In portfolio management, the scoring techniques are used for arriving at precise investment needs, in order to enhance the profitability and assistance in numerous strategic planning. This specific technique is not able to optimize things during mixed project scenario and involves little stress on the financial measures.
There are two commonly used methods of Scoring including Simple Additive Weighting (SAW) and Weight Product Method.
Simple Additive Weighting (SAW) Method
It is considered to be the best know method that is most widely used technique in portfolio management. It employs regular arithmetical operations including multiplication and addition. In this method, the attribute values are both numerical and comparable.
Weight Product Method
This method does not involve transformation when we multiplication is used among attribute values. The weights turn out to be exponents linked with each attribute value. It assigns negative power for cost attributes and positive power for benefit attributes.
Steps for deriving Scores and weights
The process of deriving weights and scores can be summarised as mentioned below.
· Identifying the applicable non-monetary attributes
· Weight the attributes for reflecting their comparative importance
· Scoring the alternatives for reflecting how each option performs against each attribute
· Calculation of the weighted scores
· Testing the results for accuracy
· Interpretation of the obtained results
Benefits of scoring techniques
Scoring techniques signify an improvement over traditional ratio analysis that is dependent on the remote use of certain ratios. By using scoring techniques, the problem of the attaching relative importance to each ratio is solved as each is weighted based on its ability.
Drawbacks of Scoring techniques
Along with various benefits, the scoring techniques also have various shortcomings. In a scoring equation, the statistical underpinnings may give rise to certain weaknesses. It is imperative to have a sufficient large sample, accurate database and consistent long period in order to reveal trends in the company’s behaviour and measuring its impact.
Features of Scoring Techniques
· The scoring equation is usually based on historical data from recent past and requires to be updated over time. The same equation cannot be used many years later when there is considerable change in financial environment in which companies operate. It is thus imperative for scoring equations to remain updated.
· The scoring equations are designed for measuring the risk of failure for small and medium-sized companies. However, these equations do not serve other purposes like they do not predict about the profitability of the companies in advance. Moreover, they do not measure the risk of failure for big groups. Scoring equations can only be used for companies whose size and business activities are at par with those included in the original sample.
· Scoring technique is the simple and quick way of synthesising figures and these techniques exhibit considerable appeal. The development of scoring methods may lead to mean self-fulfilling effects. The scoring techniques are aimed at providing prior knowledge of the risks of failure. It assists the companies to take required preventive measures.