5.2 analysing financial performance Flashcards
define: budgets
- Financial plans for future periods of time
- Businesses forecast their revenue and expenditure (or costs) using a budget
- Budgets are usually drawn up on a monthly basis, over the period of a financial year
types of budget:
- Revenue or earnings budgets- businesses expected revenue from selling its product. (the expected level of sales and the likely selling price of the product)
- Expenditure budgets- costs for labour, raw materials, fuel and other items.
- Profit budgets- combining sales revenue and expenditure budgets
Construction of budgets needs research which may involve:
- Analysing the market to predict likely trends in sales/ prices
- Researching costs for labour, fuel and raw materials by contacting suppliers (negotiating cheaper if buying in bulk)
- Considering government estimates for wage rises and inflation -> then incorporating into future sales rev + expenditure budgets
Sources of information for budgets:
- Previous trading records
- Market research - predict likely sales
- Suppliers
- Government agencies
Difficulties in constructing budgets:
- Difficult to accurately forecast sales - tastes and preferences
- The risk of unexpected changes - external environment
- Decisions by governments and other public bodies - publishing of the budget
define: Adverse variance
difference between the figures in the budget and actual figures will lead to the firm’s profits being lower than planned.
define: Favourable variance
difference between the figures in the budget and actual figures will lead to the firms profits being higher than planned.
causes of adverse variances:
- Competitors introduce new products + win extra sales
- Government increases business tax rates by an unexpected amount
- Fuel prices increase as price of oil rises
causes of favourable variances:
- Wage rises were lower than expected
- Economic boom leads to higher than expected sales
- Rising value of the pound makes imported raw materials cheaper
Overcoming an adverse budget: Due to low revenue
- Cut prices - this will work if customers are sensitive to price.
- Improve brand image /reputation.
- Seek new markets.
- Expand product range.
- Increase advertising / promotions.
Overcoming an adverse budget: Due to high costs
- Seek cheaper raw materials.
- Reduce waste.
- Cut wages.
- Increase labour productivity.
benefits to budgeting:
- Control finance effectively
- Enable managers to make informed and focused decisions
- Production budgets ensures that a business doesn’t overspend
- Can allocate finances where needed
- ## Used to motivate staff
drawbacks to budgeting:
- Revenue budget used as a target (not accurate)
- If employees are delegated responsibility then they will need to be trained, which could be costly
- Teething problems, errors or delays as employees adjust to the position
- Allocating budgets fairly and in the best interest of the business can be difficult
- Budgets are normally within the current financial year - so may try and stay within budget which may not be in the longer term interest of the business
define: cash flow
relates to the timing of payments and receipts (money flowing in and out a business)
Reasons for a cash flow forecast:
- Support applications for loans - banks and other financial lenders more likely to lend to a business that has done some financial planning which gives them more confidence the repayments will be met
- Avoid unexpected cash flow issues - forecasting to see when additional cash will be needed so that solutions can be found to keep a business functioning
