Theme 3.3 Decision Making Techniques.

Theme 3.3 Decision Making Techniques.

1. Moving Averages - a technique for identifying an underlying trend by smoothing out fluctuations in data.

   • The moving trend line gives a clear idea of the trend by reducing the impact of these. This trend can be extrapolated forward to predict future sales.
   • Add moth, one before and after, then divide it by three.

2. Extrapolation - a prediction of a future trend based on an identified current trend. Normally shown by a dotted line.

   • Pros - Using actual data to estimate predictions, can help set financial targets, spot seasonal products.
   • Cons - Could be influenced by external factors, trends are often temporary, doesn't take into account competitor actions, only a predicton.

3. Correlation - an apparent statistical relationship between two factors or variables.

   • Positive - a direct relationship between two variables - e.g. advertising should lead to an increase in sales revenue.
   • Negative - an inverse relationship between two variables e.g. higher prices often result in lower sales.
   • No Correlation - no discernible link e.g. price of fish vs sales of cinema tickets.

4. Benefits of Quantitative Sales forecasting - can be good with targets, easy to implement and analyse, help a business deal with seasonal change, help a business decide if there are opportunities.

5. Limitations of Quantitative Sales Forecasting - doesn't always look at what competitors are doing, still risk and uncertainty, external factors can have an effect, cost, reliability of data.

6. Investment Appraisal - Payback Period - the length of time that it takes for a capital investment to pay for itslef from the Net cash flow provided by that investment.

   • Calculated by adding the Net Cash Flow from the investment until the cumulative total equals the initial cost of the investment.
     • Advantages - easy to calculate, easy to understand, relevant to businesses with cash flow problems, emphases speed of return.
     • Disadvantages - ignores money received after payback, difficult to establish target payback period, doesn't consider the future value of money, short term approach, doesn't take qualitative factors into approach.
   • Average Rate of Return - this calsulates the ARR made by the investment, by taking the total net profit and dividing it by the number of years.
     • Average Profit - Total Net Profit divided by useful life of the asset.
     • Advantages - Simple to understand and easy to calculate, focuses on overall profitability of an investment, uses all the returns generated by a project.
       • Disadvantages - ignores the timings of returns, focuses on profits rather than cash flows, does not adjust for the time-value of money.
   • Net Present Value - calculates the monetary value ow of the projects future cash flows. Considers the costs and benefits of an investment.
     • Cash Flow x Discount Factor = Present Value
     • Advantages - considers all future cash flows, different levels of risk can be accounted for by adjusting the discount rate, creates a straightforward decisons.
       • Disadvantages - The Most complicated method, choosing the discount rate is hard, results can be influenced/manipulated using the discount rate.

7. Critical Path Analysis - sets out all the individual activities that make up a larger project and the order in which they have to be taken place.

   • Node - circles representing a point in time. Top Right - EST - earliest an activity can begin, works from left to right. Formula - EST of previous + duration of previous activity. Bottom Right - LFT latest an activity can begin, works from right to left. LFT of previous activity - duration of previous activities.
   • Advantages - Managers must consider all of the activities involved, projects can be completed in the earliest time, critical activities can be identified, working capital control, can be used as a control mechanism to control a project.
     • Disadvantages - Relies on estimates of task durations. the quickest way of completing a task isn't always the best way, projects need to be well manage, very complex for big companies, may be too rigid and lack flexibility.

8. Decision Trees - a mathematical model that helps managers make decisions. They use estimates and probabilities to calculate likely outcomes.

   • Probabilities - the chance of an outcome happening. Ranges between 1 and 0. The total probability must add up to 1.
   • Expected Value - The financial value of an outcome calculated by multiplying the estimated financial effect by its probability.
   • Net Gain - The value to be gained from taking a decision. Calculated by adding together the expected vale and deducting the costs associated with the decision.
   • Advantages - choices are set out in a logical way, use of probabilities enables the 'risk' of the options to be addressed, likely costs are considered as well as benefits.
     • Disadvantages - probabilities are just estimates - always prone to error, uses quantitative data only, decision-making technique doesn't necessarily reduce the amount of risk.