3 - Developing a Business Plan - Cost Volume Profit Analysis

Question 1

What is a business plan?

Answer 1

It is an evolving report that describes a business’s goals and its plans for achieving those goals.

Question 2

What are the three main purposes of a business plan?

Answer 2

1. It is an effective organisational tool
2. It serves as a benchmark
3. It serves as a tool to gain financing

Question 3

How does a business plan help organise a business?

Answer 3

It encourages you to think critically about your hopes for the business and putting a plan on paper will help to imagine how the plan will work, and evaluate the plan, develop new ideas and refine the plan.

Similarly, by looking at the plan from different perspectives, such as those of managers who have the responsibility for various sections of the business, you can discover and correct flaws before implementing the plan.

Question 4

How does a business plan serve as a benchmark?

Answer 4

It provides a model of how business performance is projected to occur which can later be compared to and measure the actual performance of a business.

As such, it allows a business to quickly find whether there are any shortfalls or surpluses in the actual performance of a business, which can be addressed much faster.

Question 5

How can a business plan help gain financing?

Answer 5

A business plan helps an entrepreneur to obtain the financing that new and growing companies often need. When looking for additional funding, potential investors and creditors may request a copy of the business plan to help them decide whether or not to invest in the business or to loan it money.

Question 6

What is a risk?

Answer 6

Amount of uncertainty that exists about the future operations of a business.

Question 7

What is a return?

Answer 7

Money received from investment and credit decisions.

Question 8

What are the five parts of a business plan?

Answer 8

1. A description of the business
2. A marketing plan
3. A description of the operations of the business
4. An environmental management plan
5. A financial plan

Question 9

What is the description of the business?

Answer 9

This description includes information about the organisation of the business, its products or services, its current and potential customers, its objectives, where it is located, and where it conducts its business.

Question 10

What is the marketing plan?

Answer 10

The marketing plan shows how the business will make sales, and how it will influence and respond to market conditions. It provides evidence of demand for the business’s product or services, including any market research available.

It describes current and expected competition in the market, as well as relevant government regulations. It outlines how the business will promote, price, and distribute its products (the business’s ‘marketing strategy’), as well as the predicted growth, market share, and sales of products (its ‘sales forecast’) by period.

Question 11

What is the operating plan?

Answer 11

The business operations section includes a description of the relationships among the business, its suppliers, and its customers, as well as a description of how the business will develop, service, protect and support its products or services.

Other influences on the operations of the business might also be described in this section. These might include the availability of employees, concerns of special-interest groups, regulations, the impact of international trade, and the need for patents, trademarks, and licensing agreements.

Question 12

What is the environmental management plan?

Answer 12

The environmental management plans describe how the actions of your business might impact the natural environment in which it occurs and sets out clear commitments from the business taking the actions on how those impacts will be avoided, minimised, and managed so that they are environmentally acceptable.

Question 13

What is the financial plan?

Answer 13

The financial plan identifies the business’s capital requirements and sources of capital and describes its projected financial performance.

Question 14

What are the steps a business takes to identify capital requirements?

Answer 14

1. Determine the resources needed
2. Determine the capital needed to acquire the resources
3. Analyse the business’s projected cash receipts and payments
4. Determine available cash and any need for borrowing

Question 15

What is a cash buffer and why is useful?

Answer 15

A cash buffer is an extra cash on hand above the projected short-run cash payments of the business. The buffer serves to protect the business from differences between actual cash flows and projected cash flows, as well as from unanticipated problems.

It lets the business operate normally through downturns without having to look for financing. It also lets the business take advantage of unexpected opportunities that require cash.

Question 16

How does a business identify sources of capital?

Answer 16

The business must know both the length of time for which the business plans to use the capital before paying it back to creditors or returning it to investors and the availability of short and long-term sources of capital.

Short term capital can come from two sources:

1. Trade credit from suppliers
2. Loans from financial institutions

Other sources of capital are lines of credit and long-term capital.

A sufficiently large company may offer private placements and public offerings as possible sources of capital.

Question 17

What is short-term capital?

Answer 17

Captial that will be repaid within a year or less.

Question 18

What is trade credit?

Answer 18

Trade credit is a business-to-business (B2B) agreement in which a customer can purchase goods without paying cash upfront, and paying the supplier at a later scheduled date.

Question 19

What is a line of credit?

Answer 19

Amount of money a business is allowed to borrow with a prearranged, agreed-upon interest rate and a specific payback schedule.

Question 20

What is long-term capital?

Answer 20

Capital that will be repaid to creditors or returned to investors after more than one year.

Question 21

What are public offerings?

Answer 21

Issued bonds or shares to the public (investors) through security firms or investment bankers.

Question 22

What are private placements?

Answer 22

Securities that are sold directly to private individuals or groups (called investors).

Question 23

What are the steps involved in projecting a business’s financial performance?

Answer 23

1. Ensure the date you use is as reliable as possible
2. Consider numerous scenarios because predicting a business’s financial performance is uncertain.
3. Revise your projections as more facts become available
4. Ensure that the financial plan is consistent with the information in the other sections of the business plan

Question 24

What is Cost-Volume-Profit (CVP) analysis?

Answer 24

An analysis tool that shows how profit is affected by changes in sales volume, selling prices of products, and the various costs of a business. It is sometimes called break-even analysis. It can be expressed as an equation or a graph.

Question 25

What is volume?

Answer 25

Activity level in a business.

Question 26

What are fixed costs?

Answer 26

Costs that are constant in total and that are not affected by changes in volume.

Question 27

What is a relevant range?

Answer 27

Range of volumes over which cost estimates are needed for a particular use and over which observed cost behaviours are expected to remain stable.

Question 28

What are variable costs?

Answer 28

Costs that are constant per unit and that change in total in direct proportion to changes in volume.

Question 29

How do you calculate the total amount of variable costs?

Answer 29

Total variable costs = V*X

X = Sales volume
V = variable cost per unit sold

Question 30

What are the total costs?

Answer 30

The sum of the fixed costs and variable costs at a given volume.

Question 31

How do you calculate total costs?

Answer 31

Total cost = F + V*X

F = Total fixed costs
X = Sales volume
V = variable cost per unit sold

Question 32

How do you calculate profit?

Answer 32

Profit = Revenue - Expenses

Question 33

What is the break-even point?

Answer 33

Unit sales volume at which a business earns zero profit.

Question 34

What is the total contribution margin?

Answer 34

Difference between the total sales revenue and the total variable costs

Question 35

How does accounting information contribute to the planning process?

Answer 35

Finding and evaluating alternative plans is a crucial part of the planning process in a business. Accounting information can help decision-makers to evaluate alternative plans by using CVP analysis to show the profit effect of each plan.

CVP analysis is a tool that helps managers think critically about the different aspects of each plan. This understanding can produce better-informed decisions during the ongoing planning process. With it you can find vital information such as break-even points, contribution margins, etc.

Question 36

What is the contribution margin per unit?

Answer 36

Difference between the sales revenue per unit and the variable costs per unit.

Question 37

How do you calculate profit at a given sales volume?

Answer 37

P = S * X - V * X - F

P = Profit
S = Selling price per unit
F = Total fixed costs
X = Sales volume
V = Variable cost per unit sold

Or

P = C * X - F

Where:

C = Contribution margin per unit

Question 38

How do you calculate the break-even point?

Answer 38

X = F / C

F = Total fixed costs
X = Sales volume
C = Contribution margin per unit

Question 39

How do you calculate the total fixed costs?

Answer 39

F = C * X

F = Total fixed costs
X = Sales volume
C = Contribution margin per unit

Question 40

How do you find the unit sales volume to achieve a target profit?

Answer 40

X = (F + P)/C

F = Total fixed costs
X = Sales volume
C = Contribution margin per unit
P = Desired profit

Question 41

How can decision-makers use accounting information to evaluate alternative plans?

Answer 41

Decision-makers can determine how changes in costs and revenues affect the business’s profit. Based on accounting information alone, the alternative that leads to the highest profit will be the best solution. However, decision-makers should also consider the non-financial effects that their decisions may have.