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Forecasting involve the generation of a number, set of numbers, or scenario that corresponds to a future amount. It is absolutely fundamental to short-range and long-range planning. By definition, a forecast is based on past data, as opposed to a prediction, which is more prejudiced and based on impulse, gut feel, or guess. For example, the evening news gives the weather "forecast" not the weather "prediction." Regardless, the terms forecast and prediction is often used inter-changeably. For example, definitions of regression-a technique occasionally used in forecasting in general state that its purpose is to explicate or "predict." (Finch, 2006)
William J. Stevenson lists an amount of features that are common to a good forecast:
Accurate-some degree of accuracy should be determined and stated so that assessment can be made to substitute forecasts.
Reliable-the forecast method should constantly provide a good forecast if the user is to establish some degree of assurance.
Timely-a certain amount of time is needed to take action to the forecast so the forecasting horizon must allow for the time required to make changes.
Easy to use and understand-users of the estimate must be confident and secure working with it.
Cost-effective-the cost of making the forecast should not outweigh the benefits obtain from the foretell. (Stevenson, 2005)
Time series forecasting is the use of a model to forecast future events based on known past events: to predict data points before they are measured. An example of time series forecasting in econometrics is predicting the opening price of a stock based on its past performance. Time series are very frequently plotted via line charts.
Time series data have a natural temporal ordering. This makes time series analysis distinct from other common data examination problems, in which there is no natural ordering of the observations (e.g. explaining people's earnings by reference to their education level, where the individuals' data could be entered in any order). Time series analysis is also distinct from spatial data analysis where the observations typically relate to geographical locations (e.g. accounting for house prices by the location as well as the intrinsic characteristics of the houses). (Bloomfield, 1976)
Regression analysis is widely used for prediction and forecasting, where its use has substantial overlap with the field of machine learning. Regression analysis is also used to understand which among the independent variables are related to the dependent variable, and to explore the forms of these relationships. In restricted circumstances, regression analysis can be used to infer causal relationships between the independent and dependent variables.
A large body of techniques for carrying out regression analysis has been developed. Familiar methods such as linear regression and ordinary least squares regression are parametric, in that the regression function is defined in terms of a finite number of unknown parameters that are estimated from the data. Nonparametric regression refers to techniques that allow the regression function to lie in a specified set of functions, which may be infinite-dimensional.
Linear Regression analysis is the simplest kind of regression analysis concerned with describing and evaluating the relationship between two variables. So it is basically a bivariate analysis.
Consider a firm having data on its sales (y) and corresponding advertising expenditure (X).In linear regression analysis we try to find out the best possible straight line, called the linear regression line, through the data. This line is used as the standard curve to find new values of X from Y, or Y from X.
First the bivariate data are plotted in the XY plane to get the scattered diagram.
Then the line that minimizes the sum of the squares of the vertical distances of the points from the line is found out. This is the linear regression line.
However, the values of Y for different values of X can not be determined exactly. We determine the statistical relationship between the sales (Y) and the advertising expenditure(X) of the firm in probabilistic terms. Here the vertical distances are the error and we get the following stochastic relationship.
Y= a+bX+U where a is the intercept, b is the slope and U is the error term.
r2, a measure of goodness-of-fit of linear regression
r2=1-( SSreg / SStot ) where SSreg is the sum of square of the errors and SStot is the sum of square of the vertical distances from the horizontal line depicting the mean value of Y.
The value r2 is a fraction between 0.0 and 1.0, and has no units. An r2 value of 0.0 means that knowing X does not help you predict Y. There is no linear relationship between X and Y, and the best-fit line is a horizontal line going through the mean of all Y values. When r2 equals 1.0, all points lie exactly on a straight line with no scatter. Knowing X lets you predict Y perfectly. (www.mu-sigma.com)
The scatter graph method (also called scatter plot or scatter chart method) involves estimating the fixed and variable elements of a mixed cost visually on a graph.
The scatter-graph method requires that all recent, normal data observations be plotted on a cost (Y-axis) versus activity (X-axis) graph. Vertical axis of graph represents total costs and horizontal axis shows the volume of related activity.
Let us again use the example of Friends Corporation and review their activities for the last six months (see Illustration 14 from the previous section). First step is to plot the points, according to given data. Then a line that most closely represents a straight line composed of all the data points should be drawn. The graph using data points is shown on Illustration 15.
The point where this line intersects the vertical axis is the fixed costs, or $14,000 in our case. The angle (slope) of the line can be calculated to give a fairly accurate estimate of the variable cost per unit. We can see from the graph that production of 20,000 valves will cost Friends Corporation $75,000 and production of 25,000 valves will cost $90,000. Knowing this information we can calculate the variable cost per unit.
Y2 - Y1
$90,000 - $75,000
X2 - X1
25,000 - 20,000
When two variables are known, we may use them in the cost formula:
Y = F + V x X,
where F is fixed costs, V is variable cost per unit, and X is production level (may be different values).
So, the cost formula looks like this:
Y = $14,000 + $3 x X
Using this formula we can predict the total cost of activity in the range of 10,000 to 28,000 valves per month and then separate them into fixed and variable components. For example, assume that production of 24,000 valves is planned for the next period. Using the formula we can predict that total costs would be:
Y = $14,000 + $3 x 24,000 = $86,000
Of this total cost, $14,000 is fixed and $72,000 is variable, for a total of $86,000 ($14,000 + $72,000).
This method is simple to use and provides clear representation of correlation between costs and volume of activity. (www.simplestudies.com)
An index number is an economic data figure reflecting price or quantity compared with a standard or base value. The base usually equals 100 and the index number is usually expressed as 100 times the ratio to the base value. For example, if a commodity costs twice as much in 1970 as it did in 1960, its index number would be 200 relative to 1960. Index numbers are used especially to compare business activity, the cost of living, and employment. They enable economists to reduce unwieldy business data into easily understood terms.
In economics, index numbers generally are time series summarising movements in a group of related variables. In some cases, however, index numbers may compare geographic areas at a point in time. An example is a country's purchasing power parity. The best-known index number is the consumer price index, which measures changes in retail prices paid by consumers. In addition, a cost-of-living index (COLI) is a price index number that measures relative cost of living over time. In contrast to a COLI based on the true but unknown utility function, a superlative index number is an index number that can be calculated. Thus, superlative index numbers are used to provide a fairly close approximation to the underlying cost-of-living index number in a wide range of circumstances.
There is a substantial body of economic analysis concerning the construction of index numbers, desirable properties of index numbers and the relationship between index numbers and economic theory. (Turvey, 2004)
Sources of finance:
For many businesses, the issue about where to get funds from for starting up, development and expansion can be crucial for the success of the business. It is important, therefore, that you understand the various sources of finance open to a business and are able to assess how appropriate these sources are in relation to the needs of the business. The latter point regarding 'assessment' is particularly important at A level where you are expected to make judgements.
Traditionally, the major sources of finance for a limited company were internal sources:
Sale of assets
In this context, 'owners' refers to those people/institutions who are shareholders. Sole traders and partnerships do not have shareholders - the individual or the partners are the owners of the business but do not hold shares. Shares are units of investment in a limited company, whether it is a public or private limited company. Shares are generally broken down into two categories:
Whilst the following sources of finance are important, they are not classed as Ownership Capital - Debenture holders are not shareholders, nor are banks who lend money or creditors. Only shareholders are owners of the company.
Lines of credit from creditors
Financial structures of four well known British companies
Factoring and invoice discounting:
Leasing. (Kalecki, 2003)
A budget (from old French bougette, purse) is generally a list of all planned expenses and revenues. It is a plan for saving and spending. A budget is an important concept in microeconomics, which uses a budget line to illustrate the trade-offs between two or more goods. In other terms, a budget is an organizational plan stated in monetary terms.
In summary, the purpose of budgeting is to,
Provide a forecast of revenues and expenditures i.e. construct a model of how our business might perform financially speaking if certain strategies, events and plans are carried out.
Enable the actual financial operation of the business to be measured against the forecast. (Sullivan, 2003)
Function of budget committee:
Budget committee is a group of key management persons who are responsible for overall policy matters relating to the budget program and for coordinating the preparation of the budget.
A standing budget committee will usually be responsible for overall policy matters relating to the budget program and for coordinating the preparation of the budget itself. This committee generally consists of the president; vice president in charge of various functions such as sales, production, and purchasing; and the controller. Difficulties and disputes between segments of the organization in matters relating to the budget are resolved by the budget committee. In addition, the budget committee approves the final budget and receives periodic reports on the progress of the company in attaining budgeted goals. (Campbell, 1998)
Types of budget:
Incremental budget: This is a budget prepared using a previous period's budget or actual performance as a basis with incremental amounts added for the new budget period.
Zero based budget: Zero-based budgeting is a technique of planning and decision-making which reverses the working process of traditional budgeting. In traditional incremental budgeting, departmental managers justify only increases over the previous year budget and what has been already spent is automatically sanctioned. By contrast, in zero-based budgeting, every department function is reviewed comprehensively and all expenditures must be approved, rather than only increases. No reference is made to the previous level of expenditure. Zero-based budgeting requires the budget request be justified in complete detail by each division manager starting from the zero-base. The zero-base is indifferent to whether the total budget is increasing or decreasing.
Continuous budget: It can be defined as budget or plan that is always available for a specified future period by adding a period (month, quarter or year) to the period that just ended.
Activity based budget: Activity based budgeting stands in contrast to traditional, cost-based budgeting practices in which a prior period's budget is simply adjusted to account for inflation or revenue growth.Â As such, provides opportunities to align activities with objectives streamline costs and improve business practices. (Campbell, 1998)
Behaviour aspects of budget:
Participation: Participation in the budgetary process tends to result increased efficiency and fulfilment.
Imposition: Imposition of will can be demonstrated by the existence of any one of the following condition-
The ability to modify or approve the budget of the organization.
The ability to modify or approve the rate or fee changes affecting revenues, such as water usage rate increases.
The ability to remove appointed member's of the organization's governing board.
The ability to hire, appoint, reassign or dismiss those persons responsible for day to day operations or management of the organization. (Hopwood, 1973)