When utilizing the percentage of sales approach managers
|A. Estimate company sales based on a desired level of net income and the current profit margin.|
B. Consider only those assets that vary directly with sales.
C. Consider the current production capacity level.
D. Can project both net income and net cash flows.
E. Both C and D.
The Correct Answer Is:
E. Both C and D.
Correct Answer Explanation: E. Both C and D.
When employing the percentage of sales approach, managers utilize various strategies to forecast financial outcomes and make informed decisions. The correct answer, E (Both C and D), aligns with the key considerations involved in this approach.
To elaborate on the correctness of E, let’s delve into the intricacies. Firstly, option C, considering the current production capacity level, is essential. Managers need to assess the existing production capabilities to understand the maximum output the company can generate.
This knowledge is pivotal in forecasting sales accurately. If production capacity is limited, it could impact the potential sales growth and affect the feasibility of meeting increased demand.
Secondly, option D highlights the approach’s capability to project both net income and net cash flows. Forecasting net income is crucial for assessing profitability, while estimating net cash flows allows managers to understand the liquidity position and potential financial constraints.
This dual projection helps in comprehensive planning, enabling managers to balance profitability and liquidity effectively.
Now, let’s scrutinize the other options to understand why they are not the correct answer:
A. “Estimate company sales based on a desired level of net income and the current profit margin.”
While estimating sales based on desired net income and profit margins seems intuitive, this option oversimplifies the forecasting process. It overlooks crucial factors such as production capacity and the broader spectrum of costs involved in generating sales.
The percentage of sales approach aims at a more holistic analysis, considering not just profit margins but also fixed costs, variable costs, and the impact of production limitations on sales forecasts.
Relying solely on desired net income and profit margins might lead to inaccurate sales projections, as it neglects the complexities of operational constraints and their influence on sales volume.
B. “Consider only those assets that vary directly with sales.”
This option focuses on variable costs that fluctuate directly with sales volume, such as raw materials or labor. While variable costs are an integral part of the percentage of sales approach, concentrating solely on these costs disregards the broader financial landscape.
The approach encompasses both variable and fixed costs, along with assessing production capacity and projecting net income and cash flows. Ignoring fixed costs, which remain constant regardless of sales fluctuations, limits the comprehensive understanding required for accurate sales forecasting and managerial decision-making.
Therefore, while options A and B touch upon essential aspects of financial analysis, they fall short of encompassing the breadth and depth of considerations inherent in the percentage of sales approach.
This approach demands a more comprehensive evaluation that incorporates production capacity, fixed and variable costs, as well as the projection of net income and net cash flows to derive accurate sales forecasts and facilitate informed decision-making for managers.