Paper 1- Theme 2.2- Financial planning ✅

Question 1

define contribution

Answer 1

how much revenue generated goes towards covering the fixed costs and then the profit

Question 2

total contribution =

Answer 2

total contribution = Total Revenue - Total Variable Costs

total contribution = contribution per unit x output
cpu x output

Question 3

define break even output

Answer 3

level of output where total costs = total revenue

Question 4

Break even output

Answer 4

break even output = fixed costs
————————————
contribution per unit

Question 5

Margin of safety =

Answer 5

Margin of safety = no. of units sold - break even output

Question 6

Benefits of break even analysis

Answer 6

• can test feasibility of a business idea or product easily
• calculations are quick and easy

•business can calculate level of cushion between being profitable & breaking even
—> can plan investment based on this

• use to make targets & budgets, and monitor progress

• —> help startups ensure survival
• —> direction for employees —-> motivation

• use to determine pricing strategy
—–> can increase price if low breakeven

Question 7

Drawbacks of break even analysis

Answer 7

DRAWBACKS

• variable costs don’t always stay the same

• –> may drop due to EoS
• –> may rise due to supplier increased bargaining power (due to increased comp)

• assumes price stays constant

• –> ignores promotional offers
• –> lower price to wholesalers buying using EoS
• –> lower price to extend product life cycle
• –> price skimming strategy, increase prise to absorb indirect taxes

•static model- doesn’t account for sale trends, and external shocks

• –> change in demand
• –> change in consumer trends
• assumes all output is sold
• —> assumes no wastage & ignores product’s that become obsolete or become out of fashion
• time consuming if have to calculate for each product in portfolio
• need motivated and highly qualified management to interpret data
• may encourage a more short termist approach
• –> detriment to long term investments

Question 8

specific pros and cons of calculating margin of safety

cons will be similar to break even analysis

Answer 8

pros

• allocate investment funds efficiently, based on projected profit
• understand levels of risk making a loss at certain output levels
• —> can take appropriate action

cons

• may become complacent, as predicted to make profit
• –> vcpu may rise, productivity may decrease, increasing unit costs

Question 9

factors influencing break even

Answer 9

• selling price
• output
• costs

Question 10

Define a budget

Answer 10

-financial plan for the future, projecting costs, income and profit over a period of time

Question 11

Three things budgets can focus on

Answer 11

• revenue budget (expected sales)
• cost budget
• profit budget (combine cost and revenue budgets)

Question 12

purpose of budgets

Answer 12

• monitor performance through target creation
—> provide clear direction —> cohesive culture —-> productive workforce

•forecast your profits (know how much can be reinvested)

• ensure no department is overspending
—-> meet financial objectives —-> improve shareholder morale

• effective allocation of resources

• –> can identify how much capital will be available at certain times
• —> prioritise spending in areas of high growth potential

• enable local managers to have spending power
—> speed up decision making —> most expertise in area on where to spend

Question 13

limitations of budgeting

Answer 13

• 𝗽𝗿𝗼𝗳𝗶𝘁, 𝗿𝗲𝘃𝗲𝗻𝘂𝗲 𝗮𝗻𝗱 𝗰𝗼𝘀𝘁:

• may encourage a more short termist approach to meet targets
—> may risk sustainable competitive advantage

• need motivated and highly qualified management to interpret data
• very time consuming for large businesses

•doesn’t account for changes in the market
—> higher production costs, lower demand

• 𝗮𝗹𝗹 𝘀𝗽𝗲𝗰𝗶𝗳𝗶𝗰𝗮𝗹𝗹𝘆 𝗰𝗼𝘀𝘁:
• complacency if under budget
• may miss out on opportunities due to budget restrictions
• staff demotivation if blame culture on budget variance
• –> also if budget cuts means staff cant complete tasks efficently
• –> also less chance of piece rate pay with low cost budget

Question 14

two types of budget

Answer 14

historical

zero budgeting

Question 15

define historical budgeting

pros and cons

Answer 15

whatever you used last year is reallocated (+inflation or growth rate)

pros:

• based on actual results
• may feel trusted and so motivated (improve corporate culture)

cons:
- doesn’t encourage efficiency
- —-> may feel obliged to spend full amount so you get same amount next year
- no incentive for developing innovative ways to reduce costs
- may force people to be more short term (budget is yearly)
- may miss opportunities as reluctant to splash a lot of budget
- may become out of date if trends or demand change

Question 16

define zero based budgeting

pros and cons

Answer 16

-each year you start at zero and budget is based off new proposals put to the manager

pros:
- prevents gradual increase of budgets each year
- less complacency, drive for innovation to reduce costs
- can propose new projects or opportunities and receive financial support for them

cons:

• hard to find good reasoning for small sum differences
• time consuming
• potential bias to better pitchers