Question

Do you think it would be a good method to use the average of the previous three months actual expenses as the current periods estimate? What are some advantages and disadvantages of this approach?

Answer 1

Yes When the actual expenses are not available average of previous three months(quarter) will provide a best estimate.

Advantages of using average expenses as estimate for Current period

1) Average is normally a median figure which takes into account both the extremes of an amount (both highest and lowest figure)and gives the most approximate value(median value) in cases where actuals are not available.

2) It is easier to calculate and statistically acceptable for arriving at an estimate

3) Gives the Central tendency of actuals to arrive at an estimate

4) Highly Suitable for calculating estimates of recurring expenses whose quantum of deviation(difference between two actuals) level every month is minimum

For ex:Electricity expenses,Water Charges,Fuel expenses

The above mentioned expenses are not completely fixed expenses..They are variable to the extent of usage per month .Unless there is a huge Change in the Volume of activity,these expenses tend to maintain a constant range where averages of actuals will be helpful in calculating estimates of current period.

Disadvantages of using averages for calculating Current period estimates

1) Average value will not help if actuals are highy Volatile.(Have extreme Fluctuations)

2) It is not recommended for highly variable expenses where Volume of activity on the basis of which expenses are calculated varies drastically every month

3) It is not suitable to calculate when time plays a vital role for the quantum of expenditure.

4) It can be used only when all other situation and Conditions remain constant during the current period like the previous period