3.5.2 Analysing Financial Performance Flashcards
4 what is a budget
an agreed plan establishing the planned income, spend and profit for a business over a period of time
4 what is budgeting
the process involved in setting a budget
4 why should you have a budget
provide a plan of future activity
ensure finances are available to fund activity
prevent overspending and control costs
set targets to be achieved
help employees stay focused on achieving companies objectives
4 why are budgets set
set over a specific time period to monitor performance of set targets of income, expenditure, profit, budget, capital
4 how do you construct a budget?
- set objectives
- market research
- research costs
- sales income budget
- expenditure budget
- profit budget
- divisional budgets
- summarise
4 what is setting objectives
what are the budgets trying to achieve
4 what is market research
discover probable level of sales volume and market price
4 what are research costs
based on sales volumes expected
4 what is sales income budget
gives an estimate of how much to produce
4 what is expenditure budget
what costs will be incurred trying to achieve sales targets
4 what is profit budget
combine income and expenditure budget to give overall profit
4 what is divisional budgets
also know as departmental budgets
the overall budget broken down into products and departments
4 what is summarise
the detailed budgets feed up in to the master budget
4 what is the problem with setting budgets
4 reliant on accurate forecasts information
lack of effective research
changes in consumer tastes- popularity
unforeseen changes to cost of raw materials
changes in interest rates, inflation
rapid changes in prices caused by inflation
4 how are inaccurate forecasts unhelpful
will not give any potential lenders confidence in an entrepreneurs ability to set up and run a business
4 why are entrepreneurs not the best at budgeting
not have much experience and may be inaccurate, no historical data so hard to start the forecast anyway
4 why are impossible targets unhelpful
too high and unrealistic can demotivate staff as they regard impossible targets to achieve so give up
4 why are small budgets unhelpful
be challenging if too low and will not move a business towards goals effectively
4 why must you monitor budgets continuously
any problems can be flagged early on and appropriate action taken
4 how to do you set a budget with historical data
uses past data
able to adapt for planned forecasts
can be calculated quickly and easily
encourage reliance by departments to assume a certain level of budget
4 how do you set a budget with zero data
new businesses have no historical data
used by firms who make no assumptions so every spend is justified
more time needed to construct it
4 what are the difficulties in setting a budget, using sales forecasting:
harder when market experiences changes- new tech
start up firms find it hard to estimate likely revenue and sales
competitor actions are difficult to predict
4 what are the difficulties in setting a budget, using costs:
always likely to be unexpected costs
will vary depending on sales budgets
changes in external environment will impact costs, like taxes and exchanges rates
4 what are the drawbacks of using budgets
conflict may arise between departments as they are competing for a larger slice of funding available
short term budget cuts to meet strict targets might lead to long term problems for the business if sales fall as a result
ambitious targets may be unrealistic and lead to demotivation
staff many have no input in budget and can lead to demotivation
4 what is variance analysis
the process where sales costs are compared with the budgets
5 what formulas do you need for a cash flow forecast?
net cash flow
closing balance
opening balance
5 what does a business estimate
how much it will sell
costs to make
fixed costs
5 how do business estimate costs
cash flow forecasts
5 what is a cash flow forecast
predict when cash is expected to come into and leave a business over a period of time
5 what are cash inflows
cash from the individual
loans from the bank
cash from sales
5 what are cash outflows
wages and training
telephone, gas, electric bills etc
equipment and stock
advertising
interest on loans
maintenance and repairs
5 what is the difference between cash inflows and cash outflows?
net cash flow
5 what is positive net cash flow
Inflows are greater than out flows
5 what is negative net cash flow
Inflows are not enough to cover out flows
5 what is closing balance
The amount of money in a business at the end of a month (net cash flow + opening balance)
5 what is opening balance?
The amount of money in a business at the start of a month. This is always the previous month’s closing balance.
5 what are some cash flow objectives?
Maintaining a minimum closing monthly cash balance
Reducing the bank overdraft by a certain sum by the end of the year
Creating a more even spread of sales revenue
Spreading costs more evenly
Achieving a certain level of liquid, non-cash items.
Raising certain levels of cash at a particular point in time.
Setting contingency fund levels
5 example of Maintaining a minimum closing monthly cash balance
A minimum cash balance of £10,000 would be a sensible objective for a small newsagent
5 example of Reducing the bank overdraft by a certain sum by the end of the year
A new start-up is likely to rely on an overdraft to support everyday expenses. Not advisable to maintain a permanent overdraft - expensive
5 example of Creating a more even spread of sales revenue
One reason why Mars Ltd introduced the Mars Ice Cream was because sales of chocolate fall in the summer months. This strategy means that it is less likely that Mars will become short of cash in the summer months.
5 example of Spreading costs more evenly
Pay utility bills such as gas and electricity on a monthly basis rather than quarterly or once every six months.
5 example of Achieving a certain level of liquid, non-cash items.
Many businesses set an objective to hold stock. If the business does run low on cash, it can turn these assets into cash quickly.
5 example of Raising certain levels of cash at a particular point in time.
If the business knows through its cash flow forecasts that it needs to acquire a higher level of cash at a certain time (e.g. a retailer building up stock levels for Christmas), it may set an objective of raising a particular level of cash.
5 example of Setting contingency fund levels
Emergency source of finance that can be used if unexpected difficulties occur
5 what do cash flow objectives depend on?
financial position of the business
4 what is favourable variance
costs lower than budget
revenue higher than budgeted
profit higher than budgeted
opposite is trye for all
6 what is profitability
The measure of a firm’s ability to keep a proportion of revenue after all costs have been paid.
6 Why do we measure Profitability?
Simply stating an amount of profit does not determine:
How well the firm is managing its costs
How it compares to similar firms in the same industry
What proportion of revenue is kept
Measure against previous years and highlight any improvements or causes for concern
6 what is profit and loss
If revenue > total costs = profit
If revenue < total costs = loss
6 what is gross profit?
revenue - direct costs= gross profit
Gross profit broad measure of profit and can identify wastage and fall in efficiency of production
6 what is operating profit
gross profit - indirect costs
Fair measure of profit as takes in to account all trading activities
6 how do you get profit for the year?
revenue - direct costs = gross profit - indirect costs = operating profit
operating profit adjusted by tax and interest = profit for the year
6 how do you increase profit equation?
(new profit - old profit)/ old profit
x 100 = %
6 how do you gross profit margin equation?
(gross profit)/ revenue
x100 = %
6 how do you operating profit margin equation?
(operating profit)/revenue
x100 = %
7 what are fixed costs
indirect costs
must be paid even if the firm sells nothing
may change in time but don’t change by a set amount
often presented as a a cost per month, per year, per week etc
7 what are variable costs
directly change with output
7 what is revenue
money received from selling goods or services
7 what is profit
what’s left after revenue - costs
7 what is contribution
selling price - variable cost per unit
7 what is Break Even
when total costs = revenue
no profit or loss made
(fixed costs)/(contribution per unit)
7 what’s the impact on break even point when
Increase selling price
decrease selling price
inc- reduced BE
dec- increased BE
7 what’s the impact on break even point when
Increase varaiable costs
decrease variable costs
inc- increased BE
dec- reduced BE
7 what’s the impact on break even point when
Increase fixed costs
decrease fixed costs
Inc- increased BE
red- Reduced BE
7 what is the equation for Break Even
(Fixed costs)/(Contribution per unit)
Contribution = selling price - variable cost per unit
7 what is the uses and benefits of a break even?
can help decide whether a new business should start trading, sell a product or set up a new location
forecasting
help managers assess impact in change of level of production
help support an application to financial institutions or investors for a loan or capital
7 what are some assumptions of break even?
selling price stays the same
fixed costs remain the same
variable costs vary in direct proportion to output
all units are sold
7 what are some limitations of break even?
over simplified model
based on a forecast so unreliable
dependent on accuracy
only shows short-term situations
