour that is detrimental to the overall performance or objectives of the business, such as building up excess inventories, cutting quality, manipulating data, etc. May be motivated by achieving favourable variances or avoiding adverse variances.
  - - - • Identifying alternative courses of action
      - • Performing cost/benefit analysis on each course
      - • Evaluating qualitative issues
      - • Choosing a course of action
    - - • Providing quantitative data and performance measures
        
        • The data from these systems can be part of the organisation's big data plans by:
        
        • Providing internal information on various aspects of performance
        
        • Enabling comparisons, benchmarks and analysis
        
        • Supporting the formulation and implementation of future strategy
        
        • Key factors to consider in using these systems for strategic planning are:
        
        • The level of participation in budgets, which should involve all levels of management in a collaborative way
        
        • The relevance of standard costs, which should reflect the future strategic environment
        
        • The effective performance measurement system, which should include broader measures beyond financial and accounting ones
        
        Gives each measure a clear title and purpose:
        • Measure: Punctuality (trains arriving on time)
        • Objective: Reliable service for passengers
        
        Clarifies relationships with other measures:
        Affects/conflicts with: Safety takes priority; Cleaning reductions
        
        Assigns responsibility:
        • Operations director
        
        Defines accurate measurement methods:
        Measured by station managers
        5 minute allowance
        
        Requires analysis to explain results
        • Analyze causes of delays
        
        Sets ambitious yet realistic targets
        • Target from timetable
        • Target updated twice yearly
        
        Gets regular reporting and follow up with action planning:
        • Report weekly performance
        • Operations director reports monthly with improvement plans
        
        • The accuracy and responsibility of variances, which should indicate long term patterns and fundamental changes
      - • Highlighting trends, opportunities and threats
      - • Aligning operational and tactical plans with strategic goals
  - - - • Purpose: to provide a benchmark for measuring and evaluating performance
      - • Examples: standard costs, standard revenues, standard output, standard quality, etc.
    - - • Purpose: to identify and analyse the differences between actual and standard performance and to take corrective or preventive actions
      - • Steps: establish standard costs or revenues for products or services, obtain actual costs or revenues, compare actual and standard results and calculate variances, analyse variances and report them to relevant managers, take actions to improve performance or revise standards if necessary
      - • Reasons for variances: the factors that cause the actual results to differ from the standard results
      - • Examples: unrealistic or inaccurate budgets, poor performance or efficiency, changes in market conditions or prices, process inefficiencies or waste, etc.
      - • Drawbacks of standard costing: the limitations and challenges of using standard costing for decision making and performance evaluation
      - • Examples: standards may become outdated or irrelevant due to changing conditions, standards may not provide motivation or innovation for managers or employees, standards may not reflect the uncontrollable factors that affect performance, variances may be difficult to assign responsibility or accountability for, variances may encourage dysfunctional behaviour or manipulation of data, etc.
- - - - expanded from collecting, paying and reporting money to gaining competitive advantage, providing decision support, finding cost efficiency, improving information quality and becoming a strategic partner to the business
    - - analysing the competitive position, the organisational environment, the benefits and problems from different strategic options, implementing the strategy, measuring the performance and controlling the activities
  - - - • Cost: lower cost by economies of scale, low-cost locations, outsourced resource management
      - • Variable support: better support by more business partnering, flexible resource allocation
      - • Processing times: faster processing by modern technology, standardised processes
    - - • Drivers and benefits: define reasons and objectives, measure and evaluate outcomes
      - • Partner selection: find suitable provider, establish clear contract
      - • Location selection: find suitable location, balance cost, quality, compatibility
      - • Activity selection: find suitable activities, based on strategic importance, complexity, frequency
      - • Project management: set up project team, plan and execute transition, seek external support if needed
      - • Staff management: manage impact on staff, provide communication, training, support
- - - - A step in the fixed costs is a change in the fixed costs that occurs when the activity level crosses a certain threshold.
      - A step in the fixed costs means that the fixed costs are not constant over all levels of output, but rather change in a step-like manner. For example, if a company needs to hire an additional supervisor when the production exceeds 1,000 units, then there is a step in the fixed costs at 1,000 units
      - • A step in the fixed costs can affect the marginal cost and the relevant cost of a decision, as it represents an additional cost that varies with the activity level
    - - Accepting special contracts
        
        Compare the contract's contribution (revenue less costs) to the opportunity cost of lost business. calculate extra revenue less marginal costs, ignore unaffected costs
        
        • Consider other factors, such as future contracts, market entry, or reputation
        
        Identify the:
        
        Extra revenue from a contract (benefit)
        
        Marginal costs to fulfill the contract (cost)
        
        Ignore fixed costs and sunk costs
      - Optimal product mix
        
        Identify the limiting factor (scarce resource e.g. labour, space, or machinery) and choose the mix that maximizes total contribution per unit of that factor.
        
        identify scarce factor, calculate contribution per scarce factor, select optimal mix
      - Make or buy decisions
        
        Compare the contribution of making the product to the cost of buying it from someone else.
        
        •The savings for product C come from lower fixed costs, but these estimates may be unreliable and not actually achieved in practice
        •Outsourcing all products slightly lowers total costs, but depends on accurate fixed cost data and management's ability to achieve savings
        
        • The cost of shutting the production capacity and employee redundancy costs are not considered in the proposal
        
        • Consider qualitative factors besides relative costs
        
        Reliability of supplier:
        Can supplier meet quantity, quality, delivery, and price requirements?
        
        • Contractual terms, service level agreements, and quality acceptance criteria will have to be established and monitored
        
        • The company has no experience in managing an outsourced supplier and ensuring quality
        
        • Management of the outsource supplier will incur one-off and ongoing costs that are not considered in the proposal
        
        Specialist skills:
        Supplier may have skills not available in-house
        
        Alternative resource use:
        Outsourcing frees up resources for other use
        
        •Spare capacity may exist, but is production capacity limiting? If so, B and D output could be increased. Otherwise redundancies may be needed
        
        Social impact:
        Outsourcing may result in redundancies
        Consider redundancy costs
        
        •Outsourced products require less labour, so even utilizing spare capacity may reduce demand for labour, requiring redundancies
        and cause the reaction of the workforce (e.g. strikes, or disputes)
        
        Legal implications:
        Outsourcing may impact supply contracts, employment agreements
        
        Confidentiality:
        Risk of information leakage to supplier's other clients
        
        Customer reaction:
        Customers may prefer in-house production
        
        •Outsourcing conflicts with the company's "locally produced" marketing message, risking customer reaction
        
        •The company's production experience and local sourcing matter for marketing and customers
        
        • The company needs to understand why customers buy its products before outsourcing
        
        example:
        
        A company needs a component for its product. It can:
        
        Make:
        Invest in equipment, materials, labor, overhead
        Control quality and availability
        
        Buy:
        Pay supplier price, transport, storage costs
        Rely on supplier's quality, reliability, availability
        
        The company compares:
        
        Make costs:
        
        Variable + fixed costs of producing the component in-house
        
        Buy costs:
        
        Supplier price + transport + storage
        
        The company chooses the option with:
        
        Lower total cost
        
        Higher quality
        
        Better reliability
        
        More availability
      - Evaluating department performance
        
        Calculate each department's contribution to determine which add value, even if they make individual losses.
        
        • Prepare separate financial statements for each department or section
        
        • Calculate the contribution of each department or section to the overall organisation
        
        • Avoid closing departments or sections that make a positive contribution, even if they make a loss individually
        
        • Closure: consider relevant cash flows of closure, compare benefits and costs, consider non-quantifiable factors
        
        Relevant cash flows of closure:
        Closure is recommended if:
        Total relevant benefits > Total relevant costs
        
        Relevant costs of closure:
        
        Lost contribution from closed area
        
        Specific fixed cost savings from closure
        
        Known penalties and closure costs (e.g. redundancy pay, customer compensation)
        
        Any known reorganization costs
        
        Relevant benefits of closure:
        Additional contribution from alternative uses of freed-up resources
        
        Some costs and benefits are hard to quantify exactly:
        
        • Closure costs like penalties and redundancy payments are uncertain
        
        • Reorganisation costs are difficult to accurately estimate
        
        • Contribution from alternative uses of freed-up resources is not known precisely
        
        Knock-on effects are hard to measure:
        • Closing unprofitable products may reduce customer traffic, affecting sales of other products
        
        Other qualitative factors to consider:
        
        • Impact on company reputation
        
        • Effect on staff morale and motivation among those not made redundant
        
        • Loss of knowledge, skills and experience from redundant staff
      - considers relevant cash flows to determine if decisions like accepting contracts or closing parts of the business will increase contribution.
  - - - • All costs can be classified
      - • Fixed costs remain constant
      - • Variable costs stay constant per unit
      - • Efficiency, risk uniform
      - • Price unchanged at different activity levels
- - - - the uncertainty or variability of future cash flows or returns from the business due to factors such as leverage, volatility, competition, or regulation
      - the possibility that an organisation may not be able to meet its critical financial obligations
    - - the level of gearing, or debt
      - the liquidity
      - cash availability of the organisation
    - - increased gearing raises risk because interest payments are mandatory, unlike dividends which are discretionary;
      - low liquidity increases risk because bills may not be paid on time
  - - - the amount or percentage of cash flows or profits generated by the business relative to its investment or cost of capital
      - the amount or percentage of cash flows or profits generated by the organisation relative to its investment or cost of capital
    - - return on capital employed (ROCE), net present value (NPV), internal rate of return (IRR), and payback period
        
        • ROCE:
        
        accounting rate of return for a capital project
        
        • Method: ARR = average profits / initial investment
        
        • Decision rule: Mutually exclusive projects: select highest ROCE > target rate
        
        • Advantage:
        
        • Quick and simple; no complex formulas or assumptions
        
        • Familiar concept; percentage return; easy to understand and communicate
        
        • Relative measure; easy to compare options; profitability ratios
        
        • Look at entire project life; no ignore cash flows or benefits
        
        • Disadvantage:
        
        • Ignore timing of profits; opportunity cost; time value of money => overestimate profits of investment having delayed or uneven cash flows.
        
        • Use accounting profits; not cash flows; different treatments => underestimate profits of investment having high irrelevant costs
        
        • Relative measure; ignore size; scale; NPV
        
        • Ignore length of project; risk; profitability
        
        • Payback:
        
        time to repay; measure risk; ignore timing and later cashflows
        
        • Payback: time for cash inflows = cash outflows
        
        • Method: Payback period = original cash / annual cash inflow
        
        • Decision rule: accept if payback < target period; • Mutually exclusive projects: select shortest payback
        
        • Advantage:
        
        minimum target for project life
        
        • Simple to calculate and understand; limited resources; communication
        
        • Use cash flows; not accounting profits; more relevant and reliable
        
        • Screening device; eliminate inappropriate projects; more detailed evaluation
        
        • Bias short-term projects; minimise financial and business risk; reduce uncertainty and increase liquidity
        
        • Capital rationing; identify quick cash generators
        
        • The advantages of payback method as an initial indication of project viability, such as its simplicity, its preference for projects with shorter payback periods and its reflection of liquidity and risk aversion
        
        • Disadvantage:
        
        need target/benchmark
        
        • Ignore timing of cash flows; opportunity cost; time value of money
        
        • Ignore cash flows after payback (project 1 has a higher cumulative cash flow at the end of year 4); total return; profitability
        
        • Ignore time value of money; present value; interest rate
        
        • Unable to distinguish same payback; different cash flow patterns; returns
        
        • Arbitrary cut-off period; not optimal decision
        
        • Lead to short-term projects; not strategic goals
        
        • Account for timing risk; not variability risk
        
        • The disadvantages of payback method as an investment appraisal technique, such as its ignorance of cash flows beyond the payback period, its ignorance of time value of money, its arbitrariness in setting the target period and its inconsistency with shareholders' wealth maximization objective
        
        useful when there is an internal hurdle rate/pre-specified company rate or different scales of investment
        
        • The recommendation not to reject the project based on payback criterion alone but to consider other factors such as net present value, risk and intangible benefits
        
        • NPV:
        
        NPV
        
        • A method that compares PV of cash inflows and outflows from an investment
        
        • NPV = PV of cash inflows - PV of cash outflows
        
        • NPV shows if investment will earn more or less than cost of capital
        
        discounted cashflows; include relevant costs and benefits; positive = accept
        
        • Decision rule:
        
        • NPV positive: accept project, increases company value and shareholder wealth
        
        • NPV negative: reject project, decreases company value and shareholder wealth
        
        • NPV zero: indifferent, no impact on company value or shareholder wealth
        
        • Reasons for not using NPV:
        
        • Conflict with short-term profit goals or remuneration schemes
        
        • Conflict with other stakeholders or social opportunity costs
        
        • Not capture unquantifiable factors such as strategic investments
        
        • The problems and limitations of the net present value calculation in the summary, such as the lack of justification for sales revenue, contribution margin, other costs, tax and working capital, investment and realisable value
        
        • Sales:
        
        • The definition of sales revenue as the amount of money generated from selling goods or services to customers
        
        • The importance of sales revenue for investment appraisal as a major source of cash inflow and a determinant of project profitability and viability
        
        • The criticism of the summary's use of a single sales revenue figure without justification or breakdown by service type as an inadequate and unrealistic representation of the project's revenue potential
        
        • The factors that affect sales revenue, such as market competition, client base, pricing and marketing strategy, and how they should be considered and justified in the investment appraisal
        
        • Contribution:
        
        • The definition of contribution margin as the difference between sales revenue and variable costs
        
        • The importance of contribution margin for investment appraisal as a measure of how much each unit of sales contributes to covering fixed costs and generating profit
        
        • The criticism of the summary's use of a single contribution margin figure without justification or variation by service type as an inadequate and unrealistic representation of the project's profitability potential
        
        • The factors that affect contribution margin, such as variable costs, economies of scale, pricing strategy and demand elasticity, and how they should be considered and justified in the investment appraisal
        
        • Other costs:
        
        • The definition of other costs as the costs that are not directly related to sales revenue or variable costs, such as marketing costs and fixed costs
        
        • The importance of other costs for investment appraisal as a major source of cash outflow and a determinant of project profitability and viability
        
        • The criticism of the summary's use of a single other costs figure without justification or breakdown by element as an inadequate and unrealistic representation of the project's cost structure
        
        • The factors that affect other costs, such as marketing plan, fixed cost structure, inflation and technological change, and how they should be considered and justified in the investment appraisal
        
        • The suggestions for improving the net present value calculation, such as splitting the sales revenue by service type, breaking down the other costs by element, taking account of allowances and working capital, spreading the investment over time and using a realistic realisable value
        
        • The error in extending the net present value to year 10 and the questionable assumption of using a multiple of 6 for years 5-10
        
        Discounted cash flow
        
        • A technique that evaluates cash flows over time and profitability of a project
        
        • Cash flows > accounting profits
        
        • Future incremental cash flows only
        
        • Discounting for time value of money
        
        • DCF based on time value of money: money today > money in future due to inflation, uncertainty, opportunity cost
        
        • Advantages of DCF:
        
        • Discount future cash flows for time value of money
        
        • Use all relevant cash flows
        
        • Allow for timing of cash flows
        
        • Have accepted methods for NPV and IRR
        
        • Problems with DCF:
        
        • Use uncertain future cash flows
        
        • May not work with capital rationing
        
        • Depend on cost of capital that may vary or be hard to estimate
        
        • DCF: value investment based on NPV of future cash flows
        
        Compounding
        
        • How much an investment grows with interest over time
        
        • Formula: FV=PV (1+r)n
        
        • Example: $10,000 at 10% compound interest becomes $11,000 after 1 year, $12,100 after 2 years or $13,310 after 3 years
        
        Discounting
        
        • How much an investment is worth today given a future value and interest rate
        
        • Formula: PV = FV x (1+r)^-n
        
        • Example: To have $11,000 after 1 year, $12,100 after 2 years or $13,310 after 3 years at 10% compound interest, need to invest $10,000 now
        
        • Compare payments and receipts from a project on a common basis using present values
        
        • Guidelines for timing of cash flows:
        
        • Cash flow now: Year 0, discount factor 1
        
        • Cash flow during period: end of period
        
        • Cash flow at start of period: end of previous period
        
        • Discount rate:
        
        factors that influence the discount rate, such as inflation, interest forgone, cost of capital and risk, opportunity cost of investment
        
        • The information that is relevant for setting the discount rate, such as risk-free interest rates, risk profile of the company and CAPM
        
        • The effect of changing the discount rate on the NPV and selection of projects
        
        • The definition of discount rate as the rate used to discount future cash flows to their present value
        
        • The importance of discount rate for investment appraisal as a reflection of the opportunity cost, risk and time value of money associated with the project
        
        • The criticism of the summary's use of an incorrect discount rate based on the cost of debt instead of the weighted average cost of capital or a project-specific cost of capital as an underestimation of the project's required rate of return
        
        • The factors that affect discount rate, such as inflation, interest forgone, cost of capital, risk profile, risk-free rate and market risk premium, and how they should be used to set the appropriate discount rate for the project
        
        The discount factor
        
        • The required or expected rate of return from an investment
        
        • Based on the cost of capital, which is:
        
        • The cost of raising and using funds
        
        • The return that investors demand for investing in the company
        
        • The minimum return that a project should earn to pay investors
        
        • Not the same as the cost of borrowing, but may include it
        
        • Example: Use bank interest or loan interest as benchmarks for investments
        
        • IRR:
        
        discount rate for zero NPV; percentage return; higher than cost = accept
        
        • A method that calculates the DCF rate of return that a project achieves
        
        • The IRR shows if project earns more or less than target rate of return
        
        • Decision rule:
        
        • IRR higher than target rate: accept project
        
        • IRR lower than target rate: reject project
        
        • IRR equal to target rate: indifferent
        
        • IRR: compare investment based on IRR
        
        • Without computer or calculator, use interpolation method to calculate IRR => • Steps are:
        
        • Step 1: Calculate NPV using cost of capital or target rate
        
        • Step 2: Calculate NPV using second rate higher or lower than first depending on first NPV sign
        
        • Step 3: Estimate IRR using formula: IRR ~ a + ( ( NPVa/( NPVa – NPVb ) x ( b – a ) )% where a and b are rates and NPVa and NPVb are NPVs
        
        • Example: Project costs $80,000 and generates cash flows of $20,000 per year for five years and resale value of $10,000 at end. Cost of capital is 10%. IRR is:
        
        • Step 1: NPV at 10% = -$80,000 + $20,000 x 3.791 + $10,000 x 0.621 = $2,030 (positive)
        
        • Step 2: NPV at 12% = -$80,000 + $20,000 x 3.605 + $10,000 x 0.567 = -$2,230 (negative)
        
        • Step 3: IRR ~ 10% + ($2,030/($2,030+$2,230) x (12%-10%) = 10.95%, say 11%
        
        • IRR higher than cost of capital, so accept project
        
        Graphical representation of IRR
        
        • IRR can be shown by graph of NPV against discount rate for typical project with negative cash flow at start and positive cash flows later
        
        • Graph shows NPV decreases and becomes negative as discount rate increases
        
        • IRR is where graph crosses horizontal axis and NPV is zero
        
        • Interpolation method assumes NPV is linear between two points close to zero and draws straight line to estimate IRR
        
        • Main advantage: easy to understand by managers as percentage return
        
        Cons:
        
        may confuse IRR with accounting ROCE; ignores relative size of investments; may give wrong decisions when comparing projects
        
        Non-conventional cash flows
        
        • Cash flows that vary from typical pattern of negative at start and positive later
        
        • May produce multiple IRRs; cause confusion or errors; avoid using IRR for non-conventional cash flows
        
        • Conventional cash flows: same accept or reject decision
        
        Mutually exclusive projects
        
        • Projects that only one can be chosen from alternatives
        
        • NPV and IRR may give conflicting rankings; affect decision making
        
        • NPV preferable for ranking; reflects absolute impact on shareholder wealth; does not depend on scale or timing of cash flows
        
        Reinvestment assumptions
        
        • NPV assumes cash inflows reinvested at cost of capital or target rate
        
        • IRR assumes cash inflows reinvested at IRR of project
        
        • NPV assumption more realistic; implies all projects with return higher than cost of capital accepted; excess funds reinvested at cost of capital
        
        • Two methods of using DCF:
        NPV and IRR methods
        
        • NPV compares PV of cash inflows and outflows using target rate or cost of capital
        
        • IRR calculates DCF rate of return that makes NPV zero
        
        • Need to consider relative merits of each method
        
        • IRR: more easily understood; may confuse with ROCE
        
        • NPV: technically superior; simpler to calculate; may not be intuitive
        
        • IRR: ignores relative sizes of investments; affects project selection or ranking
        
        • Non-conventional cash flows: multiple IRRs; serious errors
        
        • NPV: superior for ranking mutually exclusive projects; absolute impact on shareholder wealth; independent of scale or timing of cash flows
        
        • IRR: unrealistic reinvestment assumption; cannot be substantiated
        
        • NPV: can incorporate variations in discount rates; IRR cannot
        
        • IRR: widely used in practice despite NPV advantages
    - - non-financial costs or benefits might outweigh the financial ones;
        
        • Intangible benefits:
        
        • The challenge of estimating future cash inflows and outflows for investment appraisal
        
        • The inclusion of monetary values for intangible benefits, such as better information and improved staff morale, for both jobs
        
        • The impact of deducting intangible benefits from the analysis on the NPV and selection of projects
        
        • The definition and examples of intangible benefits, such as a better user interface and user experience
        
        • The need to identify and list intangible benefits for each option in the business case
        
        • Benefits realisation:
        
        • The difference between feasibility study and benefits realisation
        
        • The purpose and timing of feasibility study and benefits realisation
        
        • The error in Barry's understanding of benefits realisation
        
        •Assesses if promised benefits are actually achieved
        
        •Requires clear definition of benefits
        
        • Provides yardstick to measure success against
        
        In summary:
        • Benefits realisation reviews actual outcomes
        
        The main reasons a formal business case is still needed:
        
        •To quantify costs and benefits - timing,amount
        
        •Use investment appraisal - payback,IRR,NPV
        
        •Define intangible costs/benefits more precisely
        
        In summary:
        • Business case quantifies costs/benefits precisely
        
        Benefits management:
        
        •Ensures project stays on track to deliver value
        
        •Accounts for changes in requirements
        
        •Prevents drift from original business case
        
        In summary:
        • Benefits management tracks progress against objectives
        
        Without these processes:
        
        • Projects adopted based on enthusiasm,not rationale
        
        • Costs may escalate
        
        • Benefits may not materialise
        
        • Business cases based on unrealistic benefits
        
        These ensure:
        
        •Projects are truly worthwhile
        
        • Objectives are met
        
        •Value is created for the organization
        
        Despite the enthusiasm for e-assessment:
        
        •A business case is needed to rigorously justify it
        
        •Benefits must be managed throughout
        
        •Benefits realization must confirm actual outcomes match expectations
        
        This ensures e-assessment truly delivers value for IAA.
      - managers may manipulate or omit costs or benefits to overstate or understate the case for a project;
      - projects with no financial benefits would automatically be rejected
      - weaknesses in the current management accounting system:
        
        Operating profit:
        
        Shows only overall business performance
        
        Cannot evaluate performance of individual restaurants
        
        Cannot calculate operating profit for each restaurant as a standalone unit
        
        Cannot compare efficiency and profitability of restaurants
        
        Admin expenses:
        Only shows total figures with no breakdown
        Cannot identify areas of over/under performance causing adverse variance
        
        Food cost per head:
        
        Limited as measure without consistent menu and service
        
        Different pricing structures at each restaurant make it less relevant
        
        Should consider separate food cost % for meals
        
        Kitchen labour hours:
        
        Negative variance could be due to unpaid extra hours worked (industry norm)
        
        Cannot identify which job categories caused variance
        
        Hours need to be broken down by job category
        
        Should measure customers per labour hour to evaluate productivity
        
        In summary, the system lacks:
        
        Breakdown of costs to evaluate performance at restaurant level
        
        Insight into specific areas driving variances
        
        Relevant measures that support decision making and control
        
        Metrics that consider different factors at each restaurant
        
        To improve, the system needs to provide:
        This will enable managers to take appropriate action, compare performance across restaurants and make decisions based on relevant information.
        
        Operating profit for each restaurant
        
        Detailed breakdown of admin and food costs
        
        Separate food cost % for different menus
        
        Labour hour analysis by job category and customers served
  - - - the sources and methods of raising finance for the business, such as debt, equity, retained earnings, or hybrid securities
      - the sources and methods of raising finance for the organisation, such as debt, equity, retained earnings, or hybrid securities
    - - the financial manager should identify which strategic business units (SBUs) need funding, how funding can support strategic decisions, and what type of funding they need; this will allow them to create unique funding strategies for each business unit
    - - the financial manager should recognise that funding requirements change subject to areas such as where an SBU is in its life cycle, where it lies in the organisation's portfolio (for example, within the BCG matrix) and the strategy that it is pursuing; organisations will seek to deliver value while keeping risk to an acceptable level; funding decisions are one way to manage risk; an appropriate funding model may vary over the industry life cycle
    - - • Launch (Question Mark/ Problem child):
        
        a strategic business unit (SBU) that is in the launch phase of its life cycle
        
        and has a low market share but a high market growth rate
        
        is very risky and uncertain
        
        may have high potential but also high costs and losses
        
        Therefore, it should
        
        keep its financial risk very low by avoiding debt and using equity from venture capital, which are investors who are willing to take high risks for high returns.
        
        pay low or zero dividends to its shareholders, as it needs to reinvest its earnings to grow and survive.
      - • Growth (Star):
        
        an SBU that is in the growth phase of its life cycle
        
        has a high market share and a high market growth rate
        
        is still risky but less uncertain
        
        has a strong competitive position and a high potential for profits
        
        Therefore, it should
        
        keep its financial risk low by using equity from retained earnings, which are profits that are not distributed to shareholders but reinvested in the business, and new investors seeking growth, who are willing to accept lower dividends for higher capital gains.
        
        pay nominal dividends if any to its shareholders, as it still needs to reinvest its earnings to maintain and increase its market share
      - • Maturity (Cash Cow):
        
        an SBU that is in the maturity phase of its life cycle
        
        has a high market share but a low market growth rate
        
        is less risky and more stable
        
        has a dominant competitive position and a high cash flow generation
        
        Therefore, it
        
        can increase its financial risk if necessary by using debt as well as equity from retained earnings to fund its operations or expansion.
        Debt can be cheaper than equity and can provide tax benefits.
        
        should pay high dividends to its shareholders, as it does not need to reinvest much of its earnings to sustain its market share.
      - • Decline (Dog):
        
        an SBU that is in the decline phase of its life cycle
        
        has a low market share and a low market growth rate
        
        is the least risky but also the least profitable
        
        has a weak competitive position and a low cash flow generation
        
        Therefore, it should
        
        increase its financial risk if possible by using secured debt, which is debt that is backed by collateral or assets that can be seized by the lender in case of default.
        Secured debt can be easier and cheaper to obtain than unsecured debt or equity
        
        pay total dividends to its shareholders, as it does not need to reinvest any of its earnings to survive or grow.
    - - the money that an organisation needs for its short-term and long-term activities and investments
      - • Suitability, acceptability and feasibility criteria:
        
        the criteria that help evaluate the different sources of finance based on how well they fit the purpose, how acceptable they are to stakeholders, and how realistic they are to obtain
        
        how finance influences the decisions that an organisation makes about its goals, strategies and actions
      - • Suitability:
        
        assessing how profitable and beneficial different options are for the organisation
        
        • Return on Investment: a measure of how much profit an investment generates compared to its cost
        
        • Comparison of alternatives: a process of comparing different options based on their advantages and disadvantages
        
        • Profit margins: a measure of how much profit a business makes from each unit of sales
      - • Acceptability:
        
        ensuring that the shareholders are satisfied with the dividends they receive and the risks they face
        
        • Cash flow forecasts: a projection of how much money will flow in and out of the business in the future and how it will affect the ability to pay dividends to shareholders
        
        • NPV: a method of evaluating an investment by calculating its present value minus its cost
        
        • ROCE:
        
        a measure of how efficiently a business uses its capital to generate profit
        
        profit/investment; simple; ignore timing and irrelevant costs
        
        • Valuation of real options: a method of estimating the value of an investment by considering the flexibility and uncertainty involved in it
        
        • Cost-benefit analysis: a method of comparing the costs and benefits of an action or project
        
        • Ratio analysis:
        
        (e.g. dividend yield, growth): a method of using financial ratios to evaluate the performance and position of a business or an investment
        
        (e.g. gearing, dividend cover): a method of using financial ratios to evaluate the risk and stability of a business or an investment
        
        When assessing organizational performance using financial ratios:
        
        • Interpret results in context of specific question and scenario
        
        • Explain reasons behind changes in ratios, not just state facts
        
        • Demonstrate commercial awareness beyond rote calculations
        
        Weak answers tend to:
        
        • Only know how to calculate ratios
        
        • Not link appraisal to given scenario
        
        • Show limited understanding of what ratios represent
        
        • Lack commercial awareness of factors impacting performance
        
        To improve your answer:
        
        • Fully utilize information in the scenario
        
        • Link rationale for ratio changes directly to scenario details
        
        • Draw appropriate conclusions based on your analysis
        
        • Avoid simply listing all possible reasons for ratio changes
        
        • Demonstrate understanding of what ratios indicate about business performance
        
        In summary, to score well:
        
        • Interpret ratios in context of specific factors in the question scenario
        
        • Explain reasons behind ratio changes by referring to relevant scenario details
        
        1 more item...
        
        • Show commercial awareness of business issues impacting financial performance
        
        • Draw justified conclusions from your analysis of ratios and scenario information
        
        • Sensitivity: a measure of how much a change in one variable affects another variable or outcome
        
        • Breakeven: the point where the total revenue and total cost of a business or a project are equal
        
        Examples:
        
        • Sailing dinghies:
        
        • Financial benefits: positive NPV, acceptable PP, surplus funds, diversification, steady cash flow, economies of scale
        
        • Financial drawbacks: lower margins, lower price, negative perception
        
        • Non-financial benefits: differentiation, cost leadership, learning curve, customer relationship
        
        • Non-financial drawbacks: local competition, unclear strategy, simpler design
        
        • Luxury yachts:
        
        • Financial benefits: positive NPV, higher margins, less recession-sensitive, high returns
        
        • Financial drawbacks: uncertain cash flows, high fixed costs, FX risk, full utilisation of funds, long PP
        
        • Non-financial benefits: differentiation from local competitors, international presence, appeal to investors, craftsmanship skills, innovation potential
        
        • Non-financial drawbacks: foreign competition, limited customer base, uncertain success, high resource commitment, irrelevance of new premises
        
        • Recommendations:
        
        • Reject luxury yacht project due to high risk and low success
        
        • Consider sailing dinghy project due to economies of scale and compatibility with new premises
        
        • Note that sailing dinghy project would not address cruising yacht issues
      - • Feasibility:
        
        checking if the organisation has enough money and assets to carry out its plans and what impact they will have on its cash flow and operations
        
        • Cash flow forecast: a projection of how much money will flow in and out of the business in the future and how it will affect the need for additional finance
        
        • Ability to raise finance needed: an assessment of how easy or difficult it is for the organisation to obtain more money from internal or external sources
        
        • Working capital implications: an analysis of how the organisation's plans will affect its current assets and liabilities, such as inventory, receivables, payables, etc.
        
        • Foreign exchange implications: an analysis of how the organisation's plans will affect its exposure to currency fluctuations and exchange rate risks
      - • Finance methods: different ways that a business can get money to fund its activities and investments
        
        • Equity:
        
        internally generated (retained earnings)
        
        the money that a business generates from its own operations and keeps in the business
        
        • Pros: this method is easy to use and does not affect who owns or controls the business
        
        • Cons: this method reduces the amount of money that can be paid to shareholders and may not be enough to support the expansion of the business (reinvestment)
        
        ordinary shares
        
        the money that a business raises by selling shares of its ownership to investors (share issues)
        
        • Pros: long-term capital (this method provides a large amount of money that does not have to be repaid)
        
        • Cons: may dilute control (this method may reduce the percentage of ownership and influence that the existing shareholders have over the business)
        
        • Debt:
        
        long-term (debentures, preference shares)
        
        • Loan capital:
        
        the money that a business borrows from other sources than banks, such as bonds or debentures
        
        • Pros: similar to bank loan, no covenants possible
        (this method is similar to a bank loan in terms of providing a fixed amount of money with interest over a period of time, but may not have any conditions attached to it)
        
        • Cons: slower, more public, issue costs
        (this method takes longer to arrange than a bank loan, requires more disclosure of information about the business, and involves some expenses for issuing the bonds or debentures)
        
        • Debentures:
        
        Debentures are loans with no guarantee
        
        You lend and hope they pay you back with interest
        
        But if they default, you may lose your investment.
        
        Pros: lower interest, longer maturity / Cons: higher risk, lower priority.
        
        • Preference shares:
        
        Preference shares are shares with priority
        
        They get their dividends and assets first and steady
        
        But they have no vote and may miss the growth opportunity.
        
        medium-term (loans, HP and leasing)
        
        • Bank loan:
        
        the money that a business borrows from a bank and pays back with interest over an agreed period of time
        
        • Pros: known repayments, flexible, quick, no control loss (this method allows the business to plan its cash flow, choose the amount and duration of the loan, get the money fast, and keep its ownership intact)
        
        • Cons: increases gearing and risk, interest and covenants/security required (this method increases the ratio of debt to equity in the business and makes it more vulnerable to financial difficulties, charges a cost for borrowing the money and imposes some conditions or collateral on the loan)
        
        • Hire purchase:
        
        Hire purchase is paying in bits
        
        You pay a deposit and instalments
        
        You own it when you pay the last bits
        
        It's renting with a buy option.
        
        Pros: own the asset, spread the cost
        
        This means that the buyers can own the asset at the end of the payment term and use it as they wish. They can also spread the cost of buying the asset over time and make it more affordable.
        
        Cons: higher price, lose the asset if you default.
        
        This means that the buyers have to pay a higher price for the asset than if they paid in full upfront. They also risk losing the asset if they fail to make the payments on time or in full.
        
        • Leasing:
        
        Leasing is renting an asset for a term
        
        You pay the owner a fee and use it as you confirm
        
        You don't own the asset and must return or purchase it at the end of the term.
        
        Pros: use the asset, save the cost
        
        This means that the users can use the asset for their purposes without having to buy it. They can also save the cost of buying, maintaining, or disposing of the asset.
        
        Cons: don't own the asset, pay the rent.
        
        This means that the users do not have any ownership rights or benefits from the asset. They also have to pay a rent or fee for using the asset, which may be higher than buying it.
        
        short-term (trade credit and overdrafts)
        
        • Bank overdraft:
        
        the money that a business uses when it spends more than it has in its bank account
        
        • Pros: flexible, interest on amount owing only, no gearing effect
        "this method allows the business to adjust its spending according to its needs, pay interest only on the negative balance, and not affect its debt to equity ratio"
        
        • Cons: repayable on demand, often costly
        this method can be cancelled by the bank at any time and has a high interest rate compared to other sources of finance
        
        • Trade credit:
        
        Trade credit is buying now and paying later
        
        You get the goods or services from your supplier
        
        It helps you with your cash flow and sales
        
        But you must pay on time or face fines and fails.
        
        Pros: improve cash flow and sales
        
        This means that the buyers can improve their cash flow and liquidity by delaying their payments.
        
        They can also increase their sales by buying more goods or services on credit.
        
        Cons: pay interest and fees, lose supplier's trust.
        
        This means that the buyers have to pay interest and fees for using trade credit, which may increase their costs.
        
        They also risk losing their supplier's trust and goodwill if they fail to pay on time or in full.
        
        • Other:
        
        government grants (external support)
        
        Government grants are funds that are free
        
        You get them from a government source for your project or activity
        
        They are competitive and have strict criteria to meet
        
        This means that the recipients have to compete with other applicants for getting the funds, which may be limited or scarce. They also have to meet strict criteria and conditions for applying and reporting on how they use the funds.
        
        But they can help you achieve your objectives and compete.
        
        initial coin offering (ICO) (innovation)
        
        Initial coin offering is raising funds with crypto
        
        You sell your tokens or coins to the public for your project or venture
        
        It is like an IPO but with less rules and more risk
        
        This means that the issuers do not have to comply with as many rules or laws as in an initial public offering.
        
        They can also innovate and create new products or services using blockchain technology and cryptocurrencies.
        
        But it can also be a fraud or a flop, so be careful what you pick.
        
        This means that the investors face more risk of losing their money if the project or venture fails or the cryptocurrency or token loses value.
        
        They also face more fraud or scams from dishonest or unqualified issuers.
        
        • Key sources of internal finance
        
        • Retained profits: cheap and fast but costly and risky
        
        • Working capital management: cash flow boost but profit or business trade-off
        
        • Sale of surplus assets: easy but short-sighted
        
        • ICO: cryptocurrency crowdfunding; high reward but high risk
      - • Factors to consider when choosing a financing package
        
        • Cost: compare risk and issue costs of different finance sources • Cost: compare interest rate or cost of finance options based on current and expected market interest rates and tax relief; • Cost of borrowing: compare cost of debt and equity finance and impact on profitability and risk
        
        • Bank loan < overdraft < short-term loan < long-term loan < debt < equity
        
        • Loan notes: fixed 7% p.a.; bank loan: variable 8% p.a.
        
        • Market interest rates: may change over time; affect cost of variable rate
        
        • Tax relief: available for both options; interest payments are tax deductible
        
        • Loan notes cheaper than bank loan at current rates; may change if market rates fall or rise
        
        • Olsen needs to consider market expectations on future rates and their impact
        
        • Cash held: consider cash from internal sources and grants for initial outlay or working capital
        
        • Cash at bank: $978k < both options; grants: may cover part of hotel costs
        
        • Cash needed: for working capital and interest payments
        
        • Debt < equity; tax relief; obligations; default risk
        
        • Interest cover: 23x > 1.2x for hotel; high vulnerability
        
        • Control: consider voting rights and ownership impact of different finance sources; • Equity finance and control: consider availability and impact of equity finance from venture capitalists or other sources on control and decision-making
        
        • Debt, preference shares = no control; public issue = dilute control; rights issue = maintain control
        
        • Private limited company: no public share issue; limited equity finance
        
        • Existing shareholders: inject more capital; retain control
        
        • Venture capitalists: provide equity finance; dilute ownership and power; participate in success and expect high returns; look for exit routes
        
        • Availability: assess accessibility, certainty and restrictions of different finance
        sources based on market and investor confidence
        
        • Debt = limited by covenants; rights issue = limited by affordability; equity = limited by unquoted status
        
        • Loan notes: may not be fully subscribed; bank loan: definite offer
        
        • Loan notes: higher issue costs; bank loan: lower issue costs
        
        • Bank loan more attractive; more available and less costly
        
        • Gearing: evaluate leverage and risk effect of different finance sources; • Gearing: compare debt to equity level and effect on leverage and risk
        
        • Debt = increase gearing, risk, cost of equity; equity = decrease gearing, risk, cost of equity; optimal gearing = balance benefits
        
        • Debt: increase gearing, leverage, risk, cost of equity
        
        • Equity: decrease gearing, leverage, risk, ownership, control
        
        • Optimal gearing: balance benefits of debt and equity
        
        • Gearing ratio: 46.3% > 45% covenant; rebalance needed
        
        • Security: identify collateral required and implications for assets and liabilities • Security: compare security or collateral required for finance options and their implications for assets and liabilities
        • Security: identify security for debt finance and implications for assets and liabilities
        
        • Debt = require security from assets; equity = no security but dilute claims; quality assets = preferred for security
        
        • Loan notes: fixed and floating charge over Olsen and Albiston assets; bank loan: fixed and floating charge over Albiston assets only
        
        • Acquisition: risky investment; may fail or succeed
        
        • Bank loan more attractive; limit exposure to Albiston failure by using Albiston assets only
        
        • Loan notes less attractive; expose Olsen assets to Albiston failure by using both companies' assets
        
        • Debt: require security from assets; protect lenders
        
        • Non-current assets: $1.6m < further borrowing; may be taken
        
        • Bank covenant: may renegotiate if secure on assets
        
        • Cash flow: match cash flow patterns and projections of projects and finance sources • Cash flow: compare cash flow implications of finance options based on interest payment frequency, amount, and timing
        
        • Match lifetimes of finance and project flows; equity = flexible for uncertain cash flows; fixed rates = easier for budgeting; avoid loans maturing together; cash flow forecast = essential
        
        • Loan notes: smaller interest, larger redemption; bank loan: larger interest, smaller repayment
        
        • Albiston: making losses; needs cash support
        
        • Loan notes preferable for cash flow; delay payments until profitable
        
        • Bank loan less preferable for cash flow; more frequent and larger payments; strain liquidity
        
        • Exit routes: consider options and costs for terminating or exiting finance sources
        
        • Debt = prepayment penalties or restrictions; equity = buyback provisions or restrictions; investors = exit options or costs; venture capitalists = exit in 5-7 years
        
        • Covenants: compare restrictions and conditions on operations and decisions
        
        • Loan notes: some covenants; bank loan: extensive covenants
        
        • Bank loan less attractive; more limits on dividends, debt, shares
        
        • Length: compare maturity or repayment period of finance options and match with long-term investment horizon
        
        • Loan notes: four years; bank loan: six years
        
        • Acquisition: long-term investment; two years to turn around
        
        • Bank loan more attractive; longer period; aligns with cash flow; reduces refinancing risk
        
        • Risk: evaluate business and operational risk of investment options and compatibility with financial risk
        
        • Business risk: product diversification; market uncertainty
        
        • Operational risk: fixed costs; demand fluctuations
        
        • Hotel: higher business and operational risk than restaurant
        
        • Financial risk: debt financing; interest rate changes
        
        • Hotel: higher financial risk than restaurant; too high to accept alone
        
        • The definition and examples of risk, such as supplier risk and project risk
        
        • The need to document risk for each option in the business case
        
        • The limitation of the decision tree analysis in reflecting risk
        
        • Impact on the organisation:
        
        • The definition and examples of impact on the organisation, such as the degree of change, the effect on processes and people
        
        • The need to assess the relative impact of each option on the organisation
        
        • Supplier and product features:
        
        • The definition and examples of supplier features, such as financial robustness, support availability, user group presence, process certification
        
        • The definition and examples of product features, such as functional fitness, usability, flexibility, design philosophy
        
        • The need to allocate appropriate weight to supplier and product features for each option
        
        • The limitation of the decision tree analysis in reflecting supplier and product features
- - - - calculate effect of changes in variables (demand or inflation) on forecast (cash flow or profit); identify drivers and risks of forecast, plan for scenarios
      - • The definition of sensitivity analysis as a technique that measures how much a project's net present value changes when one variable changes while holding other variables constant
      - • The purpose of sensitivity analysis as a way to assess how sensitive a project's profitability is to changes in key variables such as sales revenue, contribution margin, other costs and discount rate
      - • The correction of the summary's statement that sensitivity analysis will show the probability of making a loss as a misunderstanding of the concept of sensitivity analysis
      - • Cons:
        
        • Treating variables as independent and ignoring connections and common factors that may affect more than one variable
        
        • Focusing on individual variables and ignoring the combined effect of multiple variables changing simultaneously
        
        • Assuming linear relationships between variables and net present value and ignoring non-linear effects
        
        • Providing information on the magnitude but not the likelihood of changes in variables
      - • The suggestion to use scenario analysis instead of sensitivity analysis to show results under different outcomes, such as optimistic, pessimistic and most likely scenarios, that reflect the changes in multiple variables and their probabilities
    - - • Deficiency: cash shortfall or negative balance
      - • Surplus: excess cash or positive balance
      - • Leading and lagging: delay payments or speed up receipts to raise cash
      - • Other methods: borrow, sell investments, issue shares or bonds, reduce dividends, cut costs, increase sales
- - - - • predicting future for planning and decision
      - • Qualitative techniques: based on judgement, such as:
        
        • Delphi technique: experts agree on forecasts
        
        • Sales force opinions: sales team opinions into forecast
        
        • Executive opinions: managers' knowledge into forecast
        
        • Market research: customer surveys for demand
      - quantitative techniques: based on historical data, such as: Regression analysis
        
        • Linear regression: relationship between two variables
        
        • Least squares regression:
        
        • Regression analysis for moist food sales gives Y = 369.5714 - 9.86x; The equation of the line is y = b + ax, where x is time and y is sales -> The equation can be used to predict future sales
        
        • Slope:
        
        • The positive slope of the line (b) indicates an upward trend in sales
        
        Negative b indicates downward slope of the curve
        
        • Drawbacks:
        
        inappropriate not useful for forecasting if a curved line would fit the data better (the dependable variable changes disproportionately with the independent variable).
        
        ignores seasonal variations, uses small data set
        
        Predicted value is too low compared to actual and previous values
        
        It can establish a relationship. between two variables, but this does not mean that a change in - one variable causes a change in the other. The relationship may be coincidence, or caused by other variables.
        
        It depends on having enough data, and the data being reliable.
        
        When used for forecasting, it assumes that the past is a reliable guide to the future, which may not be correct.
        
        Calculate residual:
        
        If the dots (residual value point) tightly adhere to the zero baseline, the regression equation is reasonably accurate.
        
        actual value – predicted value y (= ax + b)
        
        If the dots are wildly scattered, the regression equation may have limited usefulness.
        
        • The high residual variation (positive/ negative value) may indicate actual sales much higher/ lower than predicted value that needs further investigation
        
        • Low residuals indicate reasonable accuracy and little residual factors
        
        • Benefits:
        
        fits a straight line of best fit through the data by minimizing the squared errors
        
        provides a regression equation that predicts dependent variable from independent variable
        
        • Linear regression might be more useful if:
        
        • Annual data was used instead of quarterly data to remove seasonal variation • To use annual data, you need to aggregate the quarterly data into yearly data by summing or averaging the sales values for each year. Then you can use the year as the independent variable and the annual sales as the dependent variable in the linear regression model. This may help reduce the seasonal variation and make the data more linear.
        
        • Alternative variables that explained seasonal variation were identified and correlated with sales data
        
        • Time series analysis:
        
        • Benefits:
        
        separate seasonal and cyclical fluctuations from long-term underlying trends
        
        Consider seasonal patterns (most companies experience)
        
        Widely understood, fairly straightforward.
        
        Past data: unreliable.
        
        • It is a simple and widely used method to identify the relationship between two variables and estimate the value of one variable based on the value of another
        
        • It can help with prediction, explanation, hypothesis testing, and inference
        
        • It can be extended to multiple linear regression to include more than one independent variable
        
        • Time series analysis is more suitable for sales forecasting at ATD than linear regression
        • Time series is the best method for forecasting, but may need to combine methods for general trend
        
        • Drawbacks:
        
        Not consider the age of data. (if too old => update or not incorrect)
        
        Not consider contributing factors besides time.
        
        Assume past is reliable guide to future/ future will repeat the past patterns, potentially incorrect. => all regression models have this issue.
        
        • It assumes a linear relationship between the variables, which may not always hold in reality
        
        • It is sensitive to outliers, which can affect the slope and intercept of the line of best fit
        
        • It may suffer from multicollinearity, heteroscedasticity, autocorrelation, or non-normality of errors, which can violate the assumptions and affect the validity and reliability of the results
        
        • Both techniques (linear regression & seasonal adjustment) have the limitation of relying on past data, which may not reflect sudden changes in the market
        
        • The sales manager may still need to use his intuition and judgement to adjust the forecasts based on current information
        
        • Least squares regression does not account for seasonal nature of data
        
        • Time series analysis does not consider where sales are growing or external trends
        
        limitation of relying on past data, which may not reflect sudden changes in the market
        
        • Limitations of data: no segmentation or external data, only historical data
        
        • Possible solution: use big data to get more insights and accuracy
        
        • Definition:
        
        a form of regression analysis where one variable represents time.
        
        alternative methods for capturing non-linear relationships in time series data
        
        Seasonal adjustment
        
        method for removing the effects of seasonal variation (e.g. weather, holidays, promotions, etc. ) from time series data.
        
        involves estimating and removing the seasonal component of the data, leaving behind the underlying trend and any remaining irregular or random fluctuations.
        
        • Step 1: Calculate moving average: taking the average of the sales data over a window of time that spans a full season
        uses a moving average to define a trend and a seasonal variation for the sales data
        The trend line is calculated from the average of two consecutive quarters and aligned with the actual sales value
        
        • Step 2: Seasonal index for time t = Average (Actual for time t/Avg for time span n + Actual for time t/Avg for time span n +...)
        
        • Step 3: Seasonally adjusted: Actual data / Seasonal index
        
        Exponential smoothing
        
        a method for forecasting time series data that involves calculating a weighted average of past observations, with more recent observations weighted more heavily than older observations
        
        capture non-linear relationships in the data by giving more weight to recent observations, which are more likely to reflect current trends and patterns
        
        patterns and variations in a series of data over time and projecting them into the future
        
        • Forecasting future values is done by extrapolating the trend line and adding or subtracting the seasonal variation
        • There is no agreed way of extrapolating the trend, but a scatter graph or a least square regression can be used
        
        Measures used to evaluate the fit of a regression line to a set of data.
        
        • Coefficient of correlation (r)
        
        • Definition: a measure of the strength of the linear relationship between two variables
        
        • Interpretation:
        
        Range from +1 (strong positive relationship): for every positive increase in one variable, there is a positive increase of a fixed proportion in the other. Eg. shoe sizes go up in (almost) perfect correlation with foot length. • Strong positive correlation between store numbers and revenue (r = 0.94, r2 = 0.88)
        
        Through 0 (no relationship):
        
        To -1 (strong negative relationship/perfect negative correlation): for every positive increase in one variable, there is a negative decrease of a fixed proportion in the other. Eg. the amount of gas in a tank decreases in (almost) perfect correlation with speed.
        
        The absolute value of the correlation coefficient gives us the relationship strength. The larger the number, the stronger the relationship.
        
        • The correlation between the variables does not imply causation or meaning and may be due to a third variable or chance.
        
        • The sample size in Figure 1 is small and may not be representative of the population, so a significance test would have to be done to verify the results.
        
        • The correlation coefficient (r) measures the strength of the linear relationship between x and y, which is weak in this case (0.253)
        
        • Correlation coefficient r and coefficient of determination r2 are low, indicating weak linear relationship
        
        • Coefficient of determination (r^2)
        
        • Definition:
        
        a measure of the proportion of the variation in one (dependent) variable that is explained by the other (independent) variable
        
        The value of 1-r^2 is the fraction or % of variability in the Y-variable that is not explained in a straight line model with predictor X.
        
        You should always complete 2 points when interpret the strength of the linear relationship. (see below)
        
        84.2% of the variation in y (eg. the auction selling price, lung cancer mortality) is explained by the variation in x/ the straight line model with the predictor X (eg. the odometer readings, per capita smoking rates).
        
        The remaining 15.8% is unexplained, i.e. due to error.
        
        also known as R-squared or r2. / the square of the correlation coefficient
        
        • Interpretation:
        
        not have a critical value that enables us to draw conclusions.
        
        always lies between 0 and 1.a number between 0 and 1 that measures how well a statistical model predicts an outcome.
        
        Describe the utility of the regression equation for making predictions.
        
        Value near 0: the regression equation is not very useful for making predictions, there is no linear relationship between x and y.
        
        Value near 1: extremely useful, perfect match between the line and the data points. (close to 1: strong prediction relationship between the variables)
        
        the higher the value of R2, the better the model fits the data.
        
        Example: if we use linear regression to predict height based on pinky finger length, the coefficient of determination is the proportion of the variability in height that is explained by the linear relationship with pinky finger length. A higher coefficient of determination means a better fit of the model to the data.
        
        • The coefficient of determination (r2) measures the proportion of variation in y explained by x, which is low in this case (6.4%)
        
        the coefficient of determination suggests that 88% of the variation in sales (y) is due to the variation in store numbers (x) • Store numbers are the main driver for growth, as suggested by time series analysis
        
        • Benefits:
        
        Establish relationship between two variables.
        
        • It is a measure of goodness of fit and the proportion of variance in the dependent variable that is explained by the model
        
        • It can be used for different types of regression, not only simple linear regression.
        
        • Drawbacks:
        
        Relationship can be coincidence or caused by other variables, instead of this one variable.
        
        Depend on sufficient, reliable data
        
        Assume past is reliable guide to future/ future will repeat the past patterns, potentially incorrect. => all regression models have this issue.
        
        • It does not indicate causality or correlation between the variables
        
        • It does not account for the number, significance, or relevance of the independent variables in the model
        
        • It may be misleading or inflated when there are too many independent variables or when they are highly correlated with each other
        
        • Formula: calculated by dividing the sum of squares explained by the model by the total sum of squares.
        
        • The low coefficients of correlation and determination may be due to the data being scattered or non-linear, or affected by seasonal variations
        
        scatter/non-linear : if the data points are scattered in a random pattern, the correlation coefficient may be low even if there is a strong non-linear relationship between the variables.
        
        Seasonal variations: the regular patterns of change in a variable that occur over specific periods of time. sales of ice cream may be higher in the summer months than in the winter months.
        If the relationship between the variables is influenced by seasonal variations, the correlation coefficient may be low because the relationship is not consistent throughout the year.
  - - - part of 'plan and control performance' skill
      - • Budget:
        
        • Successful budgeting:
        
        • Seven common features of successful budgeting:
        
        • Provokes action: Budgets are used to identify and solve problems, and to improve performance and efficiency
        
        • Timely reporting: Budgets are compared with actual results and any significant differences are reported promptly
        
        • Short reporting periods: Budgets are reviewed frequently and regularly to identify and correct any deviations or problems
        
        • Targeted reporting: Managers receive relevant and specific reports that focus on their areas of responsibility and interest
        
        • Challenging but achievable targets: Budgets are set to motivate and stretch managers, but not to discourage or frustrate them
        
        • Accountability: Managers are clearly assigned to specific business areas and are responsible for their performance and results
        
        • Serious attitude: Senior management show commitment and support to the budgetary control system and use it as a basis for decision making
        
        • How to design and implement a budgetary control system that works effectively and efficiently
        
        • Four main limitations of budgets:
        
        • Dysfunctional behaviour: Budgets may lead managers to make decisions that are beneficial for their own budget but harmful for the organisation as a whole
        
        • Short-termism: Budgets may focus on the immediate results rather than the long-term causes or consequences of performance
        
        • Slack: Budgets may induce managers to overestimate costs or underestimate revenues to make the budget easier to meet and create a buffer
        
        • Demotivation: Budgets may discourage managers and staff if they are unrealistic or unachievable and create pressure or stress
        
        • Forecasting in budgets:
        
        • One possible way to account for seasonality in sales:
        
        • Time series analysis: Budgets are based on a method that separates the sales data into four components: trend, seasonality, cyclical and irregular, and adjusts the forecasts accordingly
        
        • Three possible methods for forecasting sales:
        
        • High-low method: Budgets are based on the highest and lowest sales values in a given period, assuming that the sales change will be constant and proportional
        
        • Linear regression: Budgets are based on a mathematical formula that predicts future sales based on past sales, assuming that the sales pattern will continue in a linear fashion
        
        • Market forecasts: Budgets are based on expected market growth and trends, assuming that the organisation will maintain or increase its market share
        
        • How to estimate the principal budget factor, such as future sales, based on various methods and assumptions
        
        The principal budget factor
        
        is the factor that limits the activity for the budget period.
        
        usually the level of sales demand, but it can also be a shortage of materials, labor, or plant capacity.
        
        determines which budget should be set first and influences the other functional budgets.
        
        It is important to identify and overcome the principal budget factor to achieve maximum profitability
        
        example:
        
        principal budget factor is sales demand, which may limit the production and revenue of an organisation.
        • if the sales department can only sell 50,000 units, there is no point in producing 100,000 units. Therefore, the sales budget should be set first and then the production and purchase budgets should follow
        
        plant capacity, which may limit the output and efficiency of an organisation.
        • if the production department can only produce 50,000 units, there is no use in setting a sales target of 100,000 units. Therefore, the plant capacity budget should be set first and then the sales and other functional budgets should follow
        
        raw material, which may limit the availability and quality of an organisation's products or services. For example,
        • if the supply of raw material is restricted by quota or license, the organisation may not be able to meet the demand or standards of its customers. Therefore, the raw material budget should be set first and then the production and sales budgets should follow
        
        To overcome the principal budget factor
        
        you need to identify, the factor that restricts your performance or activities, and then take decisions to minimise its impact or eliminate it.
        
        For example, if your principal budget factor is sales demand, you may need to increase your marketing efforts, improve your product quality, or adjust your prices to boost your sales
        
        If your principal budget factor is plant capacity, you may need to invest in more machines, subcontract some work, or cut back on your sales target to match your production capacity
        
        If your principal budget factor is raw material, you may need to find alternative suppliers, negotiate better terms, or change your product design to reduce your material usage
        
        • Reasons why budgets may not be useful for control purposes:
        
        • The behavioural aspects of budgeting affect the motivation and performance of managers and staff
        
        • Behavioural aspects of budgets:
        
        • Three key factors to consider:
        
        • Staff involvement: Budgets should involve staff input and feedback, but also avoid slack and bias
        
        • Links to objectives: Budgets should align with the organisation's goals and strategies, and not conflict with other interests
        
        • Level of difficulty: Budgets should be realistic and challenging, but not too easy or too hard
        
        • How budgets can influence motivation and performance of staff and managers
        
        • Solution: involve managers and staff in the budgeting process, provide feedback and rewards, ensure transparency and accountability
        
        • Consequence: the budget loses credibility and relevance, managers and staff become demotivated or dishonest
        
        • Example: unrealistic or imposed budgets, lack of participation or feedback, gaming or manipulation of data
        
        • The organisation's environment has changed but the budget has not been adapted
        
        • Solution: change the budget to reflect the change in the environment
        
        • Consequence: the organisation looks out of control and wastes resources on unnecessary actions and investigations
        
        • Example: a change in legislation affects the sales forecast
        
        • Requirements for meaningful budgetary control: budgets must be accurate, reliable and up to date
        
        • Meaningful budgetary control: budget setting and monitoring of performance against budgets
        
        different from forecasts, which are predictions of future outcomes. Budgets are plans to use or achieve those outcomes.
        
        used to review and control strategic plans, identify and investigate variances, and highlight when a plan or process is out of control
        
        part of 'strategy in action', linking short-term plans and targets to long-term objectives
        
        fits into strategic planning process as follows:
        
        need to be controlled to ensure plans are followed and adjusted if needed
        
        represent short-term plans and targets to fulfil objectives
        
        • Strategic plans show how to pursue objectives
        
        • Strategic objectives illustrate how to achieve mission
        
        • Mission sets overall direction
        
        has benefits (e.g. setting targets, allocating resources) and problems (e.g. demotivation, short-termism)
        • Five main benefits of budgets:
        
        • Authorisation: Budgets allow managers to spend up to a certain limit that is approved by senior management and allocate resources accordingly
        
        • Control: Budgets enable managers to measure and compare actual performance with planned performance and identify any deviations or variances
        
        • Motivation: Budgets provide managers and staff with clear and specific targets that relate to the organisational objectives and inspire them to achieve them
        
        • Co-ordination: Budgets link the activities of different departments and sections of the organisation and ensure they are aligned and consistent
        
        • Forward thinking: Budgets encourage managers to plan ahead and anticipate potential problems and solutions
        
        a short-term business plan in financial terms, based on strategic plans
    - - • Encourage forward thinking and planning
      - • Improve departmental coordination and communication
      - • Enhance performance measurement and evaluation
      - • Establish control system and authorization
      - • Examples of financial changes and uncertainty: high inflation, volatile exchange rates, etc.
    - - • Demotivate staff if unachievable or unrealistic
      - • Encourage managers to create slack or manipulate data
      - • Focus on short-term results not underlying issues
    - - • Rolling budgets: budgets that are continuously updated by adding a new period when the previous one expires
        
        • Strategic role of rolling budgets: useful for budgeting in conditions of rapid financial change and uncertainty
        
        • Rolling budgets in practice: how a real company uses rolling budgets to improve financial forecasting
        
        • Solution with rolling budgeting: create an 18-month budget and update projections every month, based on actual sales figures
        
        • Benefits of rolling budgeting: more timely and relevant forecasts, more motivation and accountability for account directors
        • No more free rides: how rolling budgets can motivate managers and reflect current business outlook
        
        • Advantages of rolling budgets over static budgets:
        
        • Encourage managers to react quickly to changing conditions
        
        • Focus on realistic future plans rather than past performance
        
        • Produce forecasts that are never outdated or irrelevant
        
        • Implementation of rolling budgets: no fundamental change required, but opportunity to improve the process in other ways
      - • Problem with traditional budgeting: account directors would meet annual targets early and then relax
      - • Incremental budgeting:
        
        traditional approach to budgeting based on previous year's budget
        
        • Steps of incremental budgeting:
        
        • Add a percentage to previous year's budget to allow for inflation and other cost increases
        
        • Make other adjustments for specific items such as extra worker or machine
        
        • Check if the budget meets the performance targets of the organisation, such as cost to sales ratio
        
        • Advantages of incremental budgeting: simple, easy, consistent
        
        • Disadvantages of incremental budgeting: not useful in dynamic or uncertain environments, ignores potential improvements or changes in strategy
        
        • Incremental budgeting: based on previous year's budget, adjusted for inflation and other changes
        
        • Incremental budgeting: starts with last year's budget or results, adds a percentage for inflation or changes, simple, quick, cheap, but does not question the activities or their value
      - • Zero-based budgeting:
        
        radical alternative to incremental budgeting, based on budgeting from scratch
        
        • Steps of zero-based budgeting:
        
        • Look at every activity and its costs and purpose
        
        • Consider alternative ways of doing the activity
        
        • Eliminate non-essential activities and costs from next year's budget
        
        • Adoption of zero-based budgeting: more common in public sector than private, rare to apply to whole organisation, resource-intensive and costly
        
        • Benefits of zero-based budgeting: more outward looking, considers environmental changes, rejects past budgets as baseline
        
        • Drawbacks of zero-based budgeting: complex, time-consuming, expensive, may face resistance from managers
        
        • Zero based budgeting: based on budgeting from scratch, evaluating every activity and its costs and purpose, eliminating non-essential activities and costs
        
        how Z could operate a zero based budgeting system for its research projects
        
        • Identify all the research projects and their objectives, benefits, and costs
        
        • Rank the projects according to their priority and alignment with the company's strategy
        
        • Allocate resources to the projects based on their rank and available budget
        
        • Review and monitor the projects regularly and adjust the budget as needed
        
        • Zero based budgeting: starts from scratch, sets out objectives and activities, looks at different ways and levels of achieving them, estimates costs and benefits, ranks activities by priority and value, allocates resources accordingly, promotes a questioning attitude and efficiency
        
        How Z could operate a zero based budgeting system for its research projects
        
        • Managers/researchers decide which projects they want to undertake, including continued and new projects
        
        • For each project, ignore sunk costs and only look at future costs and benefits
        
        • Consider different ways of achieving the same research goals and compare their costs and benefits
        
        • Only approve projects if the benefits exceed the costs
        
        • If funds are limited, allocate them to the best projects based on cost-benefit analysis
        
        • Be aware of the subjective nature of ZBB and the uncertainty of the benefits, especially for research projects
      - • Activity-based budgeting: based on budgeting for activities using costs determined by activity-based costing
        
        • Advantages of activity-based budgeting:
        
        useful when overheads are significant, more accurate and realistic
        
        • Activity based costing could help to improve the accuracy and relevance of overhead costs
        
        • Identifying the cost drivers and activities that cause overheads
        
        • Allocating overheads based on the actual consumption of activities by products
        
        • Providing more accurate product costs and profitability analysis
        
        • Disadvantages of activity-based budgeting:
        
        relies on activity-based costing, which may not be used by all organisations, may be difficult to identify activities and drivers
        
        • Having no impact on material and labour costs, which need separate analysis
        
        • Being complex and costly to implement and maintain
        
        • Requiring reliable and timely data collection and processing
        
        • ABB: based on budgeting for activities using costs determined by activity-based costing
        • ABB: identifies the activities that drive the costs and revenues of the business, and allocates resources accordingly
        
        how activity-based budgeting would be implemented by the operating divisions of Z
        
        • Identify the activities that are performed by each operating division and their cost drivers
        
        • Determine the cost of each activity and its contribution to the revenue of each product or service
        
        • Prepare budgets for each activity based on the expected level of output and demand
        
        • Evaluate the profitability and efficiency of each activity and product or service
        
        Activity based budgeting: budgeting based on different levels of activity and cost drivers, rather than one measure of activity
        
        • Cost driver: the factor that causes the cost of an activity
        
        • Activity based budget: the number of units of the cost driver multiplied by the cost per unit of the cost driver
        
        How activity based budgeting would be implemented by Z:
        
        • Hire an outside specialist or use internal managers to investigate the business and determine the activities and cost drivers
        
        • Discuss with staff and understand the true cost and value of each activity
        
        • Identify and eliminate non-value-added activities
        
        • Estimate the expected incidence of cost drivers and multiply by the budgeted cost driver rate to get the budget
        
        • Break down overheads into many activities rather than expenses
        
        • Perceive most overheads as variable rather than fixed
      - • How introducing a formal budgeting process would address the issues at ATD:
        
        • How budgets can help ATD to plan, control and improve its business performance and overcome its current problems
        • How a formal budgeting process would address these issues:
        
        • Inaccurate forecasting: Using reliable data and realistic assumptions and targets for sales and other budgets
        
        A formal budgeting process would require ATD to collect and analyse reliable data on its market, customers, competitors, costs and revenues, and to base its sales and other budgets on realistic and achievable assumptions and targets
        
        • Low morale: Involving staff and managers in budgeting and giving them clear objectives, roles, feedback and rewards
        
        A formal budgeting process would involve ATD's staff and managers in setting and agreeing on the budgets, and provide them with clear objectives, roles and responsibilities, as well as regular feedback and rewards for their performance
        
        • Indiscriminate cost cutting: Identifying and monitoring key costs and revenues, and making informed decisions on how to reduce costs without compromising quality, service and innovation, and how to increase revenues by improving sales, pricing and marketing
        
        A formal budgeting process would enable ATD to identify and monitor its key costs and revenues, and to make informed decisions on how to reduce costs without compromising quality, customer service and innovation, as well as how to increase revenues by improving sales, pricing and marketing strategies
        
        • Three main issues at ATD:
        
        • Inaccurate forecasting: ATD has been overestimating its sales and underestimating its costs, leading to poor financial results and cash flow problems
        
        • Low morale: ATD's staff and managers are demotivated and dissatisfied with the lack of direction, feedback and recognition from the senior management
        
        • Indiscriminate cost cutting: ATD has been reducing its costs without considering the impact on quality, customer service and innovation, resulting in lower sales and customer loyalty
        
        • How a formal budgeting process would address these issues:
        
        • Inaccurate forecasting: Overestimating sales and underestimating costs
        
        A formal budgeting process would require ATD to collect and analyse reliable data on its market, customers, competitors, costs and revenues, and to base its sales and other budgets on realistic and achievable assumptions and targets
        
        • Low morale: Demotivated and dissatisfied staff and managers
        
        A formal budgeting process would involve ATD's staff and managers in setting and agreeing on the budgets, and provide them with clear objectives, roles and responsibilities, as well as regular feedback and rewards for their performance
        
        • Indiscriminate cost cutting: Reducing costs without considering quality, service and innovation
        
        A formal budgeting process would enable ATD to identify and monitor its key costs and revenues, and to make informed decisions on how to reduce costs without compromising quality, customer service and innovation, as well as how to increase revenues by improving sales, pricing and marketing strategies
        
        • How budgets can improve forecasting and performance evaluation at ATD:
        
        • How budgets can help ATD to set realistic and achievable targets for sales and other functions, and to assign clear accountability and responsibility to managers
        
        • How flexed budgets can help ATD to compare actual performance with budgeted performance at different levels of sales activity, and to identify and analyse any variances or differences
        
        • How flexed budgets and variances can provide ATD with valuable insights into how different functions or departments (and their managers) are performing, and how they can improve their performance
        
        Variance reporting:
        
        • Flex budget to reflect actual activity level
        
        • Separate variable and fixed cost elements
        
        More balanced measures:
        
        • Customer satisfaction surveys
        
        • Measures for sustainability e.g. reduced food waste, energy usage
        
        Definition of flexed budget:
        
        A flexed budget is a budget that shows the revenues, costs, and profits that should have been expected from the actual level of production and sales
        • Flexed budgets: budgets that are adjusted to reflect the actual level of activity
        
        • Purpose: to make a fair and realistic comparison between actual and budgeted performance by eliminating the effect of changes in activity level
        
        • Steps: identify the fixed and variable elements of costs and revenues, calculate the budgeted fixed costs and variable costs per unit, multiply the variable costs per unit by the actual output level, add the fixed costs and variable costs to get the flexed budget
        
        . It is used to compare with actual results for a period to make variances more meaningful
        
        A flexed budget adjusts to the changes in the activity or revenue level of a company, accounting for variable costs and step costs
        
        A flexed budget is more realistic and useful than a fixed budget, as it responds to the actual performance and conditions of the company
        
        Eg
        
        An example of a flexed budget would be a business whose rent is always the same (a fixed cost) but whose inventory costs fluctuate (a varying cost) based on sales. The business could use a flexed budget to help plan its finances and adjust its costs according to its sales level. For instance, if the business budgeted for $5 million in revenue and $1 million in COGS, but actually achieved $4 million in revenue and $900,000 in COGS, it could use a flexed budget to compare its actual performance with its budgeted performance at the same level of revenue
        
        • Example: materials budget flexed from $160,000 to $240,000 due to increase in production and sales from 20,000 to 30,000 units
        
        • Fixed costs: none
        
        • Variable costs: $8 per unit for materials
        
        • Flexed budget: $8 x 30,000 + $0 = $240,000
        
        • Result: favourable total materials variance of $20,000 ($240,000 - $220,000)
        
        • The flexed budget and variances show that all variances are adverse
        • All variances adverse against flexed budget
    - - • How to ensure that budgets are used as a tool for planning, monitoring and improving performance
      - • Eight common characteristics of effective budgetary control:
        
        • Serious attitude: Budgets are taken seriously and followed by all levels of management
        
        • Clear demarcation: Budgets are assigned to specific managers who are accountable for their areas of responsibility
        
        • Challenging yet achievable targets: Budgets are set to motivate and stretch managers, but not to discourage or frustrate them
        
        • Established techniques: Budgets are based on reliable data collection, analysis and reporting methods
        
        • Targeted reports: Budgets are reported to individual managers who can act on the information
        
        • Short reporting periods: Budgets are reviewed frequently and regularly to identify and correct any deviations
        
        • Timely variance reports: Budgets are compared with actual results and any significant differences are reported promptly
        
        • Corrective action: Budgets are used to identify and solve problems, and to get operations back on track if they go out of control