Question

Why do businesses choose the percentage of sales method?

What are some of the factors they consider when making this decision?

What are some unintended consequences of choosing a method; in other words, what are some things that the method chosen will NOT consider?

Answer 1

Percentage of Sales Method :

The percentage-of-sales method is used to develop a budgeted set of financial statements. Each historical expense is converted into a percentage of net sales, and these percentages are then applied to the forecasted sales level in the budget period.

1) why do business choose the Percentage of Sales Method ?

  Business choose this method because of the following advantages:

> It is the quickest way to develop a forecast.

> For items that closely correlate with sales , it can yield high quality forecasts.

3) What are some of the factors they consider before they make this decision?

This method of forecasting requires the items to be estimated based on relations to sales figures, thus it is necessary that movements in the items to be forecast are highly correlated with fluctuations in the sales figures. Forecast that item using a different technique; especially if there is no clear correlation between the item to be forecast and sales figures.

3)What are some unintended consequences of choosing a method; in other words, what are some things that the method chosen will NOT consider?

> Many expenses are fixed or have a fixed component, and so do not correlate with sales. For example, rent expense does not vary with sales. Many balance sheet items also do not correlate with sales, such as fixed assets and debt.

> Step costing may apply, where a cost is variable but will change to a different percentage of sales when the sales level changes to a different volume level. For example, purchase discounts may apply to purchases once the unit count passes 10,000 per year.