Theme 2 Flashcards
Contribution per unit
Selling price - variable cost
Total contribution
Revenue - total variable costs
Contribution definition
The amount of money left over after variable costs have been taken from revenue. The money contributes to fixed costs and profit.
BE point
Where total revenue and total costs are the same
Break even output
Fixed costs/contribution
The output a business needs to produce so total revenue and costs are the same
Margin of safety
The range of output between break even level and the current level of output, over which a profit is made
Why usebreak even analysis
Used to make decisions about the future, answers ‘what if’ questions
Limitations of BE analysis
>unchanging conditions >assumes all output is sold >assumes total cost and total rev lines are straight >some fixed costs may change >relies on quality and accuracy of data
Budget definition
Quantitative plan agreed/prepared in advance. A budget is what the firm want to happen, based on past trading records.
Name 6 Purposes of a budget
>Motivation >communication >co-ordination >Efficiency >Planning >Control
Sales budget
Planned sales for a future period of time - can be in terms of volume or revenue
Production cost budgeting
Planned production cost for a future period of time
Zero based budgeting
Where no money is allocated for costs/spending unless it can be justified by the fund holder
Variance analysis
Finding reasons for the difference between actual figure and expected financial outcome
Favourable variance
Actual figures are better than predicted/budgeted figures
Adverse variance
Actual figures are worse than predicted/budgeted figures
Difficulties of budgeting
>figures aren’t actual figures >if sales data is inaccurate budgets will be inexact >setting of budgets may lead to conflict >opportunity costs >over ambitious will cause problems
Gross profit
Revenue - cost of sales
Operating profit
Gross profit - overheads (operating costs)
Net profit
Operating profit - interest and exceptional costs
Gross profit margin (GPM)
Gross profit / revenue * 100%
Operating profit margin (OPM)
Operating profit / revenue * 100%
Net profit margin
Net profit / revenue * 100%
Ways to improve profitability
> raising prices
lowering costs
~buying cheaper resources
~using resources more efficiently
Liquidity
Is the ease with which a assets can be converted to cash
Assets
Resources that belong to a business
Current assets
Are assets that will be changed to cash within 12 months
Non current assets
Are long term resources that will be used repeatedly by the business over a period of time
Liabilities
The debts of the business
Current liabilities
Money owed that must be paid within 1 year
Non current liabilities
Long term loans and any other money owed that doesn’t have to be paid back for over at least 1 year
Capital
The money put into the business by owners
Net assets
Total assets - total liabilities
Shareholders equity
Summary of what is owed to the owners of the business
Current ratio
Current assets / current liabilities
current ratios analysis
1.5:1 to 2:1 is good
Below 1.5:1 could be argued a business doesn’t have enough working capital.
Some business can work at 1:1 that sell quickly.
Operating at 2:1 may mean that have too much money tied up in stock
Acid test ratio
(Current assets - inventories) / current liabilities
Acid test ratio analysis
A more severe test of liquidity.
1:1 may mean their assets - stocks cannot cover liabilities.
Some businesses can deal with this as they sell products quickly
Working capital
Current assets - current liabilities
The funds left over to meet day to day expenses after current debts have been paid
Managing working capital
Different businesses will have different working capital needs, depending on:
> the size of the business
stock levels
debtors and creditors
maintaining adequate levels of working capital
Importance of cash
Cash is vital to a business, without it they might fail
Ways to improve liquidity
>only make essential purchases >sales and leasebacks >use of overdrafts >negotiate short or long term loans w bank >extend credit with suppliers
Capacity utilisation
Is about the use that’s business makes of it resources
Capacity utilisation formula
Current output/maximum possible output *100
Under utilisation
The position where a business is producing at less than full capacity
Drawbacks of under utilisation
> not be making the most of resources
operating inefficiently as unit costs aren’t minimised
may affect morale of workers
Benefits of under utilisation
> Cope more easily with sudden rises in demand
less work related stress
reduce sickness and absenteeism
Over utilisation
Where a business is operating at full capacity and draining resources
Drawbacks of over utilisation
>strain on resources >causing stress leading to absenteeism >machines may be overused to break point >may not cope with increase in demand >insufficient time for staff training
Benefits of over utilisation
> average costs are lower as fixed costs are spread over more units
more staff motivation as they feel secure
busy operation improves business image
Ways of improving capacity utilisation
> increase usage
increase sales
outsourcing
reduce capacity
