Section E (BUSINESS FINANCE) Flashcards
Break-even and cash flow forecasts
What is a CASHFLOW FORECAST?
A document that shows the predicted flow of cash into and out of a business over a given period of time, normally 12 months.
By forecasting cash flow in advance, a business can identify where there might be shortages and either try to prevent this from happening or put plans in place to deal with it.
Description & Examples of INFLOW / RECEIPTS
It is money coming into the business from various places which include:
- Cash Sales = The customer pays at the time of purchase
- Credit Sales = The customer pays in a pre-agreed period after the sale, e.g. 30 days
- Loans = Bank loans to fund the purchase of assets such as machinery and vehicles
- Capital Introduced = Money invested from entrepreneurs or shareholders when a business is first set up or looks to expand
- Sales of Assets = The sale of items owned by the business which are no longer needed in order to bring a short-term cash injection into the business
- Bank Interest Received = Interest paid by the bank on credit balances
Description & Examples of OUTFLOWS / PAYMENTS
It is money going out of the business for various purposes which include:
- Cash Purchases = Items purchased by a business and paid for at the time of purchase
- Credit Purchases = Items purchased by a business and paid for at a later point in time
- Purchase of Assets = Non-current assets that a business is likely to keep for more than one year such as machinery
- Value Added Tax (VAT) = Businesses that are VAT registered must pay VAT to HM Revenue & Customs (HMRC), and this should be shown in the cash flow forecast
- Bank Interest Paid
- Rent
- Rates
- Salaries
- Wages
- Utilities
What is OPENING BALANCE?
Amount of cash available in a business at the start of a set time period (e.g. a month).
What is CLOSING BALANCE?
Amount of cash available in a business at the end of a set time period (e.g. a month).
What is BREAK-EVEN ANALYSIS?
Break-even is the point at which a business is not making a profit or loss. This means money from sales equals money on costs.
When Total Revenue (TR) = Total Costs (TC)
Can be calculated as:
Fixed Costs / Contribution per unit
4 Examples of ‘Costs to a Business’
- Variable costs = Vary with the level of output, e.g. raw materials
- Semi-variable Costs = Part of the costs stays the same and part varies in relation to the degree of business activity, e.g. a worker may be paid a fixed rate of pay but at busy times earn additional payments for working overtime
- Fixed Costs = Do not vary with output, e.g. rent
- Total Costs = Fixed Costs + Variable Costs
4 Examples of ‘Sales by a Business’ (these generate income)
- Total Revenue = The total amount of money coming in from sales, calculated as: quantity X selling price
- Total Sales = The amount of sales made in a set period of time, e.g. a year; this can be expressed as value or volume
- Selling Price per unit = The amount a customer pays for each unit bought
- Sales in Value = Sales expressed in monetary value, e.g. £’s, calculated as: quantity sold X selling price per unit
- Sales in Volume = Sales expressed as a quantity, e.g. tons or units
How is break-even point calculated?
Fixed Costs / Contribution per unit
How is contribution per unit calculated?
Selling Price - Variable Costs per unit
How is total contribution calculated?
Sales Revenue - Total Variable Costs
How is total variable costs calculated?
Variable Cost per unit X Quantity
OR
Contribution per unit X Number of units sold
PROS & CONS of Contribution per unit
PROS:
- Straightforward to calculate
- Allows for the calculation of break-even level of output
- Can be used to inform decisions, e.g. what price to charge
- Can be used to carry out what-if analysis
CONS:
- Doesn’t take into account fixed costs
- Assumes that prices remains constant
- Doesn’t take into account any unexpected changes to variables, e.g. selling price and variable costs can fluctuate
The use of BREAK-EVEN for planning, monitoring, controlling and target-setting:
PLANNING:
- Set budgets for the amount of sales necessary and costs
- Forms part of a business plan to show at what point the business will start to make a profit
- Informs pricing decisions
MONITORING:
- Monitor progress towards achieving break-even point
- Identify changes to selling price of costs
- Take corrective action if targets look unlikely to be met
CONTROL:
- Keep costs within budget
- Motivate employees
- Manage sales account
TARGET SETTING:
- Set sales targets for individual employees, teams or producers
- Set expenditure budget
- Set profit budgets based on sale targets and costs targets
PROS & CONS of Break-even
PROS:
- The business knows how many items it must sell in order to break-even
- Informs decisions on what price to charge
- Can set targets
- Identifies fixed and variable costs
- Can identify if costs are too high allowing the business to look for ways of lowering costs
- Can set targets which will motivate employees
- Easy way to calculate profit or loss at different levels of output
CONS:
- Doesn’t take into account of variations in cost or selling price
- Forecast sales may not be achieved and hence, even though the break-even point is known, it might not be achieved
- Targets set may be too high, creating stress
