Financial planning - theme 2 secretion 7

Question 1

How do you know when a business is making a profit or a loss ?

Answer 1

A business will make a profit when they sell more units than the break even point, whereas a business will make a loss when they are selling less units than the break even point

Question 1

What is break even?

Answer 1

Break even is when a businesses total costs and revenue for one product are equal, the business isn’t making a profit or a loss

Question 2

How do you calculate break even?

Answer 2

Break even = total costs % contribution per unit

Or
Total costs = total revenue

Question 3

What is contribution per unit ?

Answer 3

Contribution per unit is the difference between the selling price per unit of a product and the variable cost per unit (VCPU) / the production costs per unit

Question 4

How do you calculate contribution per unit?

Answer 4

Contribution per unit = selling price per unit - variable cost per unit (VCPU)

Question 5

How do you calculate total contribution ?

Answer 5

Total contribution = contribution per un it X no. Of units sold / no. Of units

Question 6

What is the Martian of safety (MOS)?

Answer 6

The Martian of safety is the difference between the actual output levels and the break even output levels of a product/ business.

Question 7

How do you calculate the Margain of safety ?

Answer 7

Margin of safety ( MOS) = actual output levels - break even output level/s

Question 8

What are the benefits of using a break even analysis ?

Answer 8

• is quick and easy to produce and therefore managers can take swift action to cut costs or increase sales if they need to increase their margin of safety.
• can be used to persuade sources of finance to lend finance to a business as they can see if the business will make them a return on their investment/ afford to pay back the money eg. In the case of a bank pan , break even analysis so is found in the financial section of a business plan.
• can decide whether a new product is launched or not as can see whether it will be a viable decision which is profitable for the business / firm
• can forecast how variations in levels of sales can impact the costs, revenue and profits of a business. Can also see how price and cost variations will affect the break even point ( how many units the business needs to sell )

Question 9

What are some drawbacks of using a break even analysis ?

Answer 9

• hard to produce for multiple products / a business with a large product portfolio- can become extremely complicated
• only tells you how many products that you need to sell to break even not how many products that you will actually sell
• assumes that the business will sell all of the stock/ products which realistically isn’t the case for most businesses - doesn’t allow a margin of error for stock which won’t be sold/ wastage
• assumes that variable costs always rise steadily which isn’t normally the case.

Question 10

What is the definition of a sales forecast ?

Answer 10

A sales forecast is a projection of the amount of products or services that a business expects to sell within a specified future period of time. Aims to predict the future sales volume and sales revenue based on past data and market research.

Question 11

What does sales forecasting help to make decisions about ?

Answer 11

Finance - sales are usually the main source of cash inflows for a business so they need to be aware of the sales forecast to generate accurate cash flow forecasts
Marketing - marketing methods drive sales levels so need to be aware of what type of marketing ethos is being used
Resources - needs to be aware of the level of resources required

Question 12

What factors affect sales forecasting ?

Answer 12

Consumer trends
Economic variables such as exchange rates and interest rates in different countries / the market
Actions of competitors such as launching a new product or alternating the price of a good/ service

Question 13

How to calculate revenue ?

Answer 13

Revenue = price X quantity

Question 14

How to calculate total costs ?

Answer 14

Total costs = total fixed costs + total variable costs

Question 15

How to calculate profit / loss ?

Answer 15

Profit / loss = revenue - total costs

Question 16

What is a budget?

Answer 16

A budget is a financial forecast which foresees future earnings and expenditure levels of a business throught a 2 month period

Question 17

What is an income budgeted

Answer 17

An income budget forecasts the amount of money which will be coming into the business as revenue, to create an income budget you need to predict sales levels for the next 12 months (create a sales forecast) and the selling price per unit as revenue = price X quantity

Question 18

What is an expenditure budget ? And ho do you create an expenditure budget ??

Answer 18

A n expenditure budget predicts the level of cash which will be spent in the business on total costs ( fixed + variable costs ), to predict an expenditure budget you need to research how labour, raw materials,taxes and inflation are expected to go up in the next year.
- variable costs need to be considered as they increase depending on the levels of output of a business therefore a sales forecast Will also be needed for this type of budget

Question 19

What is a profit budget and how is it calculated?

Answer 19

A profit budget measures the amount of profit or loss that a business will make in a year.

Profit budget = income - expenditure budget = profit / loss for the year

Question 20

How are budgets set ? - 4 ways which budgets are set by

Answer 20

• income budgets are set mainly based off of predicted sales levels for the year ( sales forecasts) and market research
• expenditure budgets are set by predicting how the costs of raw materials, Labour, taxes ad how inflation changes thought the year to calculate the predicted total costs of a business.
  -influenced by the businesses aims and objectives which are laid out in the business plan
  -annual budgets are often agreed though the use of negotiation between the expected budge holder and the main management of the business however this can be problematic if thw budget holder lacks negotiation skills and can case resentment between branches within the business

Question 21

Method of budgeting - what is a zero based budget, how is it calculated and Benefits and drawbacks of using a zero based budget .

Answer 21

• a zero based budget is often used by start up b businesses due to a lack of accurate market research and financial data on how to produce a budget
• the budget holder stats off with £0 and has to seek approval for spendinmoney on planned activities of that branch of the business
• can be difficult if the budget holder
  lacks significant negotiation skills
  + can be more accurate than historical budgeting if done correctly

Question 22

Methods of badgering what is historical budgeting, how is it calculated ? And benefits and drawbacks of historical budgeting

Answer 22

• historical budgeting is when a budget is based off of a percentage increase or decrease on the previous year’s budget, created using historical financial data.
  + benefits of historical budgeting are that it is quick and simple and is based off of previous data which may be more accurate than completely rouge new data which has been created
• drawbacks of historical budgeting are that it assumes that market conditions remain unchanged and that market conditions are the same for all products which may be at different stages of the product lifecycle eg. A product in the research and development stage may need more spending on marketing than a product in the growth or maturity stages of the product lifecycle

Question 23

What are some benefits as a whole of budgeting ?

Answer 23

• can be motivating for the workforce as they provide an achievable realistic goal for them to work towards
  -help to control income and expenditure levels within a business
  -help managers to review their activities and make key decicions
  -helps to focus on priorities
  -good communication tool between different branches of the business to share information such as how money is being spent
  -lets departments co-ordinate spending
  -persuade potential investors that the business will be successful

Question 24

What are some drawbacks as a whole of budgeting ?

Answer 24

• can cause resentment and rivalry between departments if they feel that they have to compete for finance
  -can be restrictive due to lack of action as a result of external factors such as the market
  -time consuming and managers may loose touch and forget to focus on more prominent issues within the business such as the needs and wants of a consumer
  -inflation is difficult to predict as some prices rise by more than usual
  -start up businesses may struggle to produce accurate budgets due to a lack of data

Question 25

What is fixed budgeting ?

Answer 25

Fixed budgeting is when a budget holder has to stick to their budget thought the year and the budget doesn’t change in response to any external marketing conditions
+ provides disciple and certainty which is extremely important for businesses with cash flow problems as helps to control cash flow levels

• can prevent a firm from reacting to new opportunities or threats that they didn’t know about when they set the budget

Question 26

What is flexible budgeting ?

Answer 26

Budgeting which alters in response to changing marketing conditions eg. Zero based budgeting