2.2 Financial Planning

Question 1

Sales Revenue equation
Contribution equation

Answer 1

Sales revenue = Selling price x Number Of Units Sold

Contribution = Selling Price Per Unit − Variable Cost Per Unit

Question 2

Fixed costs (FC)
Variable costs (VC)
Total costs (TC)
( Equations )

Answer 2

Fixed costs (FC) are costs that do not change as the level of output changes

Variable costs (VC) are costs that vary directly with the output
Total variable cost (TVC) = variable cost (VC) × quantity (Q)

Total costs (TC) are the sum of the fixed + total variable costs
Total costs (TC) = total fixed costs (TFC) + total variable costs (TVC)

Average total cost (ATC) = total cost (ATC) / quantity (Q)
Variable cost per unit (AVC) = Total variable costs (TVC) / quantity (Q)

Question 3

Break Even Output Equation
&
Revenue At Break Even Point Equation
&
Break Even Output Equation

Answer 3

Break Even Output = Fixed Costs / Sales Price - Variable Cost Per Unit
or
Break Even Output = Fixed Costs / Contribution

Revenue At Break Even Point Equation = Break Even Output × Sales Price

Break Even Output = Fixed Costs / Sale Price - Variable Costs Per Unit

Question 4

Break Even Analysis
PROS / CONS

Answer 4

PROS:
- Useful tool for management ( Predicts break even output, margin of safety, estimates profits at different outputs )
- Highlights the importance of fixed costs
↓ FC = ↓ BEO = ↑ MS ∴ Lower Risk
- Data generated can be used in business plan

CONS:
- Based on predicted data not actual data
- Many unrealistic assumptions ( No waste product, production cost same, only one product is sold, the same price used, all units sold )

Question 5

Budgets
Historical Figure Budgets
Zero Based Budgeting

Answer 5

A budget is a financial plan that a business ( or department in the business ) sets about costs and revenue

Historical Figure Budgets:
- A historical budget is based on financial data from previous years, used as a baseline for planning future budgets.

Zero Based Budgeting:
- This is particularly useful where a business needs to control costs closely ( e.g. to improve profitability )
- Zero budgeting requires all spending to be justified,
- It can be time-consuming as evidence to support spending decisions needs to be collected and presented
- Zero budgeting also requires skilled and confident employees to make a persuasive case to convince those making purchasing decisions

Question 6

Budget ( Variance Analysis )
Adverse / Favourable

Answer 6

Difference between a figure budgeted and the actual figure achieved by the end of the budgetary period

Adverse:
- Bad
- Profits = Lower than expected
- Revenue = Lower than expected
- Costs = Higher than expected

Favourable:
- Good
- Profits = Higher than expected
- Revenue = Higher than expected
- Costs = Lower than expected

Question 7

Budgeting
PROS / CONS

Answer 7

Budgeting: Planning income and expenses.

PROS:
- Gives senior + functional managers spending guidance
∴ encourages spending discipline
- Helps support a business plan if profit budget ∴ increases chance for obtaining finance

CONS:
- Who set the budget? If senior management sets budget but lacks expertise in a specific area =
( Over Ambitious Targets? ) ( Which can be demotivating )
- Historical budgets are based on previous years
- How frequently are budgets reviewed?