Budgeting and Planning

• The correlation coefficient

(r) measures the degree of correlation between the dependent and independent variable.

seasonal ratio

=(B4/C4)&":"&(B4/B4) =(put letter number column/put letter number letter column)&":"(put the first letter number column twice. drag formula down to figure out the answer.

net cash flow

A measure of a company's financial health. Equals cash receipts minus cash payments over a given period of time; or equivalently, net profit plus amounts charged off for depreciation, depletion, and amortization. also called cash flow.

quantitative forecasting

A statistical technique for making projections about the future which uses numerical facts and prior experience to predict upcoming events. The two main types of quantitative forecasting used by business analysts are the explanatory method that attempts to correlate two or more variables and the time series method that uses past trends to make forecasts.

irr Internal Rate Of Return - IRR'

BREAKING DOWN 'Internal Rate Of Return - IRR' You can think of IRR as the rate of growth a project is expected to generate. While the actual rate of return that a given project ends up generating will often differ from its estimated IRR rate, a project with a substantially higher IRR value than other available options would still provide a much better chance of strong growth. One popular use of IRR is in comparing the profitability of establishing new operations with that of expanding old ones. For example, an energy company may use IRR in deciding whether to open a new power plant or to renovate and expand a previously existing one. While both projects are likely to add value to the company, it is likely that one will be the more logical decision as prescribed by IRR. In theory, any project with an IRR greater than its cost of capital is a profitable one, and thus it is in a company's interest to undertake such projects. In planning investment projects, firms will often establish a required rate of return (RRR) to determine the minimum acceptable return percentage that the investment in question must earn in order to be worthwhile. Any project with an IRR that exceeds the RRR will likely be deemed a profitable one, although companies will not necessarily pursue a project on this basis alone. Rather, they will likely pursue projects with the highest difference between IRR and RRR, as chances are these will be the most profitable. IRRs can also be compared against prevailing rates of return in the securities market. If a firm can't find any projects with IRRs greater than the returns that can be generated in the financial markets, it may simply choose to invest its retained earnings into the market. Although IRR is an appealing metric to many, it should always be used in conjunction with NPV for a clearer picture of the value represented by a potential project a firm may undertake.

creating a forecast and budget for a new business

Budgets describe what the future is most likely to look like (based upon our plans); forecasts describe what the budget is most likely to look like.

Capital Budgeting

Capital budgeting decisions are important because they can have a significant impact on a company's profitability. These decisions are typically classified as either screening decisions or preference decisions. Screening decisions involve those proposed projects that satisfy a certain standard. For example, a company may only accept a revenue-generating project, such as the introduction of a new product line, if it provides a return of at least 15%. Preference decisions involve choosing between competing projects. An example of a preference decision is the selection of a delivery truck; the company may choose between several different makes and models, but only one truck is selected. A company should select projects that support its long-term goals. Because resources such as time and money are often limited, the company will typically have to choose between various projects. There are several methods companies can use to evaluate proposed capital projects. As we discuss some of the more common methods, we will see how they can be used to select between the following two projects: Project A requires an initial investment of $100,000, with anticipated annual cash inflows of $15,000. At the end of the project's 15-year useful life, the company can salvage the project for $25,000. Project B requires an initial investment of $40,000, with an estimated useful life of five years and no salvage value. The anticipated average cash inflow is $11,600, with the following annual cash inflows expected for each year: Year Annual Cash Inflow 1 $7,000 2 $10,000 3 $12,000 4 $13,000 5 $16,000

Profitability index

Capital rationing: profitability index The NPV rule indicates whether a project is worth investing in or not. Unfortunately it does not give you any indication of how to rank projects. A simple ranking mechanism is to divide the NPV for a project by its initial investment. This gives you the profitability index. Assuming that the project investment is limited by the amount of funds available to invest in projects today, then the ranking based on the profitability index will give you an indication of which projects you should invest in first, to give you the best NPV from your limited funds. Cash budgeting for capital projects is about rationing. Once we have decided which projects are worth investing in we then have to establish what we can afford and when, perhaps by producing a cashflow forecast that may run over several years. Some utilities we work with plan capital projects over decades.

calculate the seasonal ratio

First, we calculate the seasonal ratio by dividing the actual sales by the regression forecast for the same time period. We do this for each time period for which we have actual sales data. For future time periods in which actual data is not available, we must calculate the average seasonal ratio based on the calculated seasonal ratios for the same time periods in previous years. Finally, we calculate the seasonal forecast of sales by multiplying the seasonal ratio by the regression forecast for the corresponding time period.

adding dependent and independent variable

For example, if advertising expense of $20 is expended in the next year, the projected sales are $21.8476 [10.5836 (independent sales - Y) + .5632 (dependent X ((20)]. muliple 20 x .5632.. then add the total to 10.5836. should total 21.8476

Forecasting Cash Flow

Forecasting cash collections and potential uncollectible accounts is an essential part of creating the cash budget. Managers can use past experience and data to estimate percentages for cash collection and bad debt. These percentages are then applied to sales or accounts receivable to determine the cash receipts for a period. For example, past experience for Murphy Company indicates the following collections pattern: 10% of credit sales are collected in the same month. 70% of sales are collected in the following month. 15% of sales are collected in the second following month. 5% of sales are uncollectible. Projected sales data for the first four months is detailed in the table below. Month Cash Sales Credit Sales Total Sales January $8,000 $50,000 $58,000 February $10,000 $55,000 $65,000 March $9,000 $58,000 $67,000 April $10,000 $56,000 $66,000 Based on the estimated collection percentages, total expected cash receipts for April are $64,450: Cash receipts Cash sale $10,000 Cash collections April sales (10%) $5,600 March sales (70%) $40,600 February sales (15%) $8,250 Total cash receipts $64,450 Almost all businesses have some seasonality. This means that payments are received in a sporadic fashion, but payments are made on a regular basis. The extreme example is the toy industry, where up to 80% of total annual sales occur in the last quarter of the year, October through December. However, payments for rent, insurance, utilities, and payroll must be made every month. Therefore, we develop a cash budget that provides a monthly forecast of cash receipts, payments, borrowing, and repayment. The cash budget is a tool for cash planning and control. It tells managers how much cash is needed to run the business, and it helps avoid idle cash and possible cash shortages. From the example above, you can see that the basis for estimating cash receipts is sales. An incorrect sales estimate could result in flawed cash estimates that could be detrimental to the company's cash position. The use of computer software and spreadsheets can aid in the budgeting process. Users can easily perform what-if analysis to identify how changes in business activity affect the bottom line. Because an accurate sales estimate is vital to the preparation of several budgets, let's use it as an example. Managers may want to see what happens to the profits, cash flows, and so forth if sales are less than the forecasted amount. The use of such programs also allows for an easy comparison of budgeted and actual data so that problems can be identified and corrective actions can be taken as necessary.

Capital Expenditures

In Week 1, we discussed the strategic plan, which is an organization's long-term plan for the company as a whole. In order to achieve this plan, the company will likely incur capital expenditures to create some kind of future benefit. This future benefit might be an increase in revenues that results from the marketing of a new product, the improvement of quality in existing products and services, or the expansion of production. The future benefit might also be a decrease in costs resulting from the purchase of new equipment that reduces maintenance and operating expenses. For budgeting purposes, capital expenditures can be classified as normal or special. A normal expenditure is a routine expenditure that is made to maintain current operations, and therefore does not typically require a large cash outflow. The replacement of minor equipment such as a computer would be classified as a normal expenditure. A special expenditure is made for an unusual, specific purchase that requires a large cash outlay. An example of a special expenditure is the purchase of new production equipment for a special job. When developing the capital expenditure budget, management typically follows four steps. The first step is to approve the projects. Management will receive project proposals from operating managers; they should set a priority ranking in terms of necessity and approve projects accordingly. Once the project is approved, the estimate must also be approved, with special approval required by top management if the capital expenditure exceeds authorized limits. The next step is to authorize the project. Any current projects that are not meeting expectations may be canceled. The final step is to follow up on projects that have been undertaken. Throughout the life of the project, authorized amounts should be compared to actual costs incurred. The manager should also review a progress report to determine if the project is on track, if corrective action is necessary, and to evaluate cost underruns and overruns. At the end of the project, the manager should compare the actual and expected profit, evaluating and justifying any significant differences. The benefits from capital expenditures are often uncertain because of the extended time period involved and the significant cash outflow required. Therefore, a significant loss is likely if the capital expenditure should fail. For example, a company may spend significant amounts of money to develop, produce, and market a new product. If that product is unsuccessful, the company could realize a substantial loss. For this reason, it is important that managers carefully evaluate projects at all stages of the capital budgeting process.

Accounting rate of return

In theory, any capital expenditure that delivers benefits in excess of the 'cost of capital' should be worthwhile. We can think about the cost of capital as being the required rate of return that shareholders want, combined with the cost of borrowing in what is called the weighted average cost of capital (or WACC). Even the largest organisations face problems of 'capital rationing'. This means that whatever their cost of capital is, cash may be limited, and capital expenditure plans have to be made taking into account this constraint.

Marketing Budgets

Marketing is an integral part of most business organizations. Consumers may have little or even no knowledge of the company and its products or services if it does not market them. When creating the marketing budget, the manager should consider three major marketing expenses: selling, advertising and sales promotion, and distribution expenses. Selling expenses include any expense required to make a sale, such as salesperson salaries, sales commissions, and advertising and sales promotion (because the latter is commonly a major marketing expense, it is discussed separately). These selling costs are subject to diminishing returns because at some point, the additional time and money spent to generate additional sales is not justified by the resulting increase in sales. In addition to the expense of making sales, selling expenses also include any expense of distributing the merchandise to the customer, such as order processing, handling, and delivery charges. The manager may evaluate each of these selling costs by customer, product or service, salesperson, or any other basis that will result in information that is beneficial to the creation and implementation of the marketing budget. The majority of the marketing budget is typically used for advertising. The amount of funds allocated to the advertising budget should be sufficient so that the organization can accomplish its objectives, such as achieving a desired sales level or growth rate. The budget should also include a contingency fund that allows for flexibility in the advertising budget so that funds exist for special circumstances, such as the introduction of a new product, or to counteract competition. When creating an advertising plan, the manager must determine when, where, and how to advertise. There is a variety of media available, including print, broadcast, and direct mail. The marketing manager may evaluate the effectiveness of the advertising media by calculating the cost per thousand, which measures the cost of advertising per thousand individuals reached by the media. The manager should also evaluate the advertising plan on a regular basis to ensure that the right products are being promoted, and to determine the effectiveness of the plan in general. The latter can be accomplished by reviewing sales and profits before, during, and after promotion. Distribution expenses are the expenses incurred for activities that occur after the goods are produced but before they are received by the customers. Examples include packaging, storage, transportation, and credit and collection. The manager should compare each individual distribution cost to sales. Higher ratios mean that a larger distribution cost is needed for each sales dollar, and are therefore unfavorable. Actual and budgeted distribution costs should also be compared, with significant differences being investigated so that proper action can be taken. You should note that these marketing expenses typically increase in proportion to customer orders and sales volume, not sales dollars. For example, if the number of customer orders increases, selling expenses related to order processing and handling will increase, as will distribution expenses associated with packaging and transportation. As a result, a change in the sales mix can have a significant impact on profitability.

Net present value

NPV and DCF A criticism of the payback rule is that it puts too much emphasis on quick returns. A project or investment may not pay back within the three to five-year payback period, but may still give long-term benefits which are ultimately worth more to the company. A better method of investment appraisal is often considered to be the net present value (NPV) or discounted cash flow (DCF) technique. The NPV or DCF technique recognises all cash flows but also takes into account that cash flows received earlier are worth more than cash flows received later, due to the time value of money. Example Taking the two projects from the previous payback example, we can take the cash flows and 'discount' them according to the time value of money. The discount factor is a factor to convert a cash value in the future to what it is worth today. The following table provides the discount factors and different rates of the cost of capital together with the formula to calculate the discount factor. Discount factor in year n = 1/(1 + r)n where n = year, r = cost of capital After 'discounting' both projects at 10 per cent, they both have a positive value for the NPV (the sum of the initial investment plus all of the future discounted cash flows). So this means that both are worthwhile projects. At a discount rate of 20 per cent, however, only Project A is worth doing. Discounted cash flow can also be used to calculate a discounted payback period. Discounted cash flows for Project A and Project B at 10 per cent and 20 per cent

Net Present Value - NPV

Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows. NPV is used in capital budgeting to analyze the profitability of a projected investment or project.

Net Present Value

One capital budgeting technique that does consider the time value of money is the net present value (NPV), which compares the present value of expected future cash flows to the initial investment. Cash flows can be discounted to their present values using either interest factor tables, MS Excel functions, business calculators, or financial websites. In this course, an Excel Worksheet with formulas has been provided to calculate the required factors. The file name of the Worksheet is "TVM Interest Factor Calculator" and is located under the Doc Sharing tab above. Note that the factors are based on the value of $1.00 and therefore, must be multiplied by the amount of dollars in order to calculate the total value. Projects with a positive NPV are acceptable, and those with a negative NPV are not. When choosing between projects, the higher the NPV, the better. Like the payback period, the net present value calculation depends on the equality of cash flows. If cash flows are equal (Project A), we can compute the present value of the annual cash flows, using the discount factors for the Present Value of an Annuity (PVIFA) found by entering the given interest rate and number of time periods onto the Excel worksheet provided. The salvage value only occurs once (in year 15) and therefore the factor for the Present Value of an single amount (PVIF) must be used to discount that figure instead. Assuming a 10% required rate of return, the NPV of Project A is calculated below. Note that the initial investment is considered a cash outflow and is shown as a negative number which always has a factor of 1. Project A Net Present Value Calculation Year Explanation Cash Flow 10% Discount Factor Present Value 0 Initial Investment -$100,000 1 -$100,000 1-15 Annual cash inflow $15,000 7.6061a $114,092 15 Present value of salvage value $25,000 0.2394b $5,985 Net Present Value $20,077 a PVIFA calculated on the Excel Worksheet by entering a 10% rate for 15 time periodsb PVIF calculated on the Excel Worksheet using a 10% rate for a 15 year time period. Project A is acceptable because the NPV is positive. If cash flows are unequal (Project B), we must use the discount factors for the individual cash flows (PVIF) from the Worksheet using the 10% rate and the time periods for each separately. The total represents the present value of cash flows. Using the same required rate of return, the NPV of Project B is calculated below. Because the NPV of Project B is positive, it is also acceptable. However, Project A is the more attractive investment because it has a higher NPV. Project B Net Present Value Calculation Year Cash Flows 10% Discount Factor Present Value 0 -$40,000 1 -$40,000 1 $7,000 .9091 $6,364 2 $10,000 .8264 $8,264 3 $12,000 .7513 $9,016 4 $13,000 .6830 $8,879 5 $16,000 .6209 $9,934 Net Present Value $2,457

Quantitative Forecasting Methods

Quantitative methods are used primarily for time series forecasting models. Time series models use mathematical formulas and very specific assumptions about the relationship of past sales to future sales. You don't have to memorize formulas, but it is easier to understand the assumptions if you know how to apply the formulas. The best forecasting model will be one that has a strong correlation between the model and the actual performance of your company. The primary models are (1) moving average, (2) weighted moving average, and (3) exponential smoothing. • The moving average model uses actual sales from recent time periods to predict future sales, assuming that each time period has an equal influence on the prediction of futures sales. When using the moving average model, we first have to calculate the average of actual sales for several past time periods. Then we use this average as the forecast for the next time period's sales. • The weighted moving average model also uses actual sales from recent time periods to predict future sales, but it assumes that the closest time period is a more accurate predictor of future sales than previous time periods. Using this model, we assign weights to the time periods based on our judgment, with the sum of the weights typically being equal to one. If we believe that the closest time period is a more accurate predictor of future sales, we will assign it a greater weight than previous time periods. • The exponential smoothing model uses a smoothing constant called alpha as an adjustment when determining the forecast. We assign a value to alpha based on our assumption of the relationship between sales in one period and sales in the next period. A higher value is assigned to alpha when we believe that current sales are more predictive of future sales, and a lower value is assigned to alpha when we believe that a smoothed forecast is more predictive of future sales.

Internal rate of return

RR. The rate of return that would make the present value of future cash flows plus the final market value of an investment or business opportunity equal the current market price of the investment or opportunity. The internal rate of return is an important calculation used frequently to determine if a given investment is worthwhile. An investment is generally considered worthwhile if the internal rate of return is greater than the return of an average similar investment opportunity, or if it is greater than the cost of capital of the opportunity Read more: http://www.investorwords.com/2564/Internal_Rate_of_Return.html#ixzz43Uub0HXb

Regression Statistics

Regression Statistics In our study of short-range forecasting models last week, we used the MAD and MSE to gauge the accuracy of the models and select the one that best predicts actual results. In regression analysis, we use a variety of statistics to evaluate the accuracy and reliability of the regression results. We will discuss the most common regression statistics here. • The correlation coefficient (r) measures the degree of correlation between the dependent and independent variable. • The coefficient of determination (R2) represents the proportion of the total variation in the dependent variable that is explained by the regression equation. It ranges in value from 0 to 1; the higher the R2, the more confidence we can have in our regression equation. • The standard error of the estimate (Se) measures the accuracy of our projections. For example, if we want to use the regression line to forecast sales if advertising is $20, the standard error will tell us how much confidence we can place in our projection. We can also construct confidence intervals that provide a range of values, with the confidence level determining the probability that this interval will include the true value. A confidence level of 95% means that the probability of the actual sales falling outside our confidence interval is less than 5%. • The t-statistic measures how many standard errors the coefficient is from zero. The greater the t-value, the more confidence we can have in the coefficient as a predictor. A general rule of thumb is that a t-value less than -2 or greater than +2 is acceptable.

Regression analysis

Regression analysis uses one variable (the independent variable x) to predict another (the dependent variable y). In the simplest form of regression analysis there is a linear or straight line relationship (see Figure 2.1), described by the simple formula: y = a + bx Using a series of data for x and y we can see that there is likely to be a relation between the two, and calculate the 'best fit' to estimate a (the intercept) and b (the slope). A common mistake when using regression analysis is to confuse a correlation with a cause. For example it was noted in a study that children in households with lots of books attained higher levels of academic achievement. A potentially incorrect conclusion would be that the presence of books alone causes higher levels of academic achievement when it might just be an indicator of something else that does. Ice cream sales and the incidence of drowning may be correlated, but it is unlikely that the ice cream sales cause the drowning. They may both be related to increased temperatures resulting in more ice cream sales and more people swimming. A regression analysis on a time series of sales data can be completed quite easily in Excel, using a graph or the FORECAST function.

A typical R&D division budget is divided into which of the following two sections

Research and development

Research and Development Budgets

Research and development (R&D) is an important element of any business that desires growth. In order to remain competitive, the organization will have to develop new products or make significant improvements to existing products. For example, consider technological advancements as they apply to cell phone manufacturers. In order for these companies to remain competitive, they must continually update existing products or develop new ones with the most recent features. When creating an R&D budget, the manager must determine the funding level based on a variety of factors, including project priorities, growth rate, and competition. If researchers request additional funding, the manager must decide if the request has merit or is a waste of additional time and money. The R&D budget should consider the expected return on investment (ROI). A project's estimated and actual ROIs should be compared, with any differences being investigated, and necessary corrective actions being taken. Finally, the manager should evaluate research and development activities on a regular basis to identify where funds are being used, how successful the projects are, where additional funds are needed because of available opportunities, and where less funding should be given or provided because of unsuccessful projects. A vital part of research and development is evaluating the risks associated with a particular project. There is a greater risk when creating a new product than when improving an existing product. In addition, more risk will be assumed, as the length of time between the R&D activity and the cash flows from the project increase. If the return obtained from a research project justifies the risks assumed and the costs incurred, then the R&D activity should be undertaken, if the resources are available. Since a company often has limited resources (time, money, manpower, etc.), a priority ranking should be used so the best projects get accepted.

Profitability index

Strategic fit and 'roadmaps' There is a limit to how far using numerical analysis is useful in making investment decisions. Ultimately we need to use our judgement about the types of projects that are right for us to invest in. It may be necessary to invest in a project that has a poor NPV or a poor profitability index, because the investment is fundamental to the future success of the business. There may be some projects in which it is not easy to quantify the benefit in financial terms, yet the project may still be viewed as being an essential investment. When judging projects it makes sense to review them against business plans and strategy. You should ask yourself, 'How will this project contribute to us achieving our long-term objectives?' In some organisations, management will lay out a 'roadmap' that describes the types of projects they need to invest in to achieve their long-term objectives. All projects can then be evaluated against this roadmap. The question then to be asked is, 'Does the project move us forward to where we want to be or is it, though profitable, a distraction?'

Accounting Rate of Return

The accounting rate of return (ARR) indicates the annual profitability of capital expenditures. Projects with higher rates of return are more attractive, so the project with the greatest ARR should be chosen. The formula used to calculate the accounting rate of return is: ARR = (Avg. Cash Inflows per Year - Annual Depreciation) / Initial Investment Notice that depreciation is deducted from the cash inflows in order to convert cash flow to profit. Therefore, the first step in calculating the accounting rate of return is to calculate the annual depreciation using the following formula: Depreciation = (Cost - Salvage Value) / Life in years Using these formulas, we can calculate the depreciation and accounting rate of return for each project. Because Project A has a greater accounting rate of return, it is more attractive than Project B. Accounting Rate of Return Project A Project B Depreciation ($100,000 - $25,000) / 15 = $5,000 ($40,000 - $0) / 5 = $8,000 ARR ($15,000 - $5,000) / $100,000 = .10 ($11,600 - $8,000) / $40,000 = .09 ARR 10% 9% While there are some advantages of the accounting rate of return (it is relatively easy to calculate and it considers the profitability of potential projects), it should not be the only method used to evaluate these projects. The ARR should be used in conjunction with other capital budgeting techniques because it excludes the time value of money: $100 today is worth more than $100 in the future because of inflation and the ability to invest the money. This factor can play an important role in evaluating potential projects, particularly those with extended lives. In addition, the ARR is based on income data, rather than the cash flow data that most capital budgeting methods use.

Accounting Rate of Return - ARR

The accounting rate of return (ARR) is the amount of profit, or return, that an individual can expect based on an investment made. Accounting rate of return divides the average profit by the initial investment in order to get the ratio or return that can be expected. This allows an investor or business owner to easily compare the profit potential for projects, products and investments.

Which of the following statements regarding capital expenditures is incorrect

The benefits from capital expenditures can be planned with certainty.

participative budgeting

The budgeting method that seeks input from all levels in a company

Budget Process

The first step in creating a budget is to identify the overall company goals, which can then be developed into long-term and short-term budgets. After a realistic sales forecast has been created, the company develops production and cost budgets. The end result of the budget process is a budgeted income statement for the company, an estimated cash budget that allows management to plan for borrowing during the budget period, and a budgeted balance sheet. will also coordinate the compilation of the departmental budgets into the overall company budget. An organization may use participative budgeting by seeking input from all levels of a company.

Operating Budgets

The first step in creating a master budget is the sales budget. It estimates total sales dollars for the year by multiplying the anticipated unit sales by the unit sales price. The expected unit sales are the result of the sales forecast, which we studied in Weeks 1 and 2. Because many companies make sales on account (cash is not collected at the time of the sale but at some later point), the sales budget may also include expected cash collections from credit sales, which will be useful when preparing the cash budget. All of the remaining budgets flow from this sales budget. Therefore, it is important that management provide the most accurate forecast of sales possible. An inaccurate sales budget can have a negative effect on net income. For example, a company that underestimates sales may lose sales due to a lack of inventory. On the other hand, a company that overestimates sales may have excess inventory on hand that it cannot sell. Once the sales budget is complete, the production budget can be prepared. This budget shows how many units must be produced in order to meet expected sales. In addition to the sales budget, it should also consider the plant capacity and the finished goods inventory requirements when determining the number of units to be produced. Similar to the sales forecast, it is important that management provide a realistic estimate of ending inventory when preparing the production budget. Low inventory levels may result in a loss of sales or employee overtime, while excess inventory may result in additional storage costs. Finished goods inventory levels (dollar value or quantity) can be calculated by the formula: Beginning amount + amount produced - shipments out = Ending amount. If necessary, this formula can be used to calculate any missing inventory amount as long as the other three amounts are known. After the production level has been determined, the company can prepare a direct materials budget, which shows how much material must be purchased to meet the required production level and the cost of these materials. The amount of materials to be purchased depends on the expected usage of materials and direct (or raw) materials inventory levels. Like the ending inventory for units produced, it is important that managers provide a realistic estimate of ending inventory for direct materials. If there are not enough direct materials on hand, the company will not be able to meet production requirements. Direct (or raw) Materials inventory levels (dollar value or quantity) can be calculated by the formula: Beginning amount + amount purchased - amount used in production = Ending amount. If necessary, this formula can be used to calculate any missing inventory amount as long as the other three amounts are known. The company can also prepare a direct labor budget based on the production requirements established in the production budget. It calculates the total hours required to meet these production levels by multiplying the expected production volume by the number of direct labor hours required to produce one unit. The total direct labor cost is then calculated by multiplying this total hourly requirement by the standard direct labor cost per hour. After the direct materials and direct labor budgets are complete, a factory overhead budget that includes all other expected manufacturing costs can be prepared. It identifies costs as either fixed or variable. The variable costs are calculated using a predetermined overhead rate, such as $3 per direct labor hour. Fixed costs include expenses such as rent and depreciation. It is important to note that depreciation expense does not require a cash outflow, and therefore must be subtracted from the total factory overhead when calculating the related cash disbursements for the cash budget. The selling and administrative expense budget includes the operating expenses that are related to selling the products and managing the business. Like the factory overhead budget, this budget distinguishes between variable and fixed selling and administrative expenses for the budget period.

Payback Period

The payback period identifies the amount of time it takes to recover the cost of the investment from the net cash flows produced by the investment. This method can be particularly useful if a company has cash flow problems and needs to recover their investment in a relatively short period of time. A company may establish a limit on the payback period, rejecting any project with a calculated payback period beyond this limit. A company might also use the payback period to choose between proposed projects; when choosing between projects, the shorter the payback period, the better. The computation of the cash payback period depends on the equality of cash inflows in each year of the investment's life. Notice that the cash inflows for Project A are equal. In this case, a formula is used to compute the payback period: Payback Period = Initial Investment / Annual Cash Inflow It will take 6.67 years ($100,000/$15,000) to recover the cost of the investment, should Project A be selected. So how do we calculate the cash payback period for Project B, which has uneven cash flows? In such cases, the cash payback period occurs when the cumulative cash inflows from the project equal the cost of the project. We can prepare a cash flow schedule to help determine the payback period for Project B: Year Investment Annual Cash Inflow Cumulative Cash Inflow 0 $40,000 1 $7,000 $7,000 2 $10,000 $17,000 3 $12,000 $29,000 4 $13,000 $42,000 5 $16,000 $58,000 If we analyze the cumulative cash inflows, we can see that the initial investment of $40,000 will be recovered sometime between years 3 and 4; therefore, the payback period is 3+ years. In year 4, the remaining $11,000 ($40,000 - $29,000) of the initial investment must be recovered. We divide this remaining $11,000 by the annual cash inflow from year 4 ($13,000) to determine the point during the year when the payback occurs. The result of this calculation is .85 years, so the total payback period for Project B is 3.85 years. Based on the calculated payback periods, Project B appears to be the more attractive investment. While this method is a useful screening tool because it is easy to compute and understand, it ignores both the time value of money and the profitability of the project. Therefore, organizations should use additional capital budgeting techniques to evaluate potential projects.

Financial Budgets

The primary financial budget is the cash budget, which is prepared to assist management in cash planning and control. It presents anticipated cash inflows and outflows in four major sections: cash receipts, cash disbursements, cash surplus or deficit, and financing (some companies include a fifth investing section). The cash budget is often considered the most important financial budget because cash is so vital to a company's success. While the operating budgets are typically prepared on a quarterly basis, the cash budget should be prepared on a monthly basis in order to be effective at cash management.

linear regression formula of y = a + bx.

The primary item that we must know is which variable is x and which is y. The dependent variable is y; the value of y (dependent) depends on the value of x (independent).

Pro Forma Financial Statements

The pro forma income statement is the end result of the operating budgets. It calculates the anticipated profits by summarizing revenues and expenses for the budget period. Prepared from the various operating budgets, the pro forma income statement provides the goal that is often the basis for performance evaluation. The pro forma balance sheet is developed by adjusting the previous year's balance sheet for activities anticipated during the budget period. Like the pro forma income statement, it is also prepared from the operating and financial budgets, as well as the pro forma income statement itself. Managers use these pro forma financial statements to evaluate the expected financial condition of the company for the budget period. For example, we can compute the return on total assets by dividing the net income after taxes by the total assets. An increase in the return indicates improved overall performance. If managers are not satisfied with the expected financial condition, they may revise the budget so that target goals are achieved. As part of the budgeting process, it is important that managers estimate future financing needs. The company may seek internal financing from cash flows generated by the company's normal operations, or it may seek external financing from parties outside the company, such as a bank or other lending institution. The most common method for projecting an organization's financing needs is the percent of sales method, which estimates the various expenses, assets, and liabilities for a future period as a percent of the sales. For example, we can take our last actual balance sheet and divide each item by actual sales from the income statement to determine the percentage of sales that each item consumed. We then apply this percentage to our sales forecast to create a pro forma balance sheet.

Qualitative Forecasting Methods

The qualitative method is used for judgmental forecasting models. When we are discussing qualitative methods, we refer to the opinions of experts. An expert can be anyone who has the knowledge that we need to arrive at our forecast (consumers, corporate customers, sales agents, engineers, functional managers, etc.). We are really talking about an educated guess. If you have a lot of experience in an industry as well as extensive knowledge of the industry, then you may very well be an expert. All of the qualitative models require an expert to provide information that we will actually use in our forecast. We still require numbers; we are not using traditional mathematical formulas to obtain the number, but rather the opinions, intuition, experience, and knowledge of our experts. Several of the more common qualitative forecasting methods are briefly discussed here. • Executive opinions average the views of experts from various departments to generate a forecast of future sales. This forecasting method can be performed easily and quickly, without the use of elaborate statistics. However, this method is conducted in a group, which increases the risk of group pressure and stifles critical thinking. The result in that situation is sometimes referred to as "groupthink". • The Delphi method questions a panel of experts individually. An outside party summarizes the information obtained and returns it to the experts with further questions. The process continues until a consensus is reached. While the experts are not influenced by others participating in the forecasting, this method is often criticized for its low reliability and lack of consensus. • Sales force polling questions those salespeople closest to the customer. The information gathered in the poll is averaged to create a future forecast. This method is simple to use and understand, drawing on the knowledge of those closest to the customer. However, it may include overly optimistic or pessimistic predictions. • Consumer surveys regarding specific purchases may be conducted by a company. These surveys use personal interviews or questionnaires to collect data, which are compiled and analyzed to form assumptions regarding consumer behavior.

There are some customers who will purchase hybrid vehicles for reasons other than the price of gasoline

These individuals are represented by the intercept a in our formula y = a + bx

Seasonal Variations

To obtain the most accurate projection possible, we should also consider seasonal variations in our regression analysis. These seasonal variations can be the result of predictable shopping habits of customers: Restaurant sales are typically greatest on Fridays and Saturdays, while retail sales are commonly greatest in the fourth quarter because of the holiday shopping season. They can also be the result of annual climatic conditions: Swimming pool sales are usually greater in the hot summer months than in cold winter months. We can use a data series and its regression line to create a forecast of future sales that includes seasonal data. This process is illustrated in the Seasonal Variations spreadsheet. If you examine the actual sales, you will notice that sales in the second and fourth quarters of each year are greater than sales in the first and third quarters of the same year. To create the most accurate projection of sales for future periods, we need to consider these seasonal variations in our analysis. First, we calculate the seasonal ratio (0.99) by dividing (/) the actual sales (245) by the regression forecast (247.90) for the same time period. We do this for each time period for which we have actual sales data. For future time periods in which actual data is not available, we must calculate the average seasonal ratio based on the calculated seasonal ratios for the same time periods in previous years. Finally, we calculate the seasonal forecast of sales by multiplying the seasonal ratio by the regression forecast for the corresponding time period.

The regression trend is:

Y = a + bx, where "a" is your Intercept and "b" is your Slope. You can compute the Intercept using the INTERCEPT function and the SLOPE function in Excel. Using the attached Excel file as an example, click on "a" to see how the function is used and "b" for the Slope. Once you have "a" and "b", you can predict a forecast for any months. You can use these functions in Excel for your homework as well.

Forecasting

You will see that qualitative methods provide the data in order for quantitative analysis to be performed. Qualitative analysis is often overlook; however, when starting a new business or launching a new product qualitative analysis is often your only option. Quantitative analysis, on the other hand, provides all of the numbers and figures we all love in order to base our decisions. I stated above that qualitative methods may be your only option when starting a new business or bringing a new product to market

Zero based budgeting

Zero based budgeting means starting the budget from scratch. Every line and every cost has to be rejustified. The zero based budgeting approach was developed in the 1970s and promoted by President Carter in connection with US federal government expenditure. Building a budget from scratch means that all costs should be reviewed and challenged. In order to carry out this exercise fully you need a considerable amount of time and resources. This is difficult when most organisations already believe they spend too much time and money on budgeting. Even with a zero based approach budget setters may be tempted to base some of their cost estimates on previous years. A compromise may be to complete budgets on an incremental basis (as in the previous examples) and then to periodically review budgets on a true zero cost basis, which requires managers in selected departments to rebuild their budgets from scratch. Some budgets are more usually completed on a zero based basis, for example one-off projects, which by their individual nature will most likely be built up from scratch because they have not been set before.

Forcasting - Qualitative Forecasting

aids in determining volume of production, inventory needs, labor hours required, cash requirements, and financing needs

seasonal variations

can be the result of predictable shopping habits of customers

Budgeting

companies also implement a strategic plan, which is a long-term plan for the organization as a whole

Cash budget

controls the inflow and outflow of cash.

can use a

data series and its regression line to create a forecast of future sales that includes seasonal data

Costs that are necessary to meet short-term goals are called

discretionary costs.

management would

estimate the relationship between sales (X) and both advertising and price (Y)

capital expenditure budget

first step is to approve the projects, next step is to authorize the project, The final step is to follow up on projects that have been undertaken. Capital expenditure is money that is spent on long-term fixed assets (such as plant and equipment) usually with a view to gaining long-term benefits. In smaller organisations, decisions on capital expenditure may well be made on the basis of 'gut feel', with little formal quantification of the expenditure benefits. Proposals normally have to include a formal analysis and presentation of costs and benefits.

calculate the forecast

for example.. 6 days.. add all six numbers then divide the total by 6.

Profitability Index

he profitability index is an index that attempts to identify the relationship between the costs and benefits of a proposed project through the use of a ratio calculated as: PV of future cash / initial investment

payback period

he simplest and arguably the most commonly used method of investment appraisal is a technique known as payback. Using the payback rule requires projects to pay for themselves within a given period of time. Typically, an organisation might have required all projects to pay for themselves within a period of three to five years. Following the banking crisis of 2008, many banks restricted their lending, placing cash flow pressures on many companies in the UK. Companies switched their attention from focusing on profits to focusing on cash flow. They tried to manage their working capital, inventory (stock), accounts receivable (trade debtors) and accounts payable (trade creditors) more carefully. They were also forced to review their capital expenditure plans and many companies reduced the required payback period for projects from three to five years down to just 12 months.

• The t-statistic measures

how many standard errors the coefficient is from zero. The greater the t-value, the more confidence we can have in the coefficient as a predictor. A general rule of thumb is that a t-value less than -2 or greater than +2 is acceptable

Statistics Calculator: Linear Regression

http://www.alcula.com/calculators/statistics/linear-regression/

simple linear regression

http://www.excel-easy.com/examples/forecast-trend.html

Math Calculators, Lessons and Formulas -linear regression

http://www.mathportal.org/calculators/statistics-calculator/correlation-and-regression-calculator.php

regression Calculator - Simple/Linear

http://www.meracalculator.com/math/regression.php

y = 2x + 4 is the equation

https://www.algebra.com/algebra/homework/Graphs/Graphs.faq.question.135655.html

calculate the regression

https://www.bing.com/search?q=%281809+-+9.919199%281714%29%29%2F5&qs=n&form=QBRE&pq=%281809+-+9.919199%281714%29%29%2F5&sc=0-20&sp=-1&sk=&cvid=693B1160746E4C419DA2920E7547D7E6

IRR RATE RETURN

https://www.bing.com/videos/search?q=Rate+of+Return+Calculation+Formula&&view=detail&mid=67DAA030B0F8767EC1B367DAA030B0F8767EC1B3&FORM=VRDGAR

calculate the regression (trend) line

https://www.bing.com/videos/search?q=calculate+the+regression+trendline+word+10&&view=detail&mid=650275DE86D5AE70EFCF650275DE86D5AE70EFCF&rvsmid=F7C5474B514F523DB7A9F7C5474B514F523DB7A9&FORM=VDQVAP&fsscr=0

NVP formula

https://www.bing.com/videos/search?q=net+present+value+microsoft+10+&&view=detail&mid=D7AB8A1891879543DA2FD7AB8A1891879543DA2F&FORM=VRDGAR n = 1/(1 + r)n

npv excel

https://www.bing.com/videos/search?q=npv+excel&&view=detail&mid=970696A49E4EAC04DB5C970696A49E4EAC04DB5C&FORM=VRDGAR

payback calculation

https://www.bing.com/videos/search?q=payback+calucation&&view=detail&mid=9FA47DBF56A7DAA815F49FA47DBF56A7DAA815F4&FORM=VRDGAR

Absolute Deviation

https://www.youtube.com/watch?v=USFY2I9VGNQ&ebc=ANyPxKp51kA6VJUEswM0TlR2ViXBpjRCTinvLBtngtGznBqU6_zLCoK4OFMzlP3kdFoj4cEeTH6UAgSeR58HP_W9JBuGzRyWpw

Static budget

in an inflexible budget

We observe x

in order to predict y

Administrative departments

include general administration, personnel, accounting, legal, and information technology. Given these departments, common administrative expenses include executive salaries, legal expenses, and office expenses, such as salaries and rent

Capital expenditure budget

includes a long term budget and separated budget.

Master budget

includes the income statement and the assets. Liabilities, and equity.

Simple regression

involves only one independent variable

Multiple regression

involves two or more independent variables.

Flexible budget

is a adjustable budget

Continuous budget

is a budget that can be moved month to month

A normal expenditure

is a routine expenditure that is made to maintain current operations, and therefore does not typically require a large cash outflow.The replacement of minor equipment such as a computer would be classified as a normal expenditure

Simple regression

is also known as linear regression because it uses a trend line to represent changes in the dependent variable

Strategic Planning

is performed by upper management, who consider economic, competitive, and industry factors when creating the plan

X dependent variable y independent variable

management may be interested in how sales (the dependent variable X) are affected by factors such as price, advertising, and competition (the independent variables Y).

• The standard error of the estimate (Se)

measures the accuracy of our projections. For example, if we want to use the regression line to forecast sales if advertising is $20, the standard error will tell us how much confidence we can place in our projection. We can also construct confidence intervals that provide a range of values, with the confidence level determining the probability that this interval will include the true value. A confidence level of 95% means that the probability of the actual sales falling outside our confidence interval is less than 5%.

weighted moving average

model also uses actual sales from recent time periods to predict future sales, but it assumes that the closest time period is a more accurate predictor of future sales than previous time periods. Using this model, we assign weights to the time periods based on our judgment, with the sum of the weights typically being equal to one. If we believe that the closest time period is a more accurate predictor of future sales, we will assign it a greater weight than previous time periods.

moving average

model uses actual sales from recent time periods to predict future sales, assuming that each time period has an equal influence on the prediction of futures sales. When using the moving average model, we first have to calculate the average of actual sales for several past time periods. Then we use this average as the forecast for the next time period's sales.

Capital expenditures that meet the needs of the manager's division are called

normal capital expenditures.

exponential smoothing and a smoothing constant of .10.

page 34

Payback Period

payback period is the length of time required to recover the cost of an investment. The payback period of a given investment or project is an important determinant of whether to undertake the position or project, as longer payback periods are typically not desirable for investment positions.

• The coefficient of determination (R2)

represents the proportion of the total variation in the dependent variable that is explained by the regression equation. It ranges in value from 0 to 1; the higher the R2, the more confidence we can have in our regression equation.

Sales commissions and salesperson salaries may be classified as

selling expenses.

exponential smoothing model

uses a smoothing constant called alpha as an adjustment when determining the forecast. We assign a value to alpha based on our assumption of the relationship between sales in one period and sales in the next period. A higher value is assigned to alpha when we believe that current sales are more predictive of future sales, and a lower value is assigned to alpha when we believe that a smoothed forecast is more predictive of future sales.

regression analysis there is a linear or straight line relationship described by the simple formula:

y = a + bx

For these budgets to be effective, they must possess several key characteristics. They should

• reflect the goals of each department as they relate to the organization as a whole; • predict the future as accurately as possible; • communicate goals and objectives, and the responsibility for achieving them; • be based on accurate and reliable information generated by the accounting system; • be supported by all levels of management; and • provide the flexibility to allow for unexpected contingencies