Analysing Financial Performance Flashcards
Define a ‘budget’.
A financial plan for the future with the aim of controlling sales and costs.
Define ‘budget variance analysis’.
This compares the budgeted sales, costs and profits to what actually happened. The difference can be favourable or adverse.
Define ‘favourable variance’.
Where sales were higher than budgeted or costs were lower than budgeted.
Define ‘adverse variance’.
Where sales were lower than budgeted or costs were higher than budgeted.
Why might sales income be higher than budgeted?
- Increase in customer incomes
- Upturn in the economy
- Successful advertising campaign
- Major competitor went bust
Opposite will happen if sales are lower than budgeted.
Why might costs be higher than budgeted?
- Increase in sales so more stock was needed
- Supplier increased stock prices
- Fall in productivity
- Weaker exchange rate - higher import costs
- Poor financial management
Opposite will happen if sales are higher than budgeted.
What are the advantages of budgets?
- Budgets are a control mechanism so business does not overspend.
- More profits can be earned.
- Set targets - motivate employees if rewards are given for meeting budget targets.
Stakeholders:
- Shareholder earns more profit as costs and sales are more controlled.
- Employees motivated and given bonuses if they meet their targets based upon their budget.
- Customers may receive lower prices if costs are reduced.
- More profits due to budget target being met, and a better control of costs could mean more employment opportunities for the local community.
What are the disadvantages of budgets?
- May be difficult to forecast sales accurately, especially for a new business without any previous experience.
- May be difficult to forecast sales and costs when strategies haven’t been agreed by managers.
- Danger of unexpected changes, e.g. variable costs (e.g. raw materials) rising, new competitor.
- Overambitious objectives can lead to demotivation. If budgets are based on unreliable research then they may be inaccurate and bad decisions will be made based on incorrect predictions.
- If actual figures are highly adverse or favourable it shows that the budget itself was inaccurate and therefore, not as useful.
Stakeholders:
- Managers’ time and effort creating the budget.
- Employees demotivated and stressed if targets too high.
- Shareholder and customer benefits will not be realised if budget targets are unrealistic.
How do you evaluate budgets?
- Budgets are a useful planning tool; can act as motivation which can lead to higher productivity. But it depends on how accurate the budget is.
- Also depends on whether targets are achievable and whether the pace of change in the market makes it difficult or easy to predict future finances.
What is the ‘Profit and Loss Account’ (Income Statement)?
A profit and loss account shows how much profit or loss the company made in a financial year.
What is ‘gross profit’?
Profit after the cost of sales has been deducted from sales revenue. Cost of sales relates to direct (variable costs) in production, e.g. raw materials (stock).
What is ‘net profit’?
Profit after all expenses have been deducted from gross profit. Expenses are other indirect fixed costs (overheads), e.g. rent, machinery and equipment.
What do businesses do with what is left over?
Some of the money will be held back as RETAINED PROFIT to reinvest in the business; some will be given to shareholders as DIVIDENDS.
What is the ‘balance sheet’?
This shows how much the business is worth at a set point in time.
What are ‘fixed assets’?
Items the business owns for more than a year.
What are ‘current assets’?
What the business owns that changes on a daily basis.
What are ‘current liabilities’?
What the business owes to be paid back within a year.
What are ‘long-term liabilities’?
What the business owes but to be paid back in the long term, e.g. bank loan.
What is ‘working capital’?
Looks at whether a business can pay its short-term debts; current assets - current liabilities.
