Decision making techniques are often used by many organizations for predicting the future of there project, product or any expansion etc. If you make decision on the right time that means your team is in a well-deserved success. But if poor decisions are made, it will lead your team to face many failures and you would no longer be a leader.
These techniques help everyone to make good decisions with the available information. Any consequences which would arise with the decisions are taken into consideration with these tools and they help to choose the best action.
The following are the decision making techniques available:
- Pareto Analysis: it helps to choose what should be changed.
- Cost benefit analysis: Monitor the decision that weather it makes some financial sense.
- Cash flow forecasting: It helps to examine that whether the
- Decision tress: Only one option is to chose by their value
- Paired Comparison Analysis: Making different options into consideration.
- PMI: Cons and Pros of the decision are weighed.
- Stepladder technique: Help to create better decisions in the group.
- Six thinking hat: Looks for the decision with a different point of view.
- Grid Analysis: Picking a choice while reviewing lots of factors.
- Star bursting: By brainstorming it helps to recognize the options.
In this question we are going to discuss two of the above techniques which are as follows:
- Cost benefit Analysis
- Cash flow forecasting
Cost Benefit Analysis
This is widely used to calculate the total estimated cost being compared with the total predictable benefits just to decide whether this project is useful for the company of not. This method is very easy, adaptive and simple to understand. But still you will find many arguments against this. A team should first assess the all the goals and requirements of the project and then will evaluate all the priorities of the possible drawbacks to decide weather the cost benefit analysis is a useful speculation of recourses and time. This techniques is mostly used to decide that whether a change should be made or not.
Simply the cost benefit analysis is conceded using the financial benefits and costs. Like for example cost benefit analysis for building a road will be calculated by taking the cost required to build and deduct this with the benefit of economic which is in the form of improved transportation.
Another way of building the cost benefit models is by putting the monetary value on the intangible benefits and costs.
Advantages of cost benefit analysis:
- Cost benefit analysis helps to choose the best possible proposal in terms of the usages of funds, other resources and human help to give the company a huge net profit.
- Template for the cost benefit analysis helps you in reviewing many different projects and their proposals and by converting this information to the benefits for every project. This will also helps in choosing the best possible option.
- A cost benefit analysis save a lot of funds, valuable time and the stress, as it is very simple and easy to understand.
The disadvantages of a cost benefit analysis:
- Cost benefit analysis recognize all the benefits and costs, and quantified correctly. But as this is only done manually by the humans, it mostly eliminates some benefits and cost due to failure to predict these indirect connecting relations.
- When they apply the financial value to the intangible items leads to a incorrect cost benefit analysis, and this would lead to raise the level of risk and decision making becomes unproductive.
- The total subjectivity occupied by quantifying, approximating and recognizing the various benefits and costs is also a drawback of cost benefit analysis because some benefits and cost are non financial.
- All the assessments and prediction is mostly based on prospect and past experiences, which are mostly unfair. So this also leads to misleading and incorrect cost benefit analysis.
- In this method it is required to calculate the net present value for approximation of the benefits and costs of the period. So it matches all the future and today's costs by assessing all the objects in there present values, which abolish the need to account the monetary gains and inflation. So this is a major disadvantage because even if the present value is correctly calculated still the rate of discount used in the computation is not practical.
- Another drawback of this analysis is that the leadership team may get mislead and think of these cost as real rather than estimated and which leads to impractical goals and misappropriating costs when executing and submitting the project budget.
Cash Flow Forecasting
Forecasting the cash flows statements help the company to construct a model which shows the future expected monetary values which moves inside the specific project. It helps them to forecast that whether the predicted income and sales revenue is going to cover the total cost of the project or not. They let them to examine that whether a project is profitable enough or not.
Forecasted cash flow statements can be used to examine their own finances. This can be beneficial in making complicated financial decisions. Forecasted cash flows statement in the form of spreadsheet can help in exploring the change in factors. The prepared spreadsheet will show more or maybe less effect of the changes. The normal procedure to form forecasted cash flow statements is in a typical way but sometimes they are made with spreadsheets. A better way to examine this forecast is to form a system chart. This chart will explain the interaction between these factors. Then they can measure these relations and make a basic model.
Cash flow forecast are made on a table, on which there are columns for the time period and rows which shows the single movements of the cash like any expenses, particular products sales and its cost etc. These forecasted tables are made in three stages.
- Setting up heading for the columns:
- Setting up the tiles for each row:
- Estimate values:
In these columns the time period the forecast are to be calculated and how much long its going to continue is noted. Mostly the forecast is for one to two years and monthly columns are made inside them.
All the headings of the columns are written on the side of each column and followed by the months from which it starts. Like for example the headings would be Cash Movements, June, July, August, September, October, November, December etc. We are assuming that the forecast starts from the month of June.
The rows are followed in further three more groups which are as follows:
In this row the income which is probable is displayed and a separate row is made for each type of income. Like for example Sales of the XYZ product, Sales of any services etc. Any income form investments are also recorded here.
Here the costs are directly attributed to the selling amount of the product and it may subtract the sales direct cost which is made in these rows, and a total of all these are recorded in the bottom of the row.
This shows all the types of the cost in each separate headings like for example telecommunication costs, stationery cost, salaries of the staff etc. In the end a subtotal of the costs are noted.
This row includes the totals of every rows and it subtract the incomes from the outgoing rows for each of the month. This also shows the total profit or loss for each time period.
Below this the profit and loss of the earlier months is added to the current month and it makes the financial position for the period.
Until this there are tables which are marked out and all the titles for rows are written and heading are displayed for each columns. Now the main work is to fill the proper values in each cell for each time period. For making the estimation of values they should always be based on the previous year's values and a percentage of increase is to be calculated on it. This will lead to more accurate estimated of these values. The values for the costs and income should also be taken from the previous years and then the future estimated demand and supply is to be calculated to make then realistic.
Today's modern spreadsheets are so much advance that all these calculations are done automatically. There is no need for personally calculating each value and putting the inflation on each of them like in the Microsoft excel and many more software's. You just have to set the totals properly.
Forecasts for cash flow statements are very much simple and are very important for the project. It is an excellent way for decisions making for small as well as large projects. In the large projects it becomes more n more complex and more prescribed techniques are conducted.
Advantages for cash flow statements:
- Business can make futures decisions very quickly and accurate with this tool.
- It shows a list to cash flow both the incoming and outgoing funds and estimation is more reliable by this.
- The company can rely on this budgeted cash flow for future and check the performance of the company by comparing it with the actual one.
- It alerts the banks for any potentials problems to arrive.
- Business can plan ahead of time very easily.
Disadvantages for cash flow statements:
- The values provided in these cash flow statements are not always accurate and it is very difficult to maintain more realistic figures.
- Specialist individuals are to be appointed for making these type of statements
- There is a lot of research required for making future decision and to make it more accurate.
- No matter how much accurate it becomes it will always remain a forecast statement and a business can not fully rely on it.
Examples for cost benefit analysis and cash flow forecast are taken from the British company Virgin Media.
This is an example of cost benefit analysis of the Virgin Media Company when they are servicing or outsourcing with the BMC Blade Logic to maintain their data centre management cost. This will launch of the music, web servicing and the application in much less time and in a high quality management. So the cost benefit analysis of Virgin Media for outsourcing is as follows.
This example of cash flow is taken from the year 2006 when Virgin Media was going to merge with Telewest Company. This merger made this company the largest provider of household broadband and other triple play services in United Kingdom.
A free cash flow model is used to decide the future worth of Virgin Media. The return of equity is 15%. This seams to be high but as this company is a huge one and the level of debt is also very high so by considering this seems to be okay.
The projected cash flows are the following:
- 2009:- £778m
- 2010:- £814.2m
- 2011:- £679.5m
- 2012:- £682.2m
- 2013:- £648.7m
- Beyond 2013:- £5,568m
These values are discounted by 15% so that makes £5,219.63m of net present value. Then we the numbers of outstanding 328 million shares are divided to the value £15.91 of shares.
Using the 15% discounting rate of return
- (2009) Future Cash Flows = -90 + 1,080 - 12 - 20 - 180 = 778
- (2010) Future Cash Flows = 105.7 + 930 - 14.3 - 2.2 - 205 = 814.2
- (2011) Future Cash Flows = 245 + 805 - 17 - 3.5 - 350 = 679.5
- (2012) Future Cash Flows = 394.8 + 660 - 18.5 - 4.1 - 350 = 682.2
- (2013) Future Cash Flows = 543.2 + 550 - 19.8 - 4.7 - 420 = 648.7
And after the year 2013 the growth rate of 3% is estimated.
- Present values of all these cash flows are calculated as follows:
- Present Value of Cash Flows for Year 2009 = 778 / (1.15) = 676.5
- Present Value of Cash Flows for Year 2010 = 814 / (1.15^2) = 615.5
- Present Value of Cash Flows for Year 2011 = 679.5 / (1.15^3) = 446.78
- Present Value of Cash Flows for Year 2012 = 682.2 / (1.15^4) = 390.05
- Present Value of Cash Flows for Year 2013 and beyond = (648.7 + 5,568) / (1.15^5) = 3,090.8
- Total Company Value is 676.5 + 615.5 + 446.78 + 390.05 + 3,090.8 = 5,219.63
Conclusion: Both cash flow statements and cost benefit analysis help the company for decision making process. Without them it is not possible to predict whether the project will make profits or loss. It also show how much benefits this project will give to the company and to what extent it will increase in the value of the company.