2.2 Financial Planning Flashcards
What’s a sales forecast
Assessing the probable outcome using assumptions about the future
Where you predict the sales of a business in a period of time
What information may a business use in order to carry out a sales forecast accurately
Market research e.g market reports and customer surveys
Backdata e.g time series analysis
What is time series analysis
Predicting future sales based on last sales figures, taking into account the trend and seasonal fluctuations
What factors affect sales forecasts
Consumer trends
Economic variables
Actions of competitors
How to calculate sales revenue
Quantity sold x price
How to calculate total costs
Fixed cost + variable costs
What are some economic variables
Economic growth (GDP)
Interest rates
Inflation
Unemployment
Exchange rates
What are some consumer trends
Seasonal variations- sales fluctuate depending on the season or even day of the week
Fashions- fashions constantly change and can make it very difficult to carry out accurate sales forecasts
Long term 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
Why would a business have to change it sales forecasts because of the actions of competitors
For example if a big competitor were to launch a sales promotion, introduce a new and improved product line or open a new branch nearby, a business could rightly expect sales to fall
Similarly the closure of a large competitor might lead to an increase in sales as the business picks up trade from the switching customers
What’s the purpose of sales forecasts
Can plan our resources including Human Resources, stock and impact on finances
What are the problems with sales forecasting
Volatile customer tastes and preferences
Subjective expert opinions- many forecasts will be supported by the opinions and experience of a manager within the business
Fluctuations in economic variables- unforeseen external shocks such as changing commodity prices
The data used - the quality of the data a business uses may vary considerably
Volatile markets- some markets are more volatile and unpredictable than others
If you do market research it should limit the risk, easier to predict short term-> particularly the case for a dynamic market but it’s better to have some sort of prediction
Benefits of sales forecasting
Informs cash flow forecasts- aids in providing the ‘sales’ or ‘revenue’ figures for the cash flow forecasts
Allows the business to plan orders of supplies and components
Ensures they have the correct staffing levels
Ensures the business had the correct capacity to meet projected orders
How to calculate sales volume
Sales revenue
_____________
Price
What is sales revenue
Income from sales
How to increase sales revenue
Increase sales volume
Increase price of PED is inelastic
What’s a fixed cost
Eg
One that doesn’t change with output
Rent, interest on a bank loan
What are stepped fixed costs
Eg
When costs may go up but it has nothing to do with output
Eg rent may go up
What’s a variable cost
Eg
One that changes with output. The more you produce the higher the cost
Eg raw materials
How do you calculate total variable costs
Variable cost per unit x output
How to decrease costs
Change supplier- trustworthy, prices, quality, contacts, proximity, trade credit agreements
Reducing waste - efficiency
Move locations - cost, Human Resources
Delayering
Buying in bulk- lowers unit costs
How to calculate profit
Total revenue - total costs
How to increase sales volume
Advertising - social media, sales promotions, sponsorships, TV/ radio
USP
Differentiate
Add value
Cheaper price
Competitors
Change/ add new markets- selling abroad/ new shops
What do you need to consider when increasing sales volume
Cost
Target audience
Ethical considerations
Finance
Return on investment
What is the average cost / unit cost
The cost per unit of production. It determines the profit margin. The larger the output the lower the unit cost
How to calculate average cost
Total cost
__________
Output
What’s a favourable outcome
Actual sales are higher than predictions
What’s an adverse outcome
Actual sales are lower than predictions
What’s breakeven
The point when total revenue is equal to total costs and neither a profit or a loss is being made
How to calculate breakeven
Fixed costs
___________
Contribution per unit
Answer always given in units
What’s contribution
The amount of money that contributes towards paying off fixed costs
Also the difference between the variable costs of one unit and it’s selling price
How to calculate contribution
Selling price- variable cost per unit
How to calculate total contribution
Total output x contribution per unit
Positives of breakeven charts and break even analysis
Can see how many products need to be sold to make a profit and whether the business model is realistic
Can be used to analyse the impact of varying customers, prices and costs on a business’s profit
Simple and easy to use
The break even point is a useful guideline to help business make decisions
Negatives of break even charts and break even analysis
Reliant on market research
Need to calculate accurate costs and revenue
Can get complicated because it simplifies what can be a complex process as most businesses sell multiple products which makes break even more difficult
Might not sell the break even level
Break even focuses on output - presumes that the business will sell all of its output at the same price
Costs are rarely constant and break even analysis presumes that costs stay the same over various levels of output
What’s a margin of safety
The difference between the break even point and the current level of output.
The size of the margin of safety will determine the risk of the business
the margin of safety should be as high as possible
What can break even analysis be used for
To evaluate the potential of a business to make a profit based on its output
Eg a business with a high break even point will have to produce and sell a lot before it starts to make a profit
A small margin of safety could also suggest any negative impact on output or demand could lead to the business making a loss
What’s a budget
A financial plan for the future concerning the revenues, costs and profits of a business
What’s the purpose of budgets
To ensure efficiency in spending
Setting budgets allows large businesses to be coordinated and can be a way of motivating employees who are allocated a budget
How is budgeting a process
The process by which financial control is exercised in a business
Budgets for revenues, costs and profit are prepared in advance and then compared with actual performance to establish any variances
Managers are responsible for controllable costs within their budgets
Managers take action if adverse variances are regarded as excessive
What are the uses of budgets in business
Establish priorities and set targets
Turn objectives into practical reality
Provide direction and coordination
Assign responsibilities
Allocate resources
Communicate targets
Delegate without loss of control
Motivate staff
Forecast outcomes
Monitor performance
Control income and expenditure
What are the three main types of budget
Revenue (or income) budget
Cost (or expenditure) budget
Profit budget
What’s a revenue (or income) budget
Expected revenues
Broken down into detail ( products/ locations)
What’s a cost ( or expenditure) budget
Expected variable costs based on sales budget
Expected fixed costs
What’s a profit budget
Based on the combined sales and cost budgets
May form basis for performance bonuses
How is a profit budget constructed
Analyse market
Draw up revenue budget
Draw up cost budget
What are the problems with budgets
A budget is only as accurate as the data on which it’s based
Last trends can be a poor indicator of what is likely to happen in the future, therefore it can be very difficult to forecast sales
New decisions taken by governments and public bodies can affect budgets eg interest rate changes and employment legislation
Unexpected changes in process can impact budgets eg commodity prices
When a budget is unrealistic it loses all value as a motivational tool
Can lead to inflexibility in decision making
Need to be changed as circumstances change
Take time to complete and manage
Can result in short term decisions to keep within the budget
Managers can become too preoccupied with setting and reviewing budgets and forgetting to focus on the real issues of winning customers
What are the potential drawbacks of budgets and budgeting
•Sales forecasting
- harder when market experiences rapid change eg new technology
- start up firms find it hard to estimate likely sales and revenues
- competitor actions difficult to predict
•costs
- always likely to be unexpected costs
- will vary depending on sales budget
- changes in external environment will impact costs eg taxes, exchange rates
How can budgets create behavioural challengers in a business
Budgeting has behavioural implications for motivating employees
Budgets are demotivating if they’re imposed rather than negotiated
Setting unrealistic targets adds to demotivation
Budgets contribute to departmental rivalry battles over budget allocation
Spending up to budget can result in a ‘use it or lose it’ mentality
A ‘name, blame and shame’ culture can develop
What’s variance analysis
Involves calculating and investigating the differences between actual results and the budget
A variance arises when there is a difference between actual and budget figures
Variances can be:
Positive/ favourable (better than expected)
Adverse/ unfavourable ( worse than expected)
What are favourable variances
Actual figures are better than budgeted figure
Eg costs lower than expected
Eg revenue/ profits higher than expected
What are adverse variances
Actual figure worse than budget figure
Eg costs higher than expected
Eg revenue/ profits lower than expected
What are the possible causes of favourable variances
Stronger demand than expected-> higher actual revenue
Selling prices increased higher than budget
Cautious sales and cost assumptions eg cost contingencies
Better than expected productivity or efficiency
What are the possible causes of adverse variances
Unexpected events lead to unbudgeted costs
Over spends by budgeted holders
Sales forecasts prove over optimistic
Market conditions mean demand is lower than budget eg competitor actions
What happens in an effective budget system
Managerial responsibilities are clearly defined
Individual budgets lay down a plan of action
Performance is monitored against the budget
Corrective action is taken if results differ significantly from the budget
Departures from budgets are permitted only after approval from senior management
Unaccounted for variances are investigated
What does the significance of a variance depend on
Whether is favourable or adverse
Whether it was foreseen
Whether it was foreseeable
How big the variance was- absolute size ( money terms) and relative size (% terms)
The cause
Whether it’s a problem or the result of a long term trend
What’s management by exception
The name given to the process of focusing on activities that require attention + ignoring those that appear to be running smoothly
Budget control And analysis of variances facilitates management by exception since ur highlights areas of business performance which aren’t in line with expectations
Who are budgets usually used by
Both large and small businesses.
Small business owners often underestimate the importance of financial control when running their business and budgeting is a method of control that could easily be employed. This might help avoid problems in the future
What specific purposes do budgets fill
Control and monitoring- by setting objectives and targets. How successful the business has been can be found by comparing actual results with budget
Planning- forces management to think ahead
Co-ordination- larger business can be complex with many departments and may be spread across the world
Efficiency- in a business with many workers it’s important for management to empower staff by delegating decision making. Budgeting gives financial control to lower levels of management
Motivation- budgeting should act as motivator to the workforce by providing targets
What’s zero based budgeting
When historical data is not available a zero based budget might be adopted
With ZBB the opportunity costs of all spending decisions is considered.
Any spending has to be justified by the budget holder to ensure all spending is good value for money.
What are some advantages of ZBB
The allocation of resources should be improved
A questioning attitude is developed which will help to reduce unnecessary costs and eliminate inefficient practices
Staff motivation might improve because evaluation skills and practices and a greater knowledge of the firms operations might develop
Encourages managers to look for alternatives
What are some disadvantages of ZBB
Time consuming as the budgeting process involves the collection and analysis of quite detailed information so spending decisions can be made
Skilful decision making is required. Such skills may not be available in the organisation. In addition, decisions may be influences by subjective opinions
It threatens the status quo. This might adversely affect motivation
Managers may not be prepared to justify spending on certain costs. Money, therefore may not be allocated to spending which could benefit the business
How do businesses deal with possible problems of ZBB
A business might give each department a ‘base’ budget.
Departments could then be invited to bid for increased expenditure on a ZBB basis
What’s budgeting/ budgetary control
Involves a business using budgets to look into the future, stating what it wants to happen and deciding how to achieve these aims
What are the stages the control process/ in budgetary Control
Preparation of plans - all businesses have objectives. Targets are usually set which allows the business to see whether its objectives have been met. The results can then be compared with the targets set
Comparisons of plans with actual results- control will be effective if information is available as quickly as possible. At the end in the period the actual results can be compared with targets set in the budget
Analysis of variances- most important stage. It involves trying to find reasons for the differences between actual and expected financial outcomes.
What’s a variance
A variance in budgeting is the difference between the figure that the business has budgeted for and the actual figure.
They’re usually calculated at the end of the budget period as that’s when the actual figure will be known
They can be favourable or adverse
Managers will examine variances and try to identify reasons why they have occurred. By doing this they might be able to improve the performance of the business in the future
Examples of variances?
Wages, materials, overheads and sales revenue
What are the difficulties of budgeting
Setting budgets- problems may arise as figures in budgets aren’t actual figures. The figures are plans based on historical data, forecasts or human judgement. The most important data in the preparation of nearly all budgets is sales data. If this is inaccurate, many of the firms budgets will be in exact. Setting budgets may lead to conflict between staff/ department
Manipulation- budgets can be manipulated by managers to make it easy to achieve so they look successful but it won’t be helping the business much
Motivation- in some businesses, workers are left out of the planning process. if workers aren’t consulted about the budget it could be difficult to use it to motivate them
Rigidity- budgets can sometimes constrain business activities. Eg departments may have different views about replacing vehicles- the newer vehicles will have lower maintenance costs but the replacing them will be high cost
Short terminism- some managers nught be too focused on the current budget and may take actions that undermine the future performance of the business just to meet current budget targets. It may save costs now but could lead to customers drifting away due to poor service
