2.2 Financial Planning Flashcards
What do sales forecasts do?
Predict future revenue based on past sales figures
What do sales forecasts focus on?
What will happen in the future to:
- the volume and value of sales
- the size of the market
- sales as a result of promotional activity
- sales as a result of cyclical factors
What are sales forecasts important for?
Supporting planning and can improve the validity of cash flow forecasts
What do businesses use sales forecasts to do?
Determine resource requirements in a variety of ways, including:
- how many staff will be needed?
- how much stock will be required?
- does the capacity need to be expanded (or reduced)?
- does the equipment need to be upgraded, replaced or increased (or decreased)?
- how much and which type of finance will be required?
- is promotional activity e.g. advertising required - and when?
What are the factors affecting sales forecasts?
- seasonal variations (e.g. sales of basic home items increase when students start uni in September)
- fashion
- long term trends (consumer behaviour, attitudes and spending habits change over time)
- economic growth (increased income = higher forecasted sales)
- inflation (reduces consumer spending power)
- unemployment (high = less luxury + normal goods bought
- interest rates (when high borrow more expensive so Businesses that sell products that consumers frequently buy on credit may therefore adjust their sales forecasts downward)
- exchange rates (when the value of the pound falls against other global currencies, overseas consumer will find British exports cheaper)
What should sales forecasts consider?
Sales forecasts should consider short-term actions of competitors such as sales promotions as well as longer-term strategies such as changes to product ranges and expansion plans
What are the difficulties of sales forecasting?
Effective sales forecasting requires skill, time and the accurate use of timely data, smaller businesses in particular may lack the experience to construct, analyse and interpret sales forecasts
It is difficult to avoid experience bias (e.g. opinions of the future based on experiences in the past)
Sales forecasts will rarely reflect the full range of external influences that can affect future inflows, such as fashions, trends and the actions of competitors
There is a significant amount of data available 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
Selecting the most appropriate external data to support sales forecasts is extremely challenging and will require careful evaluation
What is sales volume?
Sales volume is the number of units sold by a business
E.g. the number of Harry Styles album download purchases
What is sales revenue?
Sales Revenue is the total value of the units sold by a business
E.g the revenue earned by Apple Music from sales of music downloads
Sales revenue is a key business performance measure and must be calculated to identify profit
How is sales revenue calculated?
Selling price x number of units sold
What are fixed costs?
Costs that do not change as the level of output changes
E.g. building rent, salaries, insurance
What are variable costs?
Costs that vary directly with output
These increase as output increases and decrease as output decreases
E.g. raw material costs
What is total costs?
The sum of the fixed + variable costs
How is total variable cost calculated?
Variable cost x quantity
How is average total cost calculated (cost per unit)?
Total cost/quantity
How is variable cost per unit calculated?
Total variable costs/quantity
Why does average total costs decrease as output increases until a certain point?
As a firm grows, it can increase its scale of output generating efficiencies that lower its average total costs (AC) of production
These efficiencies are called economies of scale
As a firm continues increasing its scale of output, it will reach a point where its average total costs (AC) will start to increase
The reasons for the increase in the average costs are called diseconomies of scale
What is contribution?
A product’s selling price - the variable costs
How can contribution be calculated?
Selling price per unit - variable cost per unit
Why is contribution called contribution?
It is called contribution as this amount contributes towards paying off the fixed costs of the business
Once the fixed costs have been paid off, then the contribution starts to contribute to the profits of the business
What is the break even point?
Where the total revenue earned from a product is exactly equal to the total costs (the business is making neither a profit nor a loss)
How is the break even point calculated?
Fixed costs/contribution (Selling price per unit - variable cost per unit)
Always round UP to the nearest whole number because only whole products can be sold
What does identifying the break even point allow a business to do?
Understand how many items it needs to produce and sell to cover all costs before it starts to make a profit
Each subsequent unit sold past this point will generate profit for the business
What is the margin of safety?
The difference between the actual level of output of a business and its break even level of output
How can the margin of safety be calculated?
Actual level of output - breakeven level of output
What is a break even chart, and what is it used to identify?
A break even chart is a visual representation of the break even point, it is used to identify:
- the fixed costs, total costs and revenue over a range of output
- the break even point - where costs = revenue
- profit or loss made at each output
- the margin of safety
Where is the break even point on a break even chart?
The point at which the total costs and the revenue lines cross is the break even point
What are the limitations of break even analysis?
Break even analysis is less useful when the business produces more than one product
The accuracy of break even analysis relies on the quality of the data used in the break even calculations
Break even analysis assumes that all output is sold
Break even charts cannot be easily amended when conditions (e.g. costs and selling price) change
Revenue and total costs do not always have a linear relationship with output
What is a budget?
A financial plan that a business (or department in the business) sets about costs and revenue
The budget is usually closely aligned with the business objective
Why are budgets used?
Planning + monitoring:
Businesses that use budgets are actively planning ahead
Therefore problems and their solutions may be considered and solved in advance
Control:
Frequent monitoring of budgets allows managers to precisely control their functional area, budgets support the setting and review of a company or departments objectives.
Coordination + communication:
Budgeting requires different parts of a business to operate as part of a coordinated whole
Budgets may be communicated throughout the organisation to provide a framework for decision-making and communication
Motivation and efficiency:
Budgets play an important role in target-setting and performance management, which can be used by managers to measure success
The allocation of budgets spreads decision making across the organisation, acting as a motivator to the managers who control them
What is a business objective?
Specific, measurable targets that businesses hope to achieve in a given period of time
Why may businesses set budgets?
To monitor the financial performance of any aspect of the business
What are the 2 methods used to prepare budgets?
- historical figure budgets
- zero based budgeting
What are historical figure budgets?
Budgets based on historical data (e.g. sales and costs data from previous years) and allow for factors such as inflation and other relevant economic indicators (e.g. exchange rate variations)
What are zero based budgets?
Zero budgeting requires all spending to be justified, which means any unnecessary costs can be eliminated
However, it can be time-consuming as evidence to support spending decisions need to be collected and presented
Zero based budgeting also required skilled + confident employees to make a persuasive case to commence those making purchasing decisions
What is a budget variance?
The difference between the figure budgeted and the actual figure spent by the end of the budgetary period
What does variance analysis determine?
The reasons for the differences in the actual figures and budgeted figure
What is a favourable variance in a revenue or profit budget?
Where the actual figure spent is higher than the budgeted figure.
What is a favourable variance in a costs budget?
Where the actual figure is lower than the budgeted figure
What is an adverse variance?
Where the actual income is less than the budgeted income
What is an adverse variance in a revenue or profit budget?
Where the actual figure is lower than the budgeted figure
What is an adverse variance in a costs budget?
Where the actual figure is higher than the budgeted figure
What should a business do once variances have been identified?
Carefully investigate the reasons why they have occurred and take appropriate action, such as:
Where adverse cost variances are identified, a business may seek alternative suppliers or investigate ways to improve efficiency
Where adverse sales variances are identified, a business may review its marketing activities to improve their effectiveness
Where favourable cost variances are identified, a business may review key quality indicators such as the volume of returns or waste levels to ensure that output standards are being met
Where favourable sales variances occur, a business may reward client-facing staff with performance based incentives
What are the difficulties of budgeting?
Budgeting can encourage managers to focus on the short-term rather than long-term performance
Unachievable or unambitious budgets can have a negative impact on motivation
Budget-setters have significant influence over the setting and review of budgets
The budget is only as good as the data used to construct it - inaccurate data makes budgets useless
Budgets take time and skill to set, monitor and review
The budgeting process can lead to competition and conflict between business functions
