3.5.2 Analysing financial performance Flashcards
What is a budget and what is budgeting?
- Budget: A financial plan for the future concerning the revenues and costs of a business
- Budgeting: The process involved in setting a budget
What are the three types of budget?
- Income budget
- Expenditure budget
- Profit budget
What is profit budget, income budget and expenditure budget?
- Profit budget: Shows the agreed, planned profit of a business (or division of a business) over a period of time
- Income budget: Shows the agreed, planned income of a business (or division of a business) over a period of time. it may be also be described as a revenue budget or sales budget.
- Expenditure budget: Shows the agreed, planned expenditure of a business over a period of time
What is contribution ?
- Contribution looks at the profit made on individual products
- It is used in calculating how many items need to be sold to cover all the business’ total costs (variable and fixed)
- Contribution is the difference between sales and variable costs of production
How do you construct a budget? (1)
- Set objectives
- Carry out market research
- Carry out research into costs
- Complete the sales (income budget)
How do you construct a budget? (2)
- Construct expenditure budget
- Construct overall profit
- Draw up divisional or departmental budgets
- Summarise the detailed budgets in the master budget
What is variance analysis?
Calculating and investigating the differences between actual results and the budget
What is a favourable variance and adverse variance?
- Favourable variance: When costs are lower than expected or revenue is higher than expected
- Adverse variance:When costs are higher than expected or revenue is lower than expected
What are some possible Causes of Favourable Variances?
- Competitor weakness leading to higher sales
- Better than expected productivity or efficiency
- Selling prices increased higher than budget
What are Possible Causes of Adverse Variances?
- Unexpected events lead to un-budgeted costs
- Over-spends by budget holders
- Sales forecasts prove over-optimistic
What is a point to remember about adverse variances?
- An adverse variance might result from something that is good that has happened in the business…
- E.g. higher production costs than budget (adverse variance) that occur because sales are significantly higher than budget (favourable budget)
What are reasons for budgeting?
- To gain financial support
- To improve efficiency
- To encourage delegation and responsibility and to motivate staff
What are some of limitations of budgets?
- Are only as good as the data being used
- Need to be changed as circumstances change
- Can lead to inflexibility in decision-making
What are the strengths of break-even analysis?
- Calculations are quick and easy
- Focuses on what output is required before a business reaches profitability
- Illustrates the importance of keeping fixed costs down to a minimum
What are the limitations of break-even analysis?
- Unrealistic assumptions - products are not sold at the same price at different levels of output; fixed costs do vary when output changes
- Most businesses sell more than one product
- A planning aid rather than a decision-making tool
What is profitability?
The ability of a business to generate profit or the efficiency of a business in generating profit
What is the gross profit margin?
- This measures gross profit as a percentage of sales (turnover)
- This ratio measures how efficiently the business is transforming raw materials into products
What is operating profit margin?
This measures operating profit as a percentage of sales (turnover). This ratio measures how efficiently the business is making a profit from the resources that it’s using for its trading activities
What is profit for the year margin or profit of the year as a percentage of sales?
- This measures the profit that is available for shareholders, as a percentage of sales (turnover)
- This ratio measures how much the shareholders may benefit directly from the financial performance of the business
What are the types of cash inflows and outflows?
Inflows:
- Cash sales
- Interest on bank balances
- Loans from bank
- Grants
Outflows:
- Payments to suppliers
- Dividends paid to shareholders
- Wages and salaries
What are the main benefits of cash flow forecasting?
- Identifying potential cash flow problems in advance
- Guiding the firm towards appropriate action
- Identifying the possibility of holding too much cash
What are the problems with cash flow forecasting?
Sales prove lower than expected:
- Easy to be over-optimistic about sales potential
- Market research may have gaps
Customers do not pay up on time:
- A notorious problem for businesses, particularly small ones
Imprudent cost assumptions:
- A common problem for a start-up
- Unexpected costs always arise - often significant
What is cash flow management?
Cash flow management is a crucial day-to-day activity for every business
How to manage cash flow problems?
- Make and action reliable cash flow forecasting
- Manage working capital effectively; credit control from trade debtors
- Choose the right sources of finance
