What does the Stock Market Index mean? Stock Index futures offer the investor a medium for expressing an opinion on the general course of the market. The general movement of the stock market is usually measured by averages or indices consisting of groups of securities that are supposed to represent the entire stock market or its particular segments. Thus, Security Market Indices or Security Market Indicators provide a summary measure of the behavior of security prices and the stock market. So, what is the topic we are going to discuss: Purpose and Limitations of Stock Market Index!
Explained Stock Market Index Concept with their Purpose and Limitations!
The principal stock market indices used in India are the Bombay Stock Exchange Sensitive Index (BSE Sensex) and the S&P CNX Nifty known as the NSE Nifty (National Stock Exchange Fifty). In addition, these contracts can be used by portfolio managers in a variety of ways to alter the risk-return distribution of their stock portfolios. For instance, much of a sudden upward surge in the market could be missed by the institutional investor due to the time it takes to get money into the stock market.
Stock Index Futures:
By purchasing stock- index contracts, the institutional investors can enter the market immediately and then gradually unwind the long futures position as they are able to get more funds invested the stock. Conversely, after a run-up in the value of the stock portfolio (assuming it is well diversified and correlates well with one of the major indexes) a portfolio manager might desire to lock in the profits much after being required to report this quarterly return on the portfolio.
By selling an appropriate number of stock index futures contracts, the institutional investors could offset any losses on the stock portfolio with corresponding gains on future position. As a speculation tool, stock index futures represent an inexpensive and highly liquid short-run alternative to speculating on the stock market.
Instead of purchasing the stock that makes up an index or proxy portfolio, a bullish (bearish) speculation can take a long (short) position in an index futures contract, then purchase treasury securities to satisfy the major requirements. A long or short speculative futures position is referred to as a purely speculative position or a naked (outright) position.
The Purpose of an Index in the Stock Market:
The security market indices are indicators of different things and are useful for different purposes.
The following are the important uses of a stock market index:
Security market indices are the basic tools to help and analyze the movements of prices of various stocks listed on stock exchanges and are useful indicators of a country’s economic health.
Indices can be calculated industry-wise to know their tread pattern and also for comparative purposes across the industries and with the market indices.
The growth in the secondary market can be measured through the movement of indices.
The stock market index can be used to compare a given share price behavior with past movements.
Generally, stock market indices are designed to serve as indicators of broad movements in the securities market and as sensitive barometers of the changes in trading patterns in the stock market.
The investors can make their investment decisions accordingly by estimating the realized rate of return on the stock market index between two dates.
Funds can be allocated more rationally between stocks with knowledge of the relationship of prices of individual stocks with the movements in the market.
The return on the stock market index, which is known as the market return, is helpful in evaluating the portfolio risk-return analysis. According to modern portfolio theory’s capital asset pricing model, the return on a stock depends on whether the stock’s price follows prices in the market as a whole; the more closely the stock follows the market, the greater will be its expected return.
Purpose and Limitations of Stock Market Index, Image credit from #Pixabay.
Limitations of Stock Market Index (Indices):
Though stock market indices are the basic tools to help and analyze the movements of the price of the stock markets and are a useful indicator of a country’s economic health, they have their own limitations also.
The following points deal with those limitations:
Whenever a company issues rights in the form of convertible debentures (to be converted at a later stage) or other instruments (warrants) entitling the holder to acquire one equity share of the company at a specified price at a notified future date, the equity capital increases only on conversion of debentures or the exercise of warrants/Secured Premium Notes (SPNs), option for equity shares but the market adjusts the ex-rights price of the share immediately (on the day the share starts trading ex-rights) on the basis of the anticipated increase in equity capital and likely reduced earnings per share, etc.
Hence, some modification is needed to adjust the equity capital suitably in advance. But the exact procedure by which this can be done is very difficult to state since the internal market mechanism which adjusts the ex-rights share price is almost impossible to know precisely.
Again, this is a common limitation of all the indices and so far, the increased equity capital is considered only after the debentures are converted into shares and are acquired for warrants/SPNs and the new shares are listed for trading on the stock exchange.
The coverage (in terms of number of scrips, number of stock exchanges used and the respective weights assigned) is different for all the indices and hence, each index may give only a partial picture of the movement of prices or the state of the market presented may be misleading.
The financial institutions sometimes convert the loans extended by them to companies into equity shares at a specified date. This causes sudden and significant changes in the market capitalization and hence the weights assigned to those scrips change violently.
The various stock market indicators around the world have been in use for many years and it has satisfied the needs of millions of investors and stockbrokers. But the stock markets, by their very nature, are very dynamic and hence, the indices should be revised or adjusted periodically to reflect the changed conditions so that they continue to be relevant.
Whenever prices of scripts listed on more than one stock exchange are used, most liquid prices (on anyone stock exchange) should be used (rather than the present practice of using the arithmetic average of prices on all the exchanges, as the same script may not enjoy the identical degree of liquidity on all exchanges).
The limitations indicated may not be eliminated totally, but appropriate adjustments are certainly called for. The classification of industries into various groups for calculation of various industry indices is presently rather vague and presents problems in the case of diversified companies. Also learned, What does Welfare Economics mean? Measuring and Value decisions!
This should be made uniform or the classification should be made in such a way that it reflects the major operations carried on by each company. Overall, one can say that the various stock market indicators devised have more or less served their purpose, despite their limitations but these can be made more effective and dynamic by introducing appropriate modifications 0£ the existing ones to serve the investing public better.
What does mean Group Technology? Group technology or GT takes advantage of the similarities of parts and machines in a manufacturing system. In this paper, the classification and clustering approaches to group technology in manufacturing systems are discussed. The mathematical programming formulations for the clustering problem are presented. GT is the important technology among the others and it will play a major role in the factory of the future. So, what is the topic we are going to discuss; Group Technology: Meaning, Definition, Advantages, and Limitations.
Here are explained; What is the Group Technology? first Meaning, Definition, Advantages, and finally Limitations.
Meaning of Group technology: GT is a concept that is currently attracting a lot of attention from the manufacturing community. GT offers a number of ways to improve productivity in batch manufacturing. The essence of GT is to capitalize on similarities in recurring tasks. GT is, very simply, a philosophy to exploit similarities and achieve efficiencies grouping like problems.
Group technology is an approach to organizing manufacture which can be applied in any industry (machining, welding, foundry, press work, forging, plastic molding, etc.) where small-batch variety production is used.
Discuss of GT list;
What is the Group Technology?
Meaning of Group Technology.
Definition of Group Technology.
Advantages of Group Technology, and.
Limitations of Group Technology.
Definition of Group technology:
The basic approach enables all aspects of manufacturing, from design, through estimating and planning, to production, to be rationalized. It forms the basis for the development of computer-aided procedures and flexible automation. Group technology is a manufacturing philosophy or principle whose basic concept is to identify and bring together related or similar parts and processes, to take advantage of the similarities which exist, during all stages of design and manufacture.
If parts can be classified into families, and machines arranged into groups, then the handling of parts during manufacture can be easily done by the robot. It must be understood that there exists a relationship between finished products and the parts from which they are made. While assemblies may bear little relation to each other, the sub-assemblies from which they are constructed will exhibit some like features. By exploiting the similarities which exist among such a population of parts, group technology sets out to reduce the time and cost of manufacture.
“Group technology is the realization that many problems are similar and that, by grouping similar problems, a single solution can be found to a set of problems, thus saving time and effort.”
Explain the Definition;
The main theme is thus to identify somehow from the large variety of parts those families which require similar manufacturing operations. Cells are created to manufacture defined types and size ranges of parts. Groups of machines, chosen for each family are situated together in a group layout, in such a way that parts flow from one machine to the next in the sequence of operation.
It is not necessary for every part to visit each machine, but the machines in a cell should ideally be capable of carrying out all the operations required in the family. It may be remembered that in a functional layout, all like machines are grouped at one place and thus a product has to move a lot of distance in a zig-zag manner. But in a cell layout, various machines are arranged so that product flows from one machine to the next in sequence.
History of Group Technology:
Prior to 1913, the era of Henry Ford and his Model T, all machining models were similar to our present job shop techniques with machines laid out usually in lines or blocks of similar machines. The work was loaded onto the machines usually by the manual progress control system. Ford introduced the assembly line and that, in turn, led to automated transfer machines. However, the majority of engineering do not produce items in the quantity that justify such methods and so the jobbing shop philosophy continued.
GT is mainly coordination of normal good engineering practices. It is impossible to say who first practiced GT. There are reports of it having been used in Germany in the 1930s. In an international Conference held in Stockholm in 1947, the basic groups were explained by C.B.Nanthorst. In Italy, M. Patrignany was an early exponent of this technology. However, little of this appears to have been in English. First published work was from the USSR by S.P.Mitrofanov in 1959 and thereafter subsequent books here published by F.S.Denyanyuk and E.K. Ivanov.
The first reported work on GT outside Russia was done by a French Forges et Ateliers de Construction Electriques de Jeurmont – and this was about in Machinery in 1962. Subsequently, several British companies conducted considerable work in this field. There have also been considerable studies done by various consultants in the Universities. The significant contribution by J.L.Burbidge in the 1960s led to GT as A total Manufacturing Philosophy.
Advantages of Group Technology:
According to Burbidge, the following are the advantages of introducing GT in manufacturing.
Short throughput times because machines are closed together.
Better quality because groups complete parts and the machines are closed together under one foreman.
Lower material handling costs because machines are closed together under one foreman.
Better accountability because of machines complete parts. The foreman can be made responsible for costs, quality, and completion by the due date.
Training for promotion since GT provides a line of succession because a group is a mini-department.
Automation GT is the first evolutionary step in automation.
Reduced set up time since similar parts brought together on the same.
Morale and job satisfaction since most workers prefer to work in groups.
The output is improved due to improved resource utilisation.
Work in progress and finished stock levels are reduced.
Simplified estimating, accounting and work management.
Improved plant replacement decisions, and.
Improved job satisfaction, morale, and communication.
Studies were undertaken by N.L.Hyer indicates the following significant savings after implementing GT Snead prepared a summary matrix, listing the benefits listing benefits achieved for the various GT. What is the Definition of Production Management?
Group Technology: Meaning, Definition, Advantages, and Limitations. #Pixabay.
Limitations of Group Technology:
Group Technology is a great concept. But all good concepts do have their own limitations and need proper care in their applications for results to be realized in practice.
The Disadvantages of Group Technology or cellular manufacturing may be as follows.
High Cost: The cost of implementation is generally high. This is because an outside consultant is often required since in-house expertise on GT is rarely available. It requires a long set up time and painful debugging.
Not Suitable for large Variety of Products: May not be suitable for a factory with a very large variety of products.
The entire production of the company cannot be put under the GT and hence GT will have to coexist with the conventional layouts.
Not suits all Applications: There are too many GT codes in used and there is no one GT code that suits all applications.
It is often difficult to conceive all the operations for a group of components being taken care of in the cell created for it.
The range of product mix in a plant may be under constant change in which case the GT cells may need a constant revision which is impractical.
The additional cost of implementation of this system.
The rate of change in product range and mix.
Difficulties with out-of-cell operations, and.
Coexistence with non-cellular systems.
How to Uses of Group Technology in the Company for Production?
Survey of product and use of group technology:
Group technology technique can be conveniently followed using a classification system. In an assembly, a variety of parts exist. These varieties of parts can be-segregated in three broad areas, viz.
Standard and proprietary parts (like nuts, bolts, screws, keys, washers, etc.)
Similar parts (like shafts, gears, bearings, levers, etc.)
Product specific parts (like gearbox, bed, saddle, etc.)
It may be noted that the group technology is not concerned with categories (i) and (iii) but relates to category (ii). The aim thus is to group the range of parts under the category (ii) in some way, for the purpose of manufacture. Several types of classification systems have been devised and one has to carefully consider the system based on his needs.
An organization with a wide range of products needs a complex detailed system but the same is not good for the one dealing with a limited range. Provision should always be made for future likely growth and classification system chose must keep this requirement in view.
Organizational suitability for Group Technology:
The suitability of a firm for the introduction of GT depends on several factors. The survey of Willey and Dale give a tentative description of a company profile likely to achieve. The greatest benefits from GT, some of these are:
The company must be a relatively small organization with reasonably small machine tools, and manufacturing equipment.
The company should not be typified by either large or small component variety.
The batch sizes and the batch size range of products of the companies it is relatively small.
Athersmith and Crookall Rajagopal and Smith Gupta Andand Grayson have suggested. Another way of finding out the suitability of GT for a batch production industry. Computer simulation has been used by the effect of the introduction of GT in the batch production. Industries based on the parameters such as throughput time. WIP inventory and plant utilization Further GT are considered a desirable stepping stone for establishing Just-In-Time production.
What does mean Economic Laws? The Generalization or Law is the establishment of a general truth based on particular observations or experiments. Which trace a causal relationship between two or more phenomena. But economic laws are statements of general tendencies or uniformities in the relationships between two or more economic phenomena. So, what is the question we going to study?
The Concept of Economic Laws: first study their Meaning, Definition, Features, Nature, and finally Limitations.
Meaning and definition of Economic Laws: Economic laws are nothing more than careful conclusions and inferences drawn with the help of reasoning or by the aid of observation of human and physical nature. In everyday life, we see that man is always busy satisfying his unlimited wants with limited means. In doing so, it acts upon certain principles.
Marshall defined economic laws in these words,
“Economic laws, or statements of economic tendencies, are those social laws, which relate to those branches of conduct in which the strength of the motives chiefly concerned can be measured by money price.”
On the other hand, according to Robbins,
“Economic laws are statements of uniformities about human behavior concerning the disposal of scarce means with alternative uses for the achievement of ends that are unlimited.”
These two definitions are common in that they consider economic laws as statements of tendencies or uniformities relating to human behavior.
Features of Economic Law:
The following six points highlight the features of economic laws.
Are not Commands:
Economic laws are not orders of the state (government) and do not command. They formulate based on people’s behavior in the real world.
Are not Exact:
Since economic laws deal with the actions of human beings having free will. They are not as exact as the laws of the natural sciences. They are statements that are true only in general. For example, the statement that men will buy goods at the cheapest available market is true generally but not universally. A man intentionally pays a higher price to help a relative or a friend. But such cases form a small fraction of the total transactions of human beings.
Economists tacitly ignore these exceptional cases and frame them. Their laws on the expectation that men’s actions will, in the great majority of cases, follow a uniform pattern. This makes economic laws generally true, but less exact than physical laws. “Economic laws are probability laws, not exact relationships.” “Abnormal as well as normal patterns of probabilities occur in economics”, as Samuelson has commented.
Statements of Cause and Effect:
Economic laws, like scientific laws, are statements of cause and effect. They attempt to state the effects that will follow from particular causes. Unfortunately, in economic affairs, many factors operate simultaneously. And it is impossible to isolate each factor to find out its effects separately. The qualifying clause “other things remaining the same” (ceteris paribus), uses to get over this difficulty. But in economic life, other things generally do not remain the same. Hence, economic laws are never exact enough to enable accurate predictions or prophecies existing made.
Hypothetical:
Economic laws are hypothetical Economic laws are also hypothetical, i.e. They are conclusions drawn from certain assumptions or hypotheses. But in this, economic laws do not differ from other scientific laws. The laws of science also start from certain hypotheses and deduce certain consequences.
Predictions are Difficult:
As regards making predictions the following example may note. The simple and exact laws of gravitation enable astronomers to make accurate forecasts. But in the case of tides, the level of water depends on so many factors (e.g., the strength of the attracting force, geographical features of the country, etc.) that it is impossible to forecast the level accurately. Marshall, therefore, says, “The laws of economics are to compare with the laws of tides rather than with the simple and exact laws of gravitation”.
There are the Same Physical Laws:
Some laws dealt with in books of economics deal with inanimate nature, e.g., the Law of Diminishing Returns. These laws borrow from other sciences.
Nature of Economic Laws:
The following Nature of Economic Laws below are;
The nature of economic laws is that they are less exact as compared to the laws of natural sciences like Physics, Chemistry, Astronomy, etc. An economist cannot predict with surety what will happen in the future in the economic domain. He can only say what is likely to happen shortly. The reasons why economic laws are not as exact as that of natural sciences are as follows:
First
Natural sciences deal with the lifeless matter. While economics, we are concerned with the man who endows with the freedom of or may act in whatever manner he likes. Nobody can predict with certainty his future actions. This element of uncertainty in human behavior results in making the laws of economics less exact than the laws of natural sciences.
Secondly
In economics, it is very difficult to collect factual data on which economic laws are to be based. Even if the data stands collected it may change at any moment due to sudden changes in the tastes of the people or their attitudes.
Thirdly
Many unknown factors affect the expected course of action and thus can easily falsify economic predictions. Dr. Marshall has devoted one chapter in his famous book “Principles of Economies” to discussing the nature of economic laws. He writes, that laws of economics are to compare with the laws of tides rather than with the simple and exact law of gravitation.
The reason for comparing the laws of economics with the laws of tides by Marshall is that the laws of tides are also not exact. The rise of tides cannot be accurately predicted. It can only say that the tide expects to rise at a certain time. It may or may not rise. Strong wind may change its direction to the opposite side. Instead of rising may fall. So is the case with the laws of economics.
Scientific or Natural or Physical Laws:
Economic laws are like scientific laws which trace out a causal relationship between two or more phenomena. As in natural sciences, a definite result expects to follow from a particular cause in economics. The law of gravitation states that things coming from above must fall to the ground at a specific rate, other things being equal. But when there is a storm, the gravitational force will reduce and the law will not work properly.
As pointed out by Marshall, “The law of gravitation is, therefore, a statement of tendencies”. Similarly, economic laws are statements of tendencies. For instance, the law of demand states that other things remain the same, a fall in price leads to an extension in demand and vice versa. Again, some economic laws are positive like scientific laws. Such as the Law of Diminishing Returns which deals with inanimate nature.
Since economic laws are like scientific laws, they are universally valid. According to Robbins, “Economic laws describe inevitable implications. If the data they postulate are given, then the consequences they predict necessarily follow. In this sense, they are on the same footing as other scientific laws.”
Non-Precise like the Laws of Natural Sciences:
Despite these similarities, economic laws are not as precise and positive as the laws of natural sciences. This is because economic laws do not operate with as much certainty as scientific laws. For instance, the law of gravitation must operate whatever the conditions may be. Any object coming from above must fall to the ground. But demand will not increase with the fall in price. If there is a depression in the economy because consumers lack purchasing power.
Therefore, according to Marshall, “There are no economic tendencies. Which act as steadily and can measure as exactly as gravitation can, and consequently. There are no laws of economics. Which can compare for precision with the law of gravitation”. Their control of experimentation in the natural sciences and the natural scientist can test scientific laws very rapidly by altering natural conditions such as temperature and pressure in their experiments in the laboratory.
But in economics
Controlled experiments are not possible because an economic situation is never repeated exactly at another time. Moreover, the economist has to deal with the man who acts by his tastes, habits, idiosyncrasies, etc. The entire universe or that part of it in which he carries out his research is the economist’s laboratory. As a result, predictions concerning human behavior are liable to error.
For instance, a price rise may not lead to a contraction in demand rather it may expand it. If people fear the shortage of goods in anticipation of war. Even if demand contracts as a result of the price rise. It is not possible to predict accurately how much the demand will contract. Thus economic laws “do not necessarily apply in every individual case. They may not be reliable in the ever-changing environment of the real economy. And they are in no sense, of course, inviolable.”
Non-predictable like the Law of Tide:
But accurate predictions are not possible in economics alone. Even sciences like biology and meteorology cannot predict or forecast events correctly. The law of tide explains why the tide is strong at the full moon and weak at the moon’s first quarter. On this basis, it is possible to predict the exact hour when the tide will rise. But this may not happen. It may rise earlier or later than the predicted time due to some unforeseen circumstances.
Marshall, therefore, compared the laws of economics with the laws of tides “rather than with the simple and exact law of gravitation. For the actions of men are so various and uncertain that the best statements of tendencies, which we can make in a science of human conduct, must need be inexact and faulty.”
Behaviorist:
Most economic laws are behaviorist, such as the law of diminishing marginal utility, the law of Equimarginal utility, the law of demand, etc., which depend upon human behavior. But the behaviorist laws of economics are not as exact as the laws of natural sciences because they are based on human tendencies which are not uniform. This is because all men are not rational beings.
Moreover, they have to act under the existing social and legal institutions of the society in which they live. As rightly pointed out by Prof. Schumpeter: “Economic laws are much less stable than are the ‘laws’ of any physical science…and they work out differently in different institutional conditions”
Indicative:
Unlike scientific laws, economic laws are not assertive. Rather, they are indicative. For instance, the Law of Demand simply indicates that other things being equal, quantity demanded varies inversely with price. But it does not assert that demand must fall when price increases.
Hypothetical:
Prof. Seligman characterized economic laws as “essentially hypothetical” because they assume ‘other things being equal and draw conclusions from certain hypotheses. In this sense, all scientific laws are also hypothetical as they too assume the ceteris paribus clause. For instance, other things being equal, a combination of hydrogen and oxygen in the proportion of 2:1 will form water. If, however, this proportion is varied or/and the required temperature and pressure are not maintained, water will not be formed.
Still, there is a difference between hypothetical elements present in economic laws and against scientific laws. It is more pronounced in the former because economics deals with human behavior and natural sciences with the matter. But as compared with the laws of other social sciences, the laws of economics are less hypothetical but more exact, precise, and accurate.
This is because economies possess the measuring rod of money which is not available to other social sciences like ethics, sociology, etc. which makes economics more pragmatic and exact. Despite this, economic laws are less certain than the laws of social sciences because the value of money does not always remain constant. Rather, it changes from time to time.
Truisms or Axioms:
Certain generalizations in economics may state as a truism. They are like axioms and do not have any empirical content, such as ‘saving is a function of income,’ ‘human wants are numerous’, etc. Such statements are universally valid and need no proof. So they are superior to scientific laws. But all economic laws are not like axioms and hence not universally valid.
Historico-Relative:
On the other hand, economists of the Historical School regarded economic laws as abstractions that are historical-relative, that is economic laws have only a limited application to a given time, place, and environment.
They have limited validity to certain historical conditions and have no relevance to the analysis of social phenomena outside that. But Robbins does not agree with this view because according to him, economic laws are not historical-relative. They are simply relative to the existence of certain conditions which assume to give. If the assumptions are consistent with one another and if the process of reasoning is logical, economic laws would be universally valid.
But these are big “ifs”. We, therefore, agree with Prof. Peterson that economic laws “are not detailed and photographically faithful reproductions of a portrait of the real world, but are rather simplified portraits whose purpose is to make the real world intelligible.”
Economic Laws: Meaning, Definition, Features, Nature, and Limitations. Image credit from #Pixabay.
Limitation of Economic Laws:
One major drawback of economic laws is they lack generality. For example, the laws developed to explain the nature and functioning of capitalist economies do not have any relevance to socialist countries. For example, Alfred Marshall developed the laws of demand and supply which apply in a free market in the absence of government intervention. Such laws do not apply in erstwhile countries like the former Soviet Union where the price (market) system yielded place to the planning system.
In a planned economy, the market mechanism replaces by government allocation or rationing. So, the question of applying the laws of demand and supply does not arise. Thus, economic laws lack generality and are not universally applicable. Furthermore, some laws of economics which have been developed in the context of advanced industrial countries may not find application in developing countries like India.
As V. K. R. V. Rao has pointed out, the multiplier principle, as enunciated by Keynes in the context of the advanced countries of the world, does not work in developing countries like India. This is attributable to the structure of such economies. Similarly, the Quantity Theory of Money has been developed in the context of industrially advanced countries. It seeks to establish an exact, proportional relationship between money and prices.
But, it cannot explain’ the present price situation in India.
Here, inflation is not a purely monetary phenomenon as predicted by the Quantity Theory. These two examples make one thing clear at least — the laws and theories of economics developed in the context of advanced countries cannot be applied in developing countries like India. There is a feeling among some groups of economists that, people in developing countries like India behave and respond differently from those in advanced countries.
For example, greater self-consumption of farmers in India explains why the supply response of agricultural commodities is not always favorable in the event of a rise in the price of agricultural products. It is often observed that, if the price of a particular commodity rises, farmers produce less of it to maintain the same level of income. Thus,’ they not only produce less at a higher price but generate less marketable surplus when the price rises. Thus, the marketable surplus of, say, wheat varies inversely with its price.
But, in developed countries, it is observed that, as usual, the supply curve of agricultural output slopes upward from left to right, and the marketable surplus increases when the price rises. All these examples make it abundantly clear that most of the laws and principles of economics which have been developed in the context of advanced countries cannot be applied in developing countries like India.
Learn about the different sales forecasting methods, their importance, advantages, and limitations. Optimize your sales strategy with expert insights. Sales Forecasting; Every manufacturer makes an estimation of the sales likely to take place in the near future. It gives focus to the activities of a business enterprise. In the absence of sales forecast, a business has to work at random. Forecasting is one of the important aspects of administration. The comer-stone of successful marketing planning is the measurement and forecasting to market demand. The sales forecast is the estimate of the number of sales to be expected for an item/product or products for a future period of time. So, what we discussing is – Types, Importance, Advantages, and Limitations of Sales Forecasting.
The Concept of Forecasting explains Sales Forecasting by Types, Importance, Advantages, and Limitations.
In this article is discussing, Sales Forecasting: Types of Sales Forecasting, Importance of Sales Forecasting, Advantages of Sales Forecasting, and Limitations of Sales Forecasting. So, let’s discuss; Meaning of Sales Forecasting: Any forecast can be termed as an indicator of what is likely to happen in a specified future time frame in a particular field. Therefore, the sales forecast indicates as to how much of a particular product is likely to be sold in a specified future period in a specified market at the specified price. Accurate sales forecasting is essential for a business house to enable it to produce the required quantity at the right time.
Types of Sales Forecasting:
The following Types of Sales Forecasting below are:
Economic: This type of forecast is important to understand the general economic trend through a careful study of Five Year Plans, Gross national products. National income, Government expenditure, Unemployment, Consumer spending habits etc. This is in order to have an accurate forecast. Big companies, in India, adopt this method.
Industry: The future market demand is calculated through industrial forecast or market forecast. The expected sales forecasts of all the industries, in the same line of business are combined. Market demand may be affected by controllable-price, distribution, promotion, etc., and uncontrollable-demographic, economic, political, technological development, cultural activities etc. The executive must take into account all these conditions while forecasting.
Company: The third step goes to the firm concerned to look into the market share, for which forecast is to be made. By considering both controllable and uncontrollable, based on chosen marketing plans within the firm, with that of other industries, steps are taken in formulating forecasts.
There are three classes (Periods) of sales forecasts:
Short-run Forecast:
It is also known as operating forecast, covering a maximum of one year or it may be half-yearly, quarterly, monthly and even weekly. This type of forecasting can be advantageously utilized for estimating stock requirements, providing working capital, establishing sales quotas, fast-moving factors. It facilitates the management to improve and coordinate the policies and practice of Marketing-production, inventory, purchasing, financing etc. The short-run forecast is preferred to all types and brings more benefits than other types.
Purpose of Short-Term Forecasting:
Production Policy: By knowing the future demand the decision regarding production policy can be taken so that there is no problem of overproduction and short supply of input materials.
Material Requirement Planning: By knowing the future demand, the availability of the right quantity and quality of materials could be ensured.
Purchase Procedure: The purchase programme could be decided depending on the material requirements.
Inventory Control: Proper control of inventory could be ensured so that inventory carrying cost is minimum or optimum.
Equipment Requirement: The decision regarding procurement of new equipment in view of the capacity and capability of the existing equipment can be taken.
Man-Power Requirement: The decision regarding recruitment of extra labor on the full time or part time could be taken.
Finance: The arrangement of funds for the purchase of raw materials, machines, and parts could be made.
Medium-run Forecast:
This type of forecast may cover from more than one year to two or four years. This helps the management to estimate probable profit and control over budgets, expenditure, production etc. The factors-price trend, tax policies, institutional credit etc., are specially considered for a good forecast.
Long-run Forecast:
This type of forecast may cover one year to five years, depending on the nature of the firm. Seasonal changes are not considered. The forecaster takes into account the population changes, competition changes, economic depression or boom, inventions etc. Also, This type is good for adding new products and dropping old ones. The forecasting that covers a considerable period of time, such as 5, 10, 20 years is called long-term forecasting.
The period no doubt depends upon the nature of business or type of the product the firm is engaged in manufacturing. In many industries like steel plants petroleum refinery or paper mills where the total investment for the equipment/infrastructure is quite high, long-term forecasting is needed.
Purposes of Long-Term Forecasting:
To plan for the new unit of production, or expansion of the existing unit or diversification of lines of production or shut down of the existing units depending upon the level of demand.
Also, To plan the long-term financial requirement for various needs.
To make proper arrangement for training the personnel so that manpower requirement of desired expertise can be met in future.
Importance of Sales Forecasting:
The following Importance of Sales Forecasting below are:
Supply and demand for the products can easily be adjusted, by overcoming temporary demand, in the light of the anticipated estimate; and regular supply is facilitated.
A good inventory control is advantageously benefited by avoiding the weakness of understocking and overstocking.
Allocation and reallocation of sales territories are facilitated.
It is a forward planner as all other requirements of raw materials, labor, plant layout, financial needs, warehousing, transport facility etc., depend in accordance with the sales volume expected in advance.
Sales opportunities are searched out on the basis of forecast; mid thus discovery of selling success is made.
It is a gear, by which all other activities are controlled as a basis of forecasting.
Advertisement programmes are beneficially adjusted with full advantage to the firm.
It is an indicator to the department of finance as to how much and when finance is needed; it helps to overcome difficult situations.
It is a measuring rod by which the efficiency of the sales personnel or the sales department, as a whole, can be measured.
Sales personnel and sales quotas are also regularized-increasing or decreasing-by knowing the sales volume, in advance.
Additional:
It regularizes productions through the vision of sales forecast and avoids overtime at high premium rates. It also reduces idle time in manufacturing.
As is the sales forecast, so is the progress of the firm. The master plan or budget of a firm is based on forecasts. “The act of forecasting is of great benefit to all who take part in the process and is the best means of ensuring adaptability to changing circumstances. The collaboration of all concerned leads to a unified front, an understanding of the reasons for decisions, and a broadened outlook.”
Sales forecast enables all the departments of the business to work together in proper coordination and cooperation.
Sales forecast helps in product mix decisions as well. It enables the business to decide whether to add a new product to its product line or to drop an unsuccessful one.
The sales forecast is a commitment on the part of the sales department and it must be achieved during the given period, and.
It helps in guiding marketing, production and other business activities for achieving these targets.
Advantages of Sales Forecasting:
Sales are the lifeblood of every company. The advantages of forecasting your company’s sales lie mainly in giving you a firm idea of what to expect in the coming months. A standard sales forecast looks at conditions present in your business during previous months and then applies assumptions regarding customer acquisition, the economy, and your product and service offerings. Forecasting sales identifies weaknesses and strengths before you set your budget and marketing plans for the next year, allowing you to optimize your purchasing and expansion plans.
The following Advantages of Sales Forecasting are four types:
1. Cash Flow:
Forecasting helps manage cash flow by predicting future sales and ensuring that the company can meet its financial obligations. This foresight can prevent potential shortfalls and ensure that there are sufficient funds for operations, investments, and emergencies.
2. Purchasing:
Sales forecasting aids in planning purchasing activities. By anticipating future demand, companies can make timely and cost-efficient procurement decisions, avoiding both overstocking and stockouts.
3. Planning:
It assists in strategic planning by providing a basis for making informed decisions. This includes production planning, workforce planning, and setting realistic sales targets and marketing strategies.
4. Tracking:
Sales forecasting offers a framework for tracking progress and performance. This allows management to monitor actual sales against forecasts, identify variances, and adjust strategies accordingly to stay on track with company goals.
By leveraging these advantages, businesses can enhance their operational efficiency, financial stability, and overall market competitiveness.
Limitations of Sales Forecasting:
In certain cases forecast may become inaccurate. The failure may be due to the following factors:
Fashion:
Changes are throughout. Present style may change any time. It is difficult to say as to when a new fashion will be adopted by the consumers and how long it will be accepted by the buyers. If our product is similar to fashion and is popular, we are able to have the best result; and if our products are not in accordance with the fashion, then sales will be affected.
Lack of Sales History:
A sales history or past records are essential for a sound forecast plan. If the past data are not available, then the forecast is made on guess-work, without a base. Mainly a new product has no sales history and forecast made on guess may be a failure.
Psychological Factors:
Consumer’s attitude may change at any time. The forecaster may not be able to predict exactly the behavior of consumers. Certain market environments are quick in action. Even rumors can affect market variables. For instance, when we use a particular brand of soap, it may generate itching feeling on a few people and if the news spread among the public, sales will be seriously affected.
Other Reasons:
It is possible that the growth may not remain uniform. It may decline or be stationary. The economic condition of a country may not be favorable to the business activities-policies of the government, the imposition of controls etc. It may affect the sales.
Basic Limitations of Sales Forecasting;
The tastes and preferences of the buyers do not remain constant. A sudden change in the preference of the buyers may render the forecasts meaningless.
The economic conditions prevailing in every country also do not remain stable. The purchasing power of money, desire to save and invest etc., are some of the important economic factors having a bearing on sales forecast.
The political conditions in a State also influence sales forecast. The policies of the Government regarding business change often. A sudden hike in excise duty or sales tax by the Government may affect sales.
The entry of competitors may also affect sales. A firm enjoying monopoly status may lose such a position if the buyers find the competitors’ products more superior.
Progress in science and technology may render the present technology obsolete. As a result, products which are right now enjoying a good market may lose the market and the demand for products made using the latest technology will increase. This is particularly true in the case of the market for electronic goods, computer hardware, software and so on.
The methods of sales forecasting discussed above have respective advantages and limitations or merits and demerits. No single method may be suitable. Therefore, a combination method is suitable and may give a good result. The forecaster must be cautious while drawing decisions on sales forecast. Periodical review and revision of sales forecast may be done, in the light of performance. A method which is quick, less costly and more accurate may be adopted.
Financial planning is an important part of financial management. It is the process of determining the objectives; policies, procedures, programmes, and budgets to deal with the financial activities of an enterprise. Financial planning reflects the needs of the business and is integrated with the overall business planning. Proper financial planning is necessary to enable the business enterprise to have the right amount of capital to continue its operations efficiently. So, what we discussing is – Financial Planning: Steps, Elements, Advantages, Limitations.
The Concept of Financial Planning explains their key points into Steps, Elements, Advantages, and Limitations.
Financial planning involves taking certain important decisions so that funds are continuously available to the company and are used efficiently. In this article we Discuss; Financial Planning: Steps of Financial Planning, Elements of Financial Planning, Advantages and Disadvantages of Financial Planning, Limitations of Financial Planning, and Process of Financial Planning.
Steps in Financial Planning:
Financial planning involves the following steps:
These are:
Set-up Financial Objectives.
Financial Policies.
Procedures, and.
Flexibility.
Now, explain each one;
Set-up Financial Objectives:
The financial objectives of a company should be clearly determined. Both short-term and long-term objectives should be carefully prepared. The main purpose of financial planning should be to utilize financial resources in the best possible manner. There should be an optimum utilization of funds. The concern should take advantage of the prevailing economic situation.
Financial Policies:
The financial policies of a concern deal with procurement, administration, and distribution of business funds in the best possible way. There should be clear-cut plans of raising required funds and their possible uses. The current and future needs for funds should be considered while formulating financial policies.
Procedures:
The procedures are formed to ensure consistency of actions. The procedures follow the formulation of policies. If a policy is to raise short-term funds from banks, then a procedure should be laid to approach the lenders and the persons authorized to initiate such actions.
Flexibility:
The financial planning should ensure proper flexibility in objective, policies, and procedures so as to adjust according to changing economic situations. The changing economic environment may offer new opportunities. The business should be able to make use of such situations for the benefit of the concern. A rigid financial planning will not let the business use new opportunities.
Elements of Financial Planning:
Financial planning involves the following steps or elements:
These are:
Objectives.
Capital Requirements.
Kinds of Securities to be issued, and.
Policies.
Now, explain each one;
Objectives:
For effective financial planning, it is essential to clearly lay down the financial objectives sought to be achieved. The financial objectives should be based on the overall objectives of the company. The objectives of financial management may be set up in the areas, namely, investment, financing, and dividend.
Capital Requirements:
Capital is required for various needs of the business. The separate assessment is to be made of the requirements of fixed and working capital. Fixed capital is needed for acquiring fixed assets such as land and building, plant and machinery, furniture, etc. It is blocked for a long time. Working capital is required for holding current assets like stock, bills receivable, etc. and cash for meeting day-to-day expenses in running the business.
Kinds of Securities to be issued:
A company can issue equity shares, preference shares, and debentures to raise long-term funds. The types and proportion of securities to be issued should be properly determined.
Policies:
Financial planning leads to the formulation of policies relating to borrowing and lending, cash control and other financial activities. Such policies will help in taking vital decisions for the administration of capital and achieving coordination in financial activities.
Advantages and Disadvantages of Financial Planning:
These are the advantages of financial planning; It will set out clearly the money that you need to put together to start the business and then to run it for a period. It will help you to obtain funding if you need it. It will help prevent you from going into a business that will not be successful. Highlight periods where your business may need extra financial help. Inspire confidence in lenders and banks that you may have to approach for finance. It will help you to spot problems early so you can make plans for the necessary solution. For example, it will highlight whether you are holding too much stock or whether your collection is less than it should be or that you will be short of cash at a particular time.
These are the disadvantages of financial planning; It can be a costly process because you will need the assistance of your accountant or financial adviser. It can take a lot of time, A financial plan merely forecasts and accounting.
Limitations of Financial Planning:
Some of the limitations of financial planning are discussed as follows:
Financial plans are prepared by taking into account the expected situations in the future. Since the future is always uncertain and things may not happen as these are expected, so the utility of financial planning is limited. The reliability of financial planning is uncertain and very much doubted.
Changes:
Once a financial plan is prepared then it becomes difficult to change it. A changed situation may demand a change in financial plan but managerial personnel may not like it. Even otherwise, assets might have been purchased and raw material and labor costs might have been incurred. It becomes very difficult to change a financial plan under such situations.
A Problem of Coordination:
The financial function is the most important of all the functions. Other functions influence a decision about the financial plan. While estimating financial needs, production policy, personnel requirements, marketing possibilities are all taken into account.
Unless there is a proper-coordination among all the functions, the preparation of a financial plan becomes difficult. Often there is a lack of coordination among different functions. Even indecision among personnel disturbs the process of financial planning.
Rapid Changes:
The growing mechanization of the industry is bringing rapid changes in the industrial process. The methods of production, marketing devices, consumer preferences create new demands every time. The incorporation of new changes requires a change in financial plan every time.
Once investments are made in fixed assets then these decisions cannot be reversed. It becomes very difficult to adjust a financial plan for incorporating fast-changing situations. Unless a financial plan helps the adoption of new techniques, its utility becomes limited.
Understand the Process of Financial Planning:
Following decisions are included in financial planning or process of financial planning is as under:
Objectives:
In the first stage, financial objectives of the organization are determined. Financial objectives of an organization may be of two kinds:
Short-term: It includes the maintenance of adequate liquidity in the organization,
Long-term: It includes the procurement of adequate finance from different sources so as to increase the efficiency of the organization.
Policies:
In the second stage of financial planning, financial policies are determined so that financial objectives could be achieved. It includes capitalization policy, capital structure policy; fixed assets management policy, dividend policy, working capital management policy, credit policy, etc.
For instance, in respect of capital structure, the policy of the company may be to depend on equity share capital in the initial years; regarding distribution of dividend, the policy may be to keep the rate of dividend low in the initial years, regarding credit sale the policy of the organization may be to sell goods on credit to creditworthy customers alone.
Procedures:
In the third stage of financial planning, financial procedures are determined. Procedures are clearer than policies. In case of a procedure, it is laid down in what order a job will be performed. For instance, the decision regarding depending on equity capital in the initial years of the company is a policy but the different steps taken to procure equity capital fall under the category of financial procedure.
Similarly, credit sale is a policy but prescribing the sequence of action to be taken in case of non-realisation of payment on time, is a financial procedure.
Financial Planning: Steps, Elements, Advantages, Limitations. Image credit from #Pixabay.
Explore the advantages and limitations of forecasting to enhance your decision-making. Gain insights into effective strategies for accurate predictions. As we know, What is Forecasting? It may not reduce the complications and uncertainty of the future. Forecasting is the process of making predictions of the future based on past and present data and most commonly by analysis of trends. A commonplace example might be an estimation of some variable of interest at some specified future date. However, it increases the confidence of the management to make important decisions. Forecasting is the basis of promising. Forecasting uses many statistical techniques.
The Concept of Business is explaining Forecasting for Company, in points of Advantages and Limitations or Disadvantages.
In this article, we will discuss Forecasting for Business Planning: First Advantages of Forecasting Methods, Advantages of Forecasting, after that Limitations of Forecasting, Basic Disadvantages of Forecasting, and finally discussing Steps in Forecasting. Usage can differ between areas of application: for example, in hydrology the terms “forecast” and “forecasting” are sometimes reserved for estimates of values at certain specific future times, while the term “prediction” is used for more general estimates, such as the number of times floods will occur over a long period.
Forecasting plays a vital role in the process of modern management. It is an important and necessary aid to planning and planning is the backbone of effective operations.
Forecasting by promoting the participation of the entire organization in this process provides opportunities for teamwork and brings about unity and coordination.
The making of forecasts and their review by managers, compel thinking ahead, looking to the future and providing for it.
Forecasting provides a way for effective coordination and control. Forecasting requires information about various external and internal factors. The information is collected from various internal sources. Thus, almost all units of the organization are involved in this process, which provides interactive opportunities for better unity and coordination in the planning process. Similarly, forecasting can provide relevant information for exercising control. Also, The managers can know their weakness in the forecasting process and they can take suitable action to overcome these.
A systematic attempt to probe the future by inference from known facts helps integrate all management planning so that unified overall plans can be developed into which divisional and departmental plans can mesh.
The uncertainty of future events can be identified and overcomes by effective forecasting. Therefore, it will lead to success in the organization.
#Limitations of Forecasting:
The following limitations of forecasting are listed below:
The basis of Forecasting:
The most serious limitations of forecasting arise out of the basis used for making forecasts. Top executives should always bear in mind that the bases of forecasting are assumptions, approximations, and average conditions.
Management may become so concerned with the mechanism of the forecasting system that it fails to question its logic. Also, This critical examination is not to discourage attempts at forecasting. But to sound caution about the practice of forecasting and its inherent limitations.
Reliability of Past Data:
The forecasting is made on the basis of past data and the current events. Although past events/data are analyzed as a guide to the future, a question is raised as to the accuracy as well as the usefulness of these recorded events.
Time and Cost Factor:
Time and cost factor is also an important aspect of forecasting. They suggest the degree to which an organization will go for formal forecasting. Also, The information and data required for forecast may be in highly disorganized form; some may be in qualitative form.
The collection of information and conversion of qualitative data into quantitative ones involves a lot of time and money. Therefore, managers have to tradeoff between the cost involved in forecasting and resultant benefits. So forecasting should be made by eliminating the above limitations.
#Disadvantages of Forecasting:
The primary disadvantage of forecasting is the same as that of any other method of predicting the future: No one can be absolutely sure what the future holds. Any unforeseen factors can render a forecast useless, regardless of the quality of its data. Also, some forecasting methods may use the same data but deliver widely different forecasts. For instance, one forecasting method can show that interest rates will rise, while another will illustrate that rates will hold steady or decline.
#Steps of Forecasting:
Procedure, stages or general steps involved in forecasting are given below:
The management can develop a sound foundation, for the future after considering available information, experience, type of business, and the rate of development.
Collecting and analyzing data:
Data collection is time-consuming. Only relevant data must be kept. Many statistical tools can be used to analyze the data.
Estimating future events:
The future events are estimated by using trend analysis. Trend analysis makes provision for some errors.
Comparing results:
The actual results are compared with the estimated results. If the actual results tally with the estimated results, there is nothing to worry. In case of any major difference between the actuals and the estimates, it is necessary to find out the reasons for poor performance.
Follow up action:
The forecasting process can be continuously improved and refined on the basis of past experience. Areas of weaknesses can be improved for the future forecasting. There must be regular feedback on past forecasting.
Above advantages and limitations, may be explained as you want to understating about Forecasting. Risk and uncertainty are central to forecasting and prediction; it is generally considered the good practice to indicate the degree of uncertainty attaching to forecasts. In any case, the data must be up to date in order for the forecast to be as accurate as possible. In some cases, the data used to predict the variable of interest is itself forecasted.
Importance of Forecasting in Business – As we know Business forecasting is an act of predicting future economic conditions based on past and present information. It refers to the technique of taking a perspective view of things likely to shape the turn of things in the foreseeable future. As the future is always uncertain, there is a need for an organized system of forecasting in business. Define, Business Forecasting is the calculation of probable events, to provide against the future. It, therefore, involves a ‘look ahead’ in business and an idea of predetermination of events and their financial implications as in the case of budgeting. So, what we discussing is – Importance, Advantages, Limitations of Business Forecasting in Business.
The Concept of Financial Management is explaining Business Forecasting for Business, in points of Importance, Advantages, and Limitations.
In this article, we will discuss Business Forecasting for Business: First Importance of Business Forecasting, then basic Advantages of Business Forecasting, after that main Advantages of Business Forecasting, and finally discussing Limitations of Business Forecasting. Let’s start discussing:
Importance of Business Forecasting:
The following key points show the growing importance of business forecasting:
These are:
Plan Formulation.
Estimation of financial requirements.
Smooth and continuous working of a concern.
The correctness of management decisions.
Promotion for new business.
Success in business.
Co-Operation and coordination, and.
Complete Control.
Each one Explanation:
Plan Formulation:
The importance of correct forecasting is apparent from the Key role it plays in planning. It should not go unaccounted that forecasting is an essential element in planning since planning premises include some forecasts. There are forecast data of a factual nature having enormous implication on sound premises. Undoubtedly, forecasting is a prelude to planning and indeed it is the foundation on which planning takes place.
In fact, planning under all circumstances and in all occasions involve a good deal of forecasting, i.e. appraising the future in the light of existing conditions and environment. Forecasting and planning are closely related. Adequate planning, no matter whether it is overall or sectoral, short-term or long-term, largely depends on forecasting.
Estimation of financial requirements:
The importance of forecasting can’t ignore in estimating the financial requirements of a concern. Efficient utilization of capital is a delicate issue before the management. No business can survive without adequate capital.
But adequacy of either fixed or working capital depends entirely on sound financial forecasting. Financial estimates can calculate in the light of probable sales and cost thereof. How much capital needs for expansion, development, etc., will depend upon accurate forecasting?
Smooth and continuous working of a concern:
“Forecasting of earnings” ensures smooth and continuous working of an enterprise, particularly to newly established ones. By forecasting, these concerns can estimate their expected profits or losses. The object of a forecast is to reduce in black and white the details of working of a concern.
The correctness of management decisions:
The correctness of management decisions to a great extent depends upon accurate forecasting.
“Administration is essentially a decision-making process and authority has responsibility for making decisions and for ascertaining that the decisions made are carried out. In business, whether the enterprise is large or small, changes in conditions occur; shifts in personnel take place, unforeseen contingencies arise. Moreover, just to get the wheels started and to keep them turning, decisions must be made.”
This shows that the decision-making process continues throughout the life of the concern. Forecasting plays an important role in various fields of concern. As in the case of production planning, management has to decide what to produce and with what resources. Thus forecasting considers an indispensable component of the business because it helps management to take correct decisions.
Promotion for new business:
Forecasting is of utmost importance in setting up a new business. It is not an easy task to start a new business as it is full of uncertainties and risks. With the help of forecasting the promoter can find out whether he can succeed in the new business; whether he can face the existing competition; what is the possibility of creating demand for the proposed product etc.
After discovering the business opportunity, he will see the possibilities of assembling men, money, materials etc. The success of a business unit depends upon as to how sound is the forecasting? Proper forecasting will help to minimize the role of luck or chance in determining business success or failure. A successful promoter is also the prophet of economic conditions.
Success in business:
The accurate forecasting of sales helps to procure necessary raw materials based on which many business activities undertake. Accurate sales forecasting becomes the basis for several other budgets. In the absence of accurate sales forecasting, it is difficult to decide as to how much production should be done.
Thus, to a great extent, the budgets of other departments depend upon the compilations based on the sales forecasts and the accuracy of these budgets also depends upon the correctness of sales forecasting. Thus, the success of a business unit depends on accurate forecasting by the various departments.
Cooperation and coordination:
Forecasting is not one man’s job. It needs proper co-ordination of all departmental heads in a company. Thus, by bringing the participation of all concerned in the process of forecasting, team spirit and coordination automatically encourage.
According to Henry Fayol,
“The act of forecasting is of great benefit to all who take part in the process and is the best means of ensuring adaptability to changing circumstances. The collaboration of all concerned leads to a united front, an understanding of the reasons for decisions and a broadened outlook.”
Complete Control:
Forecasting provides the information which helps in the achievement of effective control. The managers become aware of their weaknesses during forecasting and through implementing better effective control they can overcome these weaknesses.
Basic Advantages of Business Forecasting:
The following Advantages of Business Forecasting basically understand:
By forecasting regularly, it forces you to continually think about your future and where your business is headed. Also, This will allow you to foresee changing market trends and stay ahead of your competition.
Keep your customers satisfied by providing them with the product they want, when they want it. The advantage of forecasting in business will help predict product demand so that enough product (or staffing) is available to fill customer orders particularly if demand is seasonal.
If you expect to apply for a loan or line of credit, your financial institution will likely ask you to provide them with forecasting reports with your submission.
Forecasting can give you the intelligence to anticipate a downturn in sales and plan for it. Likewise, it can alert you to periods when you can expect an increase in sales and you can organize additional staffing ahead of time.
If you can’t measure it, you can’t improve it. Setting goals alongside your business forecast allow you to track your progress and plan your operations that are aligned with what you want to achieve.
Main Advantages of Business Forecasting:
The following Advantages of Business Forecasting below are:
These are:
Create Own a New Business.
Your Business Formulating Plans.
Based-Business Estimating Financial Require.
Facilitating Managerial Decisions.
Mostly Quality of Management.
Encourages Cooperation and coordination.
Control Better Utilisation of Resources, and.
Finally get Success in Business.
Here are Explain each:
Create Own a New Business:
While setting up a new business, several business forecasts are required. One has to forecast the demand for the product, the capacity of competitors, expected share in the market, the amount and sources of raising finances, etc. The success of a new business will depend upon the accuracy of such forecasts. If the forecasts are made systematically, then the operations of the business will go smoothly and the chances of failure will be minimized.
Your Business Formulating Plans:
Forecasting provides a logical basis for preparing plans. Also, It plays a major role in managerial planning and supplies the necessary information. The future assessment of various factors is essential for preparing plans. In fact, planning without forecasting is an impossibility. Henry Fayol has rightly observed that the entire plan of an enterprise is made up of a series of plans called forecasts.
Based-Business Estimating Financial Require:
Every business needs adequate capital. In the absence of correct estimates of financial requirements, the business may suffer either from inadequate or from excess capital. Forecasting of sales and expenses helps in estimating future financial needs. Also, The plans for expansion, diversification, or improvement necessitate the forecasting of requirements of funds. Proper financial planning depends upon systematic forecasting.
Facilitating Managerial Decisions:
Forecasting helps management to take correct decisions. By providing a logical basis for planning and determining in advance the nature of future business operations, it facilitates correct managerial decisions about material, personnel, sales, and other requirements.
Mostly Quality of Management:
It improves the quality of managerial personnel by compelling them to look into the future and make provision for the same. By focussing attention on the future, forecasting helps the management in adopting a definite course of action and a set purpose.
Encourages Cooperation and coordination:
Forecasting calls for some minimal effort on the part of all and. thus, creates a sense of participation. Also, It is not one man’s or one department’s job. No department or person can make its forecasts in isolation.
There should be a proper co-operation and co-ordination among different departments for setting proper forecasts for the business as a whole. So, the forecasting process leads to better co-operation and co-ordination among people of various departments of the organization.
Control Better Utilization of Resources:
Forecasting ensures better utilization of resources by revealing the areas of weaknesses and providing necessary information about the future. Also, Management can concentrate on critical areas and control more effectively.
Finally get Success in Business:
Success in business, to a great extent, depends upon correct predictions about the future. Systematic forecasting ensures the smooth and continuous working of the business. By knowing the future course of events in advance, one could always face the difficulties in a planned manner.
Limitations of Business Forecasting:
In spite of many advantages, some people regard business forecasting,
“As an unnecessary mental gymnastics and reject it as a sheer waste of time, money and energy.”
The reason for the same lies in the fact that despite all precautions, an element of error is bound to creep in the forecasts and we cannot eliminate guesswork in forecasts.
It is also felt that forecasting is influenced by the pessimistic or optimistic attitude of the forecaster. It may not be possible to make forecasts with pinpoint accuracy. But, it still cannot undermine the importance of business forecasting.
The management should first make use of statistical and econometric models in making forecasts and then apply collective experience, skill and objective judgment in evaluating the forecasts. Further, the forecasts should be constantly monitored and revised with the changed circumstances.
Importance, Advantages, Limitations of Business Forecasting to Business. Image credit from #Pixabay.
What is Ratio Analysis?An analysis of financial statements based on ratios knows as ratio analysis. A ratio is a mathematical relationship between two or more items taken from the financial statements. Ratio analysis is the process of computing, determining, and presenting the relationship of items. So, what we discussing is – Meaning, Definition, Nature, Steps, Limitations of Ratio Analysis. It also includes comparison and interpretation of ratios and using them as a basis for future projections.Ratio analysis is helpful to management and outsiders to diagnose the financial health of a business concern. It helps in measuring the profitability, solvency, and activity of a firm.
The Concept of Financial Statement explains the Techniques of Ratio Analysis, and they are understood by Meaning, Definition, Nature, Steps, Limitations.
In this article we will discuss Ratio Analysis: Meaning of Ratio Analysis, second in Definition of Ratio Analysis, third simply learn Nature and Steps of Ratio Analysis and last studying Limitations of Ratio Analysis. So, Ratio analysis is the process of examining and comparing financial information by calculating meaningful financial statement figure percentages instead of comparing line items from each financial statement.
Meaning of Ratio Analysis:
The company’s financial information is contained in the Balance Sheet and Profit and Loss Account. The figures contained in these statements are absolute and sometimes unconnected with one another. An absolute figure does not convey much meaning. However, it is only in the light of other information that the significance of a figure is realized. For instance, Mr. X weighs 50Kg. Is he fat? We cannot answer unless we know his age and height. Similarly, a company’s profitability cannot know unless together with the amount of profit, the capital employed is also seen.
The relationship between these two figures expressed mathematically is called a RATIO. The ratio refers to the numerical or quantitative relationship between two variables or items. A ratio is calculated by dividing one item of the relationship with the other. The ratio analysis is one of the most useful and common methods of analyzing financial statements. As compared to other tools of financial analysis, the ratio analysis provides very useful conclusions about various aspects of the working of an enterprise. The need for ratio arises because absolute figures are often misleading.
Absolute figures are certainly valuable but their value increases manifold if they are studied with another through ratio analysis. Ratios enable the mass of data to summarize and simplify. Ratio analysis is an instrument for the diagnosis of the financial health of an enterprise. Ratios are full of meaning and communicate the relative importance of the various items appearing in the Balance Sheet and Profit and Loss Account.
Definition of Ratio Analysis:
Ratio Analysis is a powerful tool for financial analysis. A ratio defines as;
Webster’s New Collegiate Dictionary,
“The indicated quotient of two mathematical expressions and as the relationship between two or mm thing?”
Hunt, Williams & Donaldson,
“The ratio analysis is an aid to management in making credit decisions, but as a mechanical substitute for thinking and judgment, it is worse than useless.”
Ratio Analysis may define as the systematic use of ratio to interpret the financial statements so that the strength and weaknesses of a firm, as well as its historical performance and current financial condition, can determine. The term ‘ratio’ refers to the numerical or quantitative relationship between two items or variables. In financial analysis, a ratio uses as an index or yardstick for evaluating the financial position and performance of a firm.
An accounting figure conveys meaning when it is related to some other relevant information. Therefore, ratios help to summaries the large quantities of financial data and to make a qualitative judgment about the firm’s financial performance and financial position. The accounting ratios serve any purposes, they can assist management in its basic functions like forecasting, planning, coordination, control, and communication. If they are used properly they can improve efficiency and therefore, profits.
Nature and Steps of Ratio Analysis:
After their meaning and definition the article following Nature of Ratio Analysis below are:
Ratio analysis is a powerful tool for financial analysis. A ratio defines as “the indicated quotient of two mathematical expressions” and as “the relationship between two or more things”. In financial analysis, a ratio uses as an index or yardstick for evaluating the financial position and performance of a firm. Analysis of financial statements is a process of evaluating the relationship between parts of financial statements to obtain a better understanding of the firm’s position and performance.
The financial analysis uses as a device to analyze and interpret the financial health of the enterprise. The absolute accounting figures reported in the financial statements do not provide a meaningful understanding of the performance and financial performance of a firm. An accounting figure conveys meaning when it is related to some other relevant information.
Just like a doctor examines his patient by recording his body temperature, blood pressure, etc., before making his conclusion regarding the illness and before giving his treatment, a financial analyst analyses the financial statements with various tools of analysis before commenting upon the financial health or weaknesses of an enterprise. A ratio knows as a symptom like blood pressure, the pulse rate or the temperature of an individual. It is with the help of ratios that the financial statements can analyze more clearly and decisions are drawn from such an analysis. The point to note is that a ratio indicates a quantitative relationship, which can be, in turn, used to make a qualitative judgment. Such is the nature of all financial ratios.
Steps in Ratio Analysis:
The following steps below are;
The first task of the financial analyst is to select the information relevant to the decision under consideration from the statements and calculates appropriate ratios. The second step is to compare the calculated ratios with the ratios of the same firm relating to past/with the industry ratios. This step facilitates assessing the success or failure of the firm. The third step involves interpretation, drawing of inferences and report-writing. Conclusions are drawn after comparison in the shape of the report or recommended the course of action.
Limitations of Ratio Analysis:
The following Limitations of Ratio Analysis below are:
Incorrect Accounting Data.
Probable Happenings in the Future.
Variation in Accounting Methods.
Price Level Changes.
Only One Method of Analysis.
No Common Standards.
Different Meanings Assigned.
Ignores Qualitative Factors, and.
Insignificant and Unrelated Figures.
Now, Explain:
Incorrect Accounting Data:
False Results if Based on Incorrect Accounting Data. Accounting ratios can be correct only if the data (on which they are based) are correct. Sometimes, the information gives in the financial statements affects by window dressing, i.e., showing position better than what is.
For example, if inventory values are inflating or depreciation is not charging on fixed assets, not only will one have an optimistic view of the profitability of the concern but also its financial position. So the analyst must always be on the look-out for signs of window dressing if any.
Probable Happenings in Future:
No Idea of Probable Happenings in the Future. Ratios are an attempt to analyze the past financial statements; so they are historical documents. Nowadays keeping in view the complexities of the business. It is important to have an idea of the probable happenings in the future.
Variation in Accounting Methods:
The two firms’ results are comparable with the help of accounting ratios only. If they follow the same accounting methods or bases. The comparison will become difficult if the two concerns follow the different methods of providing depreciation or valuing stock.
Similarly, if the two firms are following two different standards and methods. An analysis by reference to the ratios would be misleading. Moreover, utilization of inbuilt facilities, availability of facilities and scale of operation would affect financial statements of different firms. A comparison of financial statements of such firms using ratios is bound to be misleading.
Price Level Changes:
Changes in price levels make the comparison for various years difficult. For example, the ratio of sales to total assets in 1996 would be much higher than in 1982 due to rising prices, fixed assets being shown at cost and not at market price.
Only One Method of Analysis:
Ratio analysis is only a beginning and gives just a fraction of the information needed for decision-making. So, to have a comprehensive analysis of financial statements, ratios should use along with other methods of analysis.
No Common Standards:
It is very difficult to lay down a common standard for comparison because circumstances differ from concern to concern and the nature of each industry is different. For example, a business with the current ratio of more than 2:1 might not be in a position to pay current liabilities in time because of an unfavorable distribution of current assets about liquidity. On the other hand, another business with a current ratio of even less than 2:1 might not be experiencing any difficulty in making the payment of current liabilities in time because of its favorable distribution of current assets about liquidity.
Different Meanings Assigned:
The different firms, to calculate the ratio, may assign different meanings. Different Meanings Assigned to the Same Term. For example, profit to calculate a ratio may take as profit before charging interest and tax or profit before tax but after interest or profit after tax and interest. This may affect the calculation of ratio in different firms and such ratio when used for comparison may lead to wrong conclusions.
Ignores Qualitative Factors:
Accounting ratios are tools of quantitative analysis only. But sometimes qualitative factors may surmount the quantitative aspects. The calculations derived from the ratio analysis under such circumstances may go distort.
For example, though credit may grant to a customer based on information regarding his financial position, yet the grant of credit ultimately depends on the debtor’s character, honesty, record, and managerial ability.
Insignificant and Unrelated Figures:
No use if Ratios are work out for Insignificant and Unrelated Figures. Accounting ratios may work for any two insignificant and unrelated figures as the ratio of sales and investment in government securities. Such ratios may be misleading. Ratios should calculate based on cause and effect relationships. One should be clear as to what cause is and what effect is before calculating a ratio between two figures.
Meaning, Definition, Nature, Steps, Limitations of Ratio Analysis. Image credit from #Pixabay.
Financial Accounting Limitations: The financial statements reflect a combination of recorded facts, accounting conventions, and personal judgments of the preparers. Definition of Financial Accounting concerns with providing information to external users. It refers to the preparation of general-purpose reports for use by persons outside a Business Enterprise, such as Shareholders (existing and potential), Creditors, Financial analysts, Labor unions, Government authorities, and the like. So, what we were discussing: 10 Key Financial Accounting Limitations help for Better Solution.
The Concept of Financial Accounting explains their Limitations are very helpful for Better Solution.
Financial accounting is oriented towards the preparation of financial statements which summarise the results of operations for selected periods of time and show the financial position of the business at particular dates.
Simple limitations also helpful:
Financial accounting suffers from the following limitations which have been responsible for the emergence of cost and management accounting:
Does not provide detailed cost information for different departments, processes, products, jobs in the production divisions. Similarly, separate cost data are not available for different services and functions in the administration division. Management may need information about different products, sales territories, and sales activities which are also not available in financial accounting.
Recording and accounting for wages and labor does not carry out for different jobs, processes, products, departments. This creates problems in analyzing the cost associated with different activities. This also does not provide a basis for rewarding workers and employees for above-average performance.
Does not set up a proper system of controlling materials and supplies. Undoubtedly, if material and supplies are not controlled in a manufacturing concern, they will lead to losses on account of misappropriation, misutilization, scrap, defectives, etc. They may, in turn, influence the reported net income of a business enterprise.
It is difficult to know the behavior of costs in financial accounting as expenses do not assign to the product at each stage of production. Expenses are not classified into direct and indirect, and therefore, cannot classify as controllable and uncontrollable. Control of cost which is the most important objective of all business enterprises cannot achieve with the aid of financial accounting alone.
Other limitations:
Does not possess an adequate system of standards to evaluate the performance of departments and employees working in the departments. Standardization now applies to all elements of the business. Standards need to develop for materials, labor, and overheads so that a firm can compare the work of laborers, workers, supervisors, and executives with what should have been done in an allotted period of time.
Does not provide information to analyze the losses due to various factors, such as idle plant and equipment, seasonal fluctuations in the volume of business, etc. It does not help management in taking important decisions about the expansion of business, dropping a product line, starting with a new product, alternative methods of production, improvement in product, etc. Managerial decisions about these business matters have now become vital for the survival and growth of business enterprises.
Contains historical cost information which accumulates at the end of the accounting period. This accounting does not provide day-to-day information about costs and expenses. This is the reason why much dissatisfaction has been shown with external financial reporting. Historical cost is not a reliable basis for predicting future earnings, solvency, or overall managerial effectiveness. Historical cost information is relevant but not adequate for all purposes. It is now rightly contended that current cost information should report along with historical cost information.
Ten Key Financial Accounting Limitations:
The following points highlight the ten limitations of financial accounting.
They are:
Controlling Cost Impossible:
In financial accounting control of cost is not possible since the costs are known at the end of the financial year or a specified period of time whether the expense or cost has already been incurred, i.e., nothing can be done to control either the account of expense or the cost. In other words, if it even finds that a particular cost is more, it is not possible to control it. But the same is possible only when the cost accounting system introduces.
Recording Actual Cost:
The financial accounting records the actual cost only, the historical cost of the assets. The value of assets may change, but record only the cost of acquisitions of such assets. In other words, financial accounting does not record the price fluctuations or changes in the price level. As a result, it does not present the correct information.
Difficulty in Price Fixation:
We know that the total cost of a product can obtain only when all expenses relating to a product have been incurred. That is why it is not possible to ascertain the price of the product in advance for the estimated selling price. As total cost (i.e., fixed, variable, direct, and indirect cost of a product) depends on many factors, all such factors cannot supplies by financial accounting.
Unanimity about:
Although there is IASC (International Accounting Standard Committee), the accountants differ in their opinion on the application of accounting principles in the same matter. For example, some accountants prefer to use the FIFO method for valuing inventory whereas others prefer to use LIFO or some other method; or, some accountants prefer to use the Straight-line Method of depreciation but others prefer to use Diminishing Balance Method, etc.
Technical Subject:
Since financial accounting is a technical subject, a common man can’t understand it. Without the proper knowledge of principles and conventions of accounting, it is not possible to analyze the financial data to make any financial decision. Naturally, it has got little value to a person who is not conversant with the subject.
Impossible to Evaluate:
Whether the existing accounting principle is sound/correct or not, that cannot be evaluated, i.e., actual performance cannot compare with the budget figure as we can do in the case of Standard Costing/Budgetary Control. In other words, the actual result cannot compare with the budget. Financial accounting presents only the result of the business through profit and financial positions, i.e., the rate of profitability. But the profit may affect by many outside factors that not record by financial accounting.
Maybe Manipulated:
Financial accounting may manipulate, i.e., it may present as per the desire of the management. For example, profit sometimes may reduce to evade tax and to avoid bonuses to the employees. On the contrary, more profit may show to raise fresh equity shares or to pay more dividends to attract shareholders and others.
Supply Quantitative Information:
Financial accounting supplies quantitative information only through absolute figures which do not present always the required information although they are needful to the users. But relative financial information is more important and informative.
Supplies Insufficient Information:
Financial accounting provides information about the financial activities as a whole and not individual-wise, i.e., it does not record information relating to product-wise, department-wise, etc.
Historic in Nature:
Since the financial accounting records all transactions relating to a particular period, it is rather historic in nature. In short, present financial information relating to a past period and not for the future although all financial decisions take base on past financial data.
Summary:
10 Key Financial Accounting Limitations help for Better Solution.
Controlling Cost Impossible.
Recording Actual Cost.
Difficulty in Price Fixation.
Unanimity about.
Technical Subject.
Impossible to Evaluate.
Maybe Manipulated.
Supply Quantitative Information.
Supplies Insufficient Information, and.
Historic in Nature.
10 Key Financial Accounting Limitations help for Better Solution. Image Credit from #Pixabay.
Financial accounting Importance, Nature, and Limitations; It is a system that collects information, processes, and reports about changes in the performance, financial status, and financial status of an entity. A person’s ability to track the financial transactions of a person’s business, during which, he knows as financial accounting skills as a result of his operation. Do you study to learn: If Yes? Then read the lot. Let’s Study Financial Accounting Importance, Nature, and Limitations.
Every Company Current year or the end of the year want to know the financial status of the business. Financial Accounting Importance, Nature, and Limitations.
It is done by recording, summarizing, and presenting all such financial figures in the form of financial reports or statements using standardized guidelines. Such financial statements generally include balance sheets, income details, and cash flow details; which summarize a company’s performance over time. Financial accounting skills generally do not include the ability to report the value of a company but can provide enough information for the evaluation of others.
Definition of Financial Accounting:
Financial Accounting concerns with providing information to external users. It refers to the preparation of general-purpose reports for use by persons outside a business enterprise, such as shareholders (existing and potential), creditors, financial analysts, labor unions, government authorities, and the like. Financial accounting is oriented towards the preparation of financial statements which summarise the results of operations for selected periods of time and show the financial position of the business at particular dates.
Every entity, whether for-profit or not-for-profit; aims at creating maximum value for its stakeholders. The goal of maximum value addition best achieves; when there is a mechanism to monitor the management and the board of directors. Financial accounting helps in such monitoring by providing relevant, reliable, and timely information to the stakeholders.
Inputs to a financial accounting system include business transactions that are supported by source documents, such as invoices, board resolutions, management memos, etc. These inputs are processed using generally accepted accounting principles (GAAP). The processed information is reported through standardized financial statements.
Importance of Financial Accounting:
Financial accounting is integral to companies of all sizes because it helps in the following importance below are: They are three important points.
Communication of information externally.
Communicate information internally, and.
Comparison through analysis.
First Point:
This point explains Communication on information externally. The statements and reports generated by financial accounting use to communicate information about the overall health and well-being of the company to external parties. Such external users may include suppliers, banks, and leasing companies, etc. who are not part of the company but require all this information to analyze the progress of the company and compare it with their expectations.
Second Point:
This point explains Communicate on information internally. A company’s finance team or its employees who are interested in stock-based compensation etc. constitute the internal users of the information generated by financial accounting practices. The reports generated with the help of financial accounting skills are helpful for this purpose as well.
Last Point:
This point explains Comparison through analysis. Since financial accounting requires the use of standardized guidelines, the financial statements generated by all companies are comparable, providing a standard method of analysis.
Scope and Nature of Financial Accounting:
The following points are important to understand the scope and nature of financial accounting:
Contents:
The end product of the financial accounting process is the financial statements that communicate useful information to decision-makers. The financial statements reflect a combination of recorded facts, accounting conventions, and personal judgments of the preparers. There are three primary financial statements for a profit-making entity in India, viz., the Income Statement (statement of revenues, expenses, and profit), and the Balance Sheet (like the statement of assets, liabilities, and owner’s equity) and cash flow statement. The accounting information generated by financial accounting is quantitative, formal, structured, numerical, and past-oriented material.
Accounting System:
The accounting system includes the various techniques and procedures used by the accountant (preparer) in measuring, describing, and communicating financial data to users. Journals, ledgers, and other accounting techniques used in processing financial accounting information depend upon the concept of the double-entry system. This technique includes generally accepted accounting principles (GAAP). The standard of generally accepted accounting principles includes not only broad guidelines of general application but also detailed practices and procedures.
Measurement Unit:
Financial accounting primarily concerns with the measurement of economic resources and obligations and changes in them. Financial accounting measures in terms of monetary units of a society in which it operates. For example, the common denominator or yardstick used for accounting measurement is the rupee in India and the dollar in the U.S.A. The assumption is that the rupee or the dollar is a useful measuring unit.
Users of Financial Accounting Information:
Financial accounting information intends primarily to serve external users. Some users have a direct interest in the reported information. Examples of such users are owners, creditors, potential owners, suppliers, management, tax authorities, employees, customers. Some users need financial accounting information to help those who have a direct interest in a business enterprise.
Examples of such users are financial analysts and advisers, stock exchanges, financial press and reporting agencies, trade associations, labor unions. These user groups having direct/indirect interests have different objectives and diverse informational needs. The emphasis in financial accounting has been on general-purpose information which, obviously, is not intended to satisfy any specialized needs of individual users or specific user groups.
Users or Role in Financial Accounting:
The most basic motives or objectives of financial accounting is the preparation of general-purpose financial statements; which are financial statements meant for use by stakeholders external to the entity; who do not have any other means of getting such information, i.e. people other than the management. These stakeholders include:
Investors need the information to estimate the intrinsic value of the entity and to decide whether to buy, hold, or sell the entity’s shares. Equity research analysts use financial statements to conduct their research on earnings expectations and price targets.
Working as Employee groups:
Employees and their representative groups interest in information about the solvency and profitability of their employers to decide about their careers, assess their bargaining power and set a target wage for themselves.
Lead as Lenders:
Lender’s interest in the information enables them to determine whether their loans and the interest earned on them will pay when due.
Suppliers and other trade creditors:
Suppliers and other creditors interest in the information that enables them to determine whether amounts owing to them will pay when due and whether the demand from the company is going to increase, decrease, or stay constant.
One of the Customers:
Customers want to know whether their supplier is going to continue as an entity; especially when they have a long-term involvement with that supplier. For example, Apple interests in the long-term viability of Intel because Apple uses Intel processors in its computers and if Intel ceases operations at once; Apple will suffer difficulties in meeting its own demand and will lose revenue.
His also Governments and their agencies:
Governments and their agency’s interest in financial accounting information for a range of purposes. For example, the tax collecting authorities, such as IRS in the USA, interest in calculating the taxable income of the tax-paying entities and finding their tax payable. Antitrust authorities, such as the Federal Trade Commission, interest in finding out whether an entity engages in monopolization.
The governments themselves interest in the efficient allocation of resources; and, they need financial accounting information of different sectors and industries to decide on federal and state budget allocation, etc. The bureaus of statistics are interested in calculating national income, employment, and other measures.
Also Public:
The public interests in an entity’s contribution to the communities in which it operates; its corporate social responsibility updates; its environmental track record, etc.
Limitations of Financial Accounting:
Financial accounting is significant for management as it helps them to direct and control the firm activities. It also helps business management in determining appropriate managerial policies in different areas, such as production, sales, administration, and finance.
Financial accounting suffers from the following limitations which have been responsible for the emergence of cost and management accounting:
Financial accounting does not provide detailed cost information for different departments, processes, products, jobs in the production divisions. Management may need information about different products, sales territories; and, sales activities which are also not available in financial accounting.
Financial accounting does not set up a proper system of controlling materials and supplies. Undoubtedly, if material and supplies do not control in a manufacturing concern; they will lead to losses on account of misappropriation, misutilization, scrap, defectives, etc.
The recording and accounting for wages and labor are not done for different jobs, processes, products, departments. This creates problems in analyzing the costs associated with different activities.
It is difficult to know the behavior of costs in financial accounting as expenses not classify as direct; and, indirect and therefore cannot classify as controllable and uncontrollable. Cost management which is the most important objective of all business enterprises; cannot achieve with the aid of financial accounting alone.
Financial accounting does not possess an adequate system of standards to evaluate the performance of departments and employees working in departments. Standards need to develop for materials, labor, and overheads so that a firm can compare the work of workers, supervisors, and executives with what should have been done in an allotted period of time.
Other limitations:
Financial accounting contains historical cost information that accumulates at the end of the accounting period. The historical cost is not reliable for predicting future earnings, solvency, or overall managerial effectiveness. Historical cost information is relevant but not adequate for all purposes.
Financial accounting does not provide information to analyze the losses due to various factors; such as idle plant and equipment, seasonal fluctuations in the volume of business, etc. It does not help management in taking important decisions about the expansion of business, dropping of a product, alternative methods of production, improvement in product, etc.
Also, Financial accounting does not provide the necessary cost data to determine the price of the product being manufactured or the service being rendered to the consumers.
Despite the above limitations, financial accounting has utility and is an important and conceptually rich area. Because of growing business complexities and advances in knowledge of human behavior and decision processes; the scope and methods of financial accounting are changing. Financial accounting theory and practice will probably broaden and improve considerably in the future.
Financial Accounting Importance, Nature, and Limitations.
