Financial Models: The Accountant's Edge

Vance Etnyre, CPA, PhD, associate professor of quantitative methods, University of Houston, Clear Lake, Donald L. Kyle, CPA, PhD, professor of accounting, University of Houston, Clear Lake, and David E. Hamblin, CPA, management advisory services partner of Ralph & Karr, Houston, describe a useful decision-making tool. In his book Patriot Games Tom Clancy says that in almost all situations when intelligence has been gathered, the data are such a mass of information that they cannot be used. Available techniques do not allow easy analysis of large volumes of data. CPAs in particular need techniques that produce accurate and effective data analysis and enable them to forecast expectations, evaluate alternatives and provide corporate managers with the details they will need on the most relevant aspects of a business. Models, mathematical formulas or equations that state the relationships between important factors (variables) in a problem or system provide an efficient way to study relationships. Instead of observing every value of a variable, one simply gathers representative sample data and formulates inferences or decisions on the population as a whole and, ultimately, the degree of relationship that exists between cerlain variables. (For an example of a simple model, see the exhibit on page 114.) Modeling techniques can be applied to every aspect of business: production, distribution, research and development, inventory control, capital investments and pricing decisions. For example, the financial analyst may develop one equation to optimize inventory levels and another to represent the relationship between a company's sales and the issues that affect them. Models offer an extra edge by * Providing information that is sometimes impossible to collect.  Helping to quantify uncertainties. * Measuring relationships between variables.  Providing a measure of reliability.  Enabling managers to test risky decisions or experiment with complex situations on paper before implementation.  Considering many managers' data and experiences.  Removing the biases that may be held by decision makers and financial personnel.  Offering a flexible and reusable tool for similar future decision making. As models gain greater use, corporate executives will turn to CPAs for answers to a variety of different questions. Which color, shape and size package will induce customers to purchase a product? Will lower or higher purchase payments ensure better repayment trends? Can a company reasonably estimate next year's sales based on projected gross national product and past financial statements? Does lowering or raising prices have a significant effect on total sales? A CASE IN POINT The answers to most of these questions are purely speculative without modeling techniques. Take for example, the pricing query. It is commonly assumed that lowering prices should increase sales, but one Houstonbased accounting firm found in an economy-and-efficiency study that it performed that the price of a drink doesn't necessarily affect total bar sales.  The study was intended to determine how to increase bar operating revenues, decrease operating expenses and improve customer service in 25 officer, enlisted and consolidated open mess bar operations in 15 continental U.S. and overseas military installations. The main areas of concern were beverage control, bar operations, club management and external considerations and regulatory controls. Precursory study review. The first concern was to identify and evaluate all possible factors that might affect sales from data gathered at several management interviews, on-site evaluations and a thorough review of applicable financial' statements. Although many pertinent aspects of open mess operations were covered, this article addresses the use of models for managerial decision making. …

Field of study: Business