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F5 Performance Management The exam Five compulsory questions: 20 - PowerPoint PPT Presentation

F5 Performance Management The exam Five compulsory questions: 20 marks each Time allowed: 3hours plus 15 minutes reading time Balance typically 50:50 between calculations and discussion aspects The examiners key concerns


  1. Linear programming Range of applicability of dual prices • The dual price only applies as long as extra resources improve the optimal solution • i.e. the constraint line concerned moves out increasing the size of the feasible region and moving the optimal point. • Eventually other constraints become critical.

  2. 4. Pricing • Factors to consider when pricing. • Calculation aspects. • Pricing approaches .

  3. Factors to consider when pricing • Costs • Competitors • Corporate objectives • Customers

  4. Calculation aspects Price elasticity of demand (PED) • PED = % change in demand / % change in price. • PED >1 (elastic) revenue increases if the price is cut. • PED <1 (inelastic) revenue increases if the price is raised.

  5. Calculation aspects Equation of a straight line demand curve • P = a – bQ • “a” = the price at which demand would fall to zero • “b” = gradient = change in price/change in demand • Calculate “b” first

  6. Calculation aspects Equation of a cost curve • C = F + vQ • Volume based discounts

  7. Pricing approaches • Cost plus pricing • Price skimming • Penetration pricing • Linking pricing decisions for different products • Volume discounts • Price discrimination • Relevant cost pricing

  8. Cost plus pricing • Establish cost per unit – options include MC, TAC, prime cost • Calculate price using target mark-up or margin • Often used as a starting point even when using other methods

  9. Cost plus pricing Advantages • Widely used and accepted. • Simple to calculate if costs are known. • Selling price decision may be delegated to junior management. • Justification for price increases. • May encourage price stability.

  10. Cost plus pricing Disadvantages • Ignores link between price and demand. • No attempt to establish optimum price. • Which absorption method? • Does not guarantee profit • Which cost? • Inflexibility in pricing. • Circular reasoning.

  11. Price skimming • Set a high initial price to „skim off‟ customers who are willing to pay extra. • Prices fall over time. • Suitability?

  12. Penetration pricing • Set a low initial price to gain market share • If a high volume is achieved, the low price could be sustainable. • Suitability?

  13. Linking pricing decisions for different products • Basic idea: product A is cheap to attract customers who then also buy the higher margin product B. • Key issue is the extent to which customer must buy the other products. • Suitability?

  14. Volume discounts • Discount for individual large order. • Cumulative quantity discounts. • Suitability?

  15. Price discrimination • Have different prices in different markets for the same product. • Suitability?

  16. Relevant cost pricing • Price = net incremental cash flow. • Suitability?

  17. 5. Make v buy and other short term decisions • Relevant costing principles. • Make v buy decisions. • Shut down decisions. • Joint products – the further processing decision.

  18. Relevant costing principles • Include – Future incremental cash flows. – Opportunity costs • Exclude – Depreciation. – Sunk costs. – Unavoidable costs. – Apportioned fixed overheads. – Financing cash flows (e.g. interest).

  19. Make v buy Decision • Look at future incremental cash flows. • Watch out for opportunity costs – especially whether or not spare capacity exists and alternative uses for capacity. • Practical factors?

  20. Shut down decisions Decision • Look at future incremental cash flows. – Apportioned overheads not relevant – Closure costs – e.g. redundancies. – Alternative uses for resources? • Practical factors?

  21. Joint products The further processing decision • Look at future incremental cash flows: – sell at split off v process further and then sell. • Pre- separation (“joint”) costs not relevant – only include post split-off aspects.

  22. 6. Risk and uncertainty • Basic concepts. • Research techniques. • Scenario planning. • Simulation. • Expected values. • Sensitivity. • Payoff tables.

  23. Basic concepts • Risk = variability in future returns. • Investors‟ risk aversion • Upside v downside • Risk v uncertainty • Risk = probability x impact

  24. Research techniques • Desk research – Company records. – General economic intelligence. – Specific market data. • Field research – Opinion v motivation v measurement – Questionnaires, experiments, observation. – Group interviews, triad testing, focus groups.

  25. Scenario planning 1 Identify high-impact, high-uncertainty factors. 2 Identify different possible futures. 3 Identify consistent future scenarios. 4 “Write the scenario” . 5 For each scenario identify and assess possible courses of action for the firm. 6 Monitor reality. 7 Revise scenarios and strategic options

  26. Simulation 1 Apply probabilities to key factors in scenario analysis. 2 Use random numbers to select a particular scenario and calculate outcome. 3 Repeat until build up a picture of possible outcomes 4 Make decision based on risk aversion.

  27. Expected values • EV = Σ outcome × probability. • Make decision based on best EV.

  28. Expected values Advantages • Recognises that there are several possible outcomes. • Enables the probability of the different outcomes to be taken into account. • Leads directly to a simple optimising decision rule. • Calculations are relatively simple.

  29. Expected values Disadvantages • probabilities used are subjective. • EV is the average payoff. Not useful for one-off decisions. • EV gives no indication of risk • Ignores the investor‟s attitude to risk.

  30. Sensitivity • Identify key variables by calculating how much an estimate can change before the decision reverses. • Can only vary one estimate at a time.

  31. Payoff tables • Prepare table of profits based on different decision choices and different possible scenarios. • Four different ways of making a decision. – 1 Expected values – 2 Maximax – 3 Maximin – 4 Minimax regret

  32. 7. Budgeting I • The purposes of budgeting. • Budgets and performance management. • The behavioural aspects of budgeting. • Conflicting objectives.

  33. The purpose of budgets • Forecasting • Planning • Control • Communication • Co-ordination • Evaluation • Motivation • Authorisation and delegation

  34. Budgets and performance management Responsibility accounting • Responsibility accounting divides the organisation into budget centres, each of which has a manager who is responsible for its performance. • The budget is the target against which the performance of the budget centre or the manager is measured.

  35. Management by exception 1 Set up standard costs, prepare budgets and set targets. 2 Measure actual. 3 Compare actual to budget (e.g. via variances). 4 Investigate reasons for differences and take action.

  36. Behavioural aspects of budgeting Key issues – Dysfunctional behaviour – want goal congruence. – Budgetary slack. Management styles (Hopwood) – Budget constrained – Profit conscious – Non-accounting

  37. Target setting and motivation • Expectations v aspirations • Ideal target? • Targets should be: – communicated in advance – dependent on controllable factors – based on quantifiable factors – linked to appropriate rewards – chosen to ensure goal congruence.

  38. Participation Advantages of participative budgets • Increased motivation • Should contain better information, • Increases managers‟ understanding and commitment • Better communication • Senior managers can concentrate on strategy.

  39. Participation Disadvantages of participative budgets • Loss of control • Inexperienced managers • Budgets not in line with objectives • Budget preparation slower and disputes can arise • Budgetary slack • Certain environments may preclude participation

  40. Conflicting objectives • Company v division • Division v division • Short-termism • Individualism

  41. 8. Budgeting II • Rolling v periodic. • Incremental budgeting. • Zero based budgeting (ZBB). • Activity based budgeting (ABB). • Feedforward control. • Flexible budgeting. • Selecting a budgetary system. • Dealing with uncertainty. • Use of spreadsheets.

  42. Rolling v periodic budgeting Periodic budgets • The budget is prepared for typically one year at a time. No alterations once the budget has been set. • Suitable for stable businesses where forecasting is easy and where tight control is not necessary.

  43. Rolling v periodic budgeting Rolling (continuous) budgets • A budget kept continuously up to date by adding another accounting period when the earliest period has expired. • Aim: to keep tight control and always have an accurate budget for the next 12 months. • Suitable if accurate forecasts cannot be made, or if need tight control.

  44. Incremental budgeting • Start with the previous period‟s budget or actual results and add (or subtract) an incremental amount to cover inflation and other known changes. • Suitable for stable businesses where costs are not expected to change significantly. There should be good cost control and limited discretionary costs.

  45. Zero based budgeting Preparing a budget from a zero base, justifying all expenditure. 1 Identify all possible services and then cost each service (decision packages) 2 Rank the decision packages 3 Identify the level of funding that will be allocated to the department. 4 Use up the funds in order of the ranking until exhausted.

  46. Activity based budgeting • Use ABC for budgeting purposes: 1 Identify cost pools and cost drivers. 2 Calculate a budgeted cost driver rate 3 Produce a budget for each department or product by multiplying the budgeted cost driver rate by the expected usage.

  47. Feed forward control • Feed-forward control is defined as the „forecasting of differences between actual and planned outcomes and the implementation of actions before the event, to avoid such differences. • E.g. using a cash-flow budget to forecast a funding problem and as a result arranging a higher overdraft well in advance of the problem.

  48. Flexible budgeting • Fixed Budgets • Flexible Budgets • Flexed Budgets

  49. Selecting a budgetary system Determinants • Type of organisation. • Type of industry. • Type of product and product range. • Culture of the organisation.

  50. Changing a budgetary system Factors to consider • Time consuming • Are suitably trained staff are available to implement the change successfully? • Management time • Training needs. • Cost v benefits for the new system:

  51. Incorporating risk and uncertainty • Flexible budgeting. • Rolling budgets. • Scenario planning. • Sensitivity analysis. • “What if” analysis using spreadsheets

  52. 9. Quantitative analysis • High-low. • Regression and correlation. • Time series analysis. • Learning curves.

  53. High-low 1: Select the highest and lowest activity levels, and their costs. 2: Find the variable cost/unit. 3: Find the fixed cost, using either level. Fixed cost = Total cost at activity level – total variable cost.

  54. Regression and correlation y = a + bx y b x n xy - x y 2 2 n n n x - ( x) n xy - x y r = 2 2 2 2 n x - ( x) ) (n y - ( y) )

  55. Time series analysis • Four components: 1 the trend 2 cyclical variations 3 seasonal variations 4 residual variations. • Additive model Actual = Trend + Seasonal Variation • Multiplicative model Actual = Trend x Seasonal Variation

  56. Learning curves • As cumulative output doubles, the cumulative average time per unit falls to a fixed % (the learning rate) of the previous average. • Y = ax b y = average cost per batch a = cost of first batch x = total number of batches produced b = learning factor (log LR/log 2)

  57. 10. Standard costing and basic variances • Standard costing. • Recap of basic variances from F2. • Labour variances with idle time. • Variance investigation.

  58. Standard costing • A pre-determination of what a product is expected to cost under specific working conditions.

  59. Standard costing Advantages – Annual detailed examination – Performance appraisal – Management by exception – Simplifies bookkeeping • Disadvantages / problems – Standards not updated – Cost – Unrealistic standards can demotivate staff

  60. Types of standard • Attainable • Ideal • Basic • Current

  61. Sales variances

  62. Material variances

  63. Labour variances (basic)

  64. Variable overhead variances

  65. Fixed overhead variances

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