2.2 financial planning Flashcards
what is a sales forecast?
a prediction of future sales volumes and values
what information can businesses use to make a sales forecast?
-market research
-past sales (e.g. time series analysis) -economic forecasts
why is sales forecasting important?
-supports planning
-can improve the validity of cash flow forecasts
-used to determine resource requirements (stock, equipment, finance, promotions)
what are the three main methods of sales forecasting?
-extrapolation
-correlation
-confidence intervals
limitations of sales forecasting:
-sales forecasting requires skill
-market conditions are constantly fluctuating (dynamic)
-lots of data for businesses to consider when constructing sales forecasts
-the nature of the product must be considered
sales forecasting limitations - requires skill, time and the accurate use of timely data
-smaller businesses may particularly lack the experience / specialised workers to construct, analyse and interpret sales forecasts
sales forecasting limitations - market conditions are constantly fluctuating (dynamic)
-sales forecasts will rarely reflect the full range of external influences that can affect future sales,
(eg: volatile customer tastes, the actions of competitors, new market entrants)
-it is difficult to avoid experience bias (eg: opinions of the future based on experiences in the past)
↳ the future rarely repeats the events of the past
sales forecasting limitations - lots of data for businesses to consider when constructing sales forecasts
-internal data, such as previous sales figures, will be a key source of information when constructing forecasts
-choosing the most appropriate external data to support sales forecasts is hard and will require careful evaluation
sales forecasting limitations - the nature of the product must be considered
eg: product may be a fashion item and fashions move quickly
3 factors affecting sales forecasts:
-consumer trends
-economic variables
-competitor actions
consumer trends
-fashions may change from season to season, but most consumer behaviours change over a longer period of time (e.g. the trend towards solar-powered energy)
-demand for certain goods is seasonal
-fashion is often led by celebrities, and their influence can have a short-term impact on sale
issues with consumer fashions
fashions constantly change and can make it very difficult to carry out accurate sales forecasts
economic variables that affect sales forecasting:
economic growth:
increased consumer incomes → higher than forecast sales
inflation:
increase in prices → reduced consumer spending power → sales decrease
unemployment:
higher unemployment (during recession)
→ reduced spending, especially for lifestyle and luxury goods, spending is focused on essentials
exchange rates:
value of UK sterling falls → exports cheaper, businesses that sell products overseas / cater for tourists visiting the UK may adjust their sales forecasts upwards
competitor actions
-hard to predict, but often reason why sales forecasts prove over-optimistic
what must a business do to make revenue?
by satisfying customer demand
how to calculate revenue
selling price x quantity sold
terms for revenue
-sales
-income
-turnover
-takings
which two ways can a business increase revenues? (& examples)
1) increase quantity sold
↳ sales promotion, advertise, expand
2) increase selling price
↳ add value
what are costs?
amounts that a business incurs in order to make goods and/or provide services
why are costs important?
-drain away the profits made by a business
-the difference between making a good and a poor profit margin
-main cause of cash flow problems in business
what are variable costs?
costs that change as output varies
what are fixed costs?
costs which do not change when output varies
how do you calculate total costs?
fixed costs + variable costs
examples of variable costs:
-raw materials
-wages based on hours worked
examples of fixed costs:
-rent
-salaries
-insurance
examples of start up costs:
-furniture
-equipment
-training
semi fixed costs (+examples)
fixed in the short term, but change once a certain level of output is reached
eg: rent (business may need to move to bigger place)
short run costs
refers to the immediate future:
-variable costs are variable and fixed costs are fixed
long run costs
-all costs are variable
-fixed costs will eventually change over time, some fixed costs may fall, whereas others will rise, such as employee salaries.
which costs are easy to estimate & control? (examples)
rent, salaries, advertising
which costs are hard to estimate & control?
-raw materials
-product returns
what is average cost/unit cost?
the cost per unit of production
the larger the output the ______ the unit cost/average cost
lower
what is profit?
the reward or return for taking risks &
making investments
why is profit important to a business?
-a reward for taking risks
-a key source of finance
-a measure of business success
-a motivating factor
how to calculate profit?
revenue - total costs
when is profit occurring?
total sales are more than total costs
what is loss?
total costs are higher than total sales
what is breakeven?
the point where total sales equal total costs
what is profit in absolute terms?
the £ value of profits earned
what is profit in relative terms?
the profit earned as a/proportion of sales achieved or investment made
what does contribution look at?
the profit made on individual products
how do you calculate contribution & total contribution?
selling price - variable cost (SP - VC)
total contribution:
contribution per unit x quantity sold
what are three methods of calculating breakeven?
-a table
-a formula
-a graph
what assumptions are made to do a breakeven analysis?
-selling price per unit stays the same
-variable cost per unit is the same
formula for breakeven output
fixed costs / contribution per unit
steps of drawing a breakeven chart:
1) produce two axis, y axis = sales and costs, x axis = output
2) add fixed costs (horizontal line)
3) add the total costs (starts from fixed costs line)
4) draw the line for total sales (starts from zero)
5) find the breakeven point (where total sales = total costs)
tip for finding the breakeven point
go across the fixed costs line (horizontal) to the y axis, then go upwards on the total costs line until there is an intersection
Right Angled Triangle shape
what is the margin of safety??
the difference between actual output and the breakeven output
strengths of breakeven analysis
-calculations are quick and easy
-illustrates the importance of keeping fixed costs down to a minimum
-shows a business how to reach profitability
-decide whether a business idea is profitable and viable
-assess the effects of costing and pricing decisions
limitations of breakeven analysis
-unrealistic assumptions (eg: products are not sold at the same price at different levels of output)
-break-even analysis simplifies a very complex process
-most businesses sell multiple products
-costs are rarely constant, break-even analysis presumes that costs stay the same over various levels of output
what is a budget?
a financial plan for the future.
what should an effective budget do?
drive many of the decisions taken across the functional areas of a business
who is responsible for controllable costs within budgets?
managers
uses of budgets in management:
-turn objectives into practical reality
-allocate resources
-control income and expenditure
-help a business to save towards a goal
-problems can be solved in advance
-budgeting needs different parts of a business to operate as part of a coordinated whole → budgets may be communicated throughout the organisation which improves coordination
-budgets play an important role in target-setting and performance management
what is the main purpose of budgets?
to ensure efficiency in spending
what are the two main approaches to budgeting?
1) historical budgeting
2) zero-based budgeting
what is historical budgeting?!
budgets based on historical data (the previous years sales)
evaluation of historical budgeting:
strengths:
-realistic in that it is based on actual results
weaknesses:
-circumstances may have changed
what is zero based budgeting?
budget is based on new proposals for sales and costs
evaluation of zero based budgeting:
strengths:
-more realistic
-suitable for a new business
-useful where a business needs to control costs closely (eg: improve profitability)
weaknesses:
-time consuming as evidence to support spending decisions needs to be collected and presented
-needs skilled employees
what are the three main parts/types of budget?
1) revenue - expected income
2) expenditure - expected costs
3) profit budget - combined sales and cost budgets
what are two key sources of information for budgets?
-financial performance in previous periods
-market research → competitor activity, trends in market size
problems with calculating budgets:
-data must be up-to-date, accurate and free of bias
-those constructing budgets will require skills and relevant experience to do so effectively (training/ hiring specialist staff)
-past trends can be a poor indicator of what is likely to happen in the future
-sales forecasting can be inaccurate and affect budgeting
-unexpected costs always happen
what is a variance analysis?
compares the differences between actual values and budgeted values
when does a variance arise?
when there is a difference between actual and budget figures
what two things can variances be?
1) positive/favourable (better than expected)
2) adverse/unfavourable (worse than expected)
examples of favourable variance
-costs lower than expected
-revenue/profits higher than expected
examples of adverse variance
-costs higher than expected
-revenue/profits lower than expected
possible causes of favourable variances
-stronger market demand than expected
-selling prices increased higher than budget
-cautious sales and cost assumptions (e.g. cost contingencies)
-competitor weakness
possible causes of adverse variances
-unexpected events lead to unbudgeted costs
-over-spends
-market conditions mean selling prices are lower than budget
do variances matter?
it depends on…
-if the variance was foreseen
-the size of the variance
-the cause of the variance
-whether the variance was temporary or long term
what should management do with a variance?
-act only if the variance is outside an agreed margin
-investigate the cause of variance &
whether it was avoidable or unavoidable
-fix the problem
what to remember about adverse variance (+example)
it might result from something that is good that has happened in the business
eg: higher production costs than budget (adverse variance) that occur because sales are significantly higher than budget (favourable budget)
4 bad behavioural implications of budgets:
-budgets are de-motivating if they are imposed rather than negotiated
-setting unrealistic targets adds to de-motivation
-budgets can contribute to departmental rivalry - battles over budget allocation
-it can result in a “use it or lose it” mentality - spend up to the budget to preserve it for next year
