5.2 analysing financial performance

Question 1

define: budgets

Answer 1

• 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

Question 2

types of budget:

Answer 2

1. Revenue or earnings budgets- businesses expected revenue from selling its product. (the expected level of sales and the likely selling price of the product)
2. Expenditure budgets- costs for labour, raw materials, fuel and other items.
3. Profit budgets- combining sales revenue and expenditure budgets

Question 3

Construction of budgets needs research which may involve:

Answer 3

• 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

Question 4

Sources of information for budgets:

Answer 4

• Previous trading records
• Market research - predict likely sales
• Suppliers
• Government agencies

Question 5

Difficulties in constructing budgets:

Answer 5

• 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

Question 6

define: Adverse variance

Answer 6

difference between the figures in the budget and actual figures will lead to the firm’s profits being lower than planned.

Question 7

define: Favourable variance

Answer 7

difference between the figures in the budget and actual figures will lead to the firms profits being higher than planned.

Question 8

causes of adverse variances:

Answer 8

1. Competitors introduce new products + win extra sales
2. Government increases business tax rates by an unexpected amount
3. Fuel prices increase as price of oil rises

Question 9

causes of favourable variances:

Answer 9

1. Wage rises were lower than expected
2. Economic boom leads to higher than expected sales
3. Rising value of the pound makes imported raw materials cheaper

Question 10

Overcoming an adverse budget: Due to low revenue

Answer 10

• Cut prices - this will work if customers are sensitive to price.
• Improve brand image /reputation.
• Seek new markets.
• Expand product range.
• Increase advertising / promotions.

Question 11

Overcoming an adverse budget: Due to high costs

Answer 11

• Seek cheaper raw materials.
• Reduce waste.
• Cut wages.
• Increase labour productivity.

Question 12

benefits to budgeting:

Answer 12

• 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

Question 13

drawbacks to budgeting:

Answer 13

• 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

Question 14

define: cash flow

Answer 14

relates to the timing of payments and receipts (money flowing in and out a business)

Question 15

Reasons for a cash flow forecast:

Answer 15

• 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

Question 16

define: payables

Answer 16

the amount of time taken by a business to pay its suppliers and other creditors

Question 17

define: receivables

Answer 17

the amount of time taken by debtors (businesses customers) to pay for the products that has been supplied

Question 18

possible cash flow issues:

Answer 18

• Overtrading - business expands quickly without organising funds to finance the expansion
• Allowing too much trade credit
• Poor credit control - getting customers to pay on time
• Inaccurate cash flow forecasting

Question 19

Fixing cash flow issues:

Answer 19

• Offer less trade credit
• Arrange short term borrowing
• Negotiate improved terms for trade credit
• Debt factoring
• Sale and leaseback

Question 20

define: break even analysis

Answer 20

a level of output which the sales of products generate just enough revenue to cover all costs of production.

Break even output: total revenue = total costs
-> Therefore, the business makes neither a loss nor a profit
Always given in units
Always round up

Question 21

Why do managers use break even analysis?

Answer 21

1. Help to decide whether a business idea is profitable or not
2. Help to decide the necessary level of output to generate a profit
3. The results can be used to support an application for a loan
4. Used to assess the impact of changes in the level of production on profits
5. Used to assess the effects of prices / costs on potential profits

Question 22

define: Contribution (formula)

Answer 22

difference between sales revenue and variable costs of production

Contribution = revenue - variable costs

Question 23

Calculating break even analysis - Method:

Answer 23

Step 1: Find the contribution
Selling price - Variable costs = Contribution

Step 2: Find the break even point
Fixed costs/Contribution = BEP

Question 24

Q: Business B sells 500 units for £10 each. Their variable costs per unit are £4 and their fixed costs are £1,200.

Answer 24

1. £5000 - £3,200 = £1,800
2. £1,800 / 500 = £3.60
3. £1,200 / £10 - £4 = 200 units

Question 25

how do you calculate: Total Contribution?- (contribution= n.o of units sold)

Answer 25

use the contribution from the break even and multiply it by the amount of units.

Question 26

what is: margin of safety?

Answer 26

is the difference between the number of units sold and the break even point. e.g. If the break even was 250 and the number of units sold was 300, the margin of safety would be 50 units 300 - 250 = 50 units

Question 27

Revenue formula:

Answer 27

Selling Price x Quantity Sold

Question 28

define: Fixed Costs

Answer 28

Costs that do not change with output.

Question 29

define: Variable costs

Answer 29

Costs that do change with output

Question 30

Total Costs formula:

Answer 30

Fixed costs + variable costs

Question 31

see graph with total/fixed/variable/revenue lines on

Answer 31

made copy in class

Question 32

Break even analysis advantages:

Answer 32

- Forecast the effect of varying numbers of customers on revenue, costs and profit - Implications of changes in price or costs on profitability - Simple technique - particularly suitable for start up businesses and businesses that produce a single product - Quick - Used to gain additional finance - financial planning

Question 33

Break even analysis disadvantages:

Answer 33

- A prediction - information may be inaccurate - Simplification of what happens - businesses don’t usually stick to a single price - More difficult if a business sells numerous products - Costs do not rise as steadily as suggested - economies of scale

Question 34

When VC rise, the total cost line would...

Answer 34

pivot upwards and therefore a greater output is necessary to break even.

Question 35

When FC fall, the total cost line would...

Answer 35

parallel shift down and therefore a lesser output is necessary to break even.

Question 36

When selling price falls, the revenue line would...

Answer 36

pivots downwards and therefore a greater output is necessary to break even.

Question 37

When selling price rises, the revenue line...

Answer 37

pivots upwards and therefore a lesser output is necessary to break even.

Question 38

Which costs do the following consider? Net profit Operating profit Gross profit

Answer 38

Net profit - direct, indirect, remaining Operating profit - direct + indirect Gross profit - indirect

Question 39

gross profit margin formula:

Answer 39

Gross profit / revenue x 100