Theme 2.2- Financial Planning

Question 1

Why try to forecast sales?

Answer 1

• the sales forecast forms the basis for most other common parts of business planning
• HR plan: how many people we need linked with expected output
• production/capacity plans
• cash flow forecasts
• profit forecasts and budgets
• a very useful part of regular competitor analysis and helps to focus market research

Question 2

What are the key factors affecting the accuracy and reliability of sales forecasts?

Answer 2

Consumer trends
-demand changes as consumer tastes and fashions change affects both overall market demand and market shares of existing competitors

Economic variables

• demand often sensitive to changes in variables e.g. exchange rates, interest rates.
• overall strength of the economy also important

Competitor actions
-hard to predict, but often significant reason why sales forecasts prove over- optimistic

Question 3

What are the circumstances where sales forecasts are likely to be inaccurate?

Answer 3

• business is new
• market subject to significant disruption from technological change
• demand is highly sensitive to changes in price and income
• product is a fashion item
• significant changes in market share
• management have demonstrated poor sales forecasting ability in the past

Question 4

What are consumer trends?

Answer 4

The changes in the buying habits of consumers that will influence business decisions.

Question 5

What is revenue?

Answer 5

the amount (value) of a product that customers actually buy from a business

Question 6

What is demand?

Answer 6

• the amount of a product that customers are prepared to buy

- can be measured in terms of volume (quantity bought) and/or value

Question 7

What factors affect the level of demand?

Answer 7

• price and incomes
• tastes and fashions
• competitor actions
• social and demographic change
• seasonal changes
• changing technology
• government decisions

Question 8

How do you calculate total revenue?

Answer 8

total revenue= Volume sold x average selling price

Question 9

How can a business increase revenue?

Answer 9

increase quantity sold

• cutting price or offering volume related incentives (e.g. 2 for 1)
• is demand sensitive to price?

achieve higher selling price

• best to add value rather than increasing price
• does market research suggest that prices are high enough or too low?

Question 10

Why are costs important to a business?

Answer 10

• are the thing that drains away the profits made by a business
• are the difference between making a good and a poor profit margin
• are the main cause of cash flow problems in a business
• change as the output or activity of a business changes

Question 11

What are variable costs?

Answer 11

• costs which change as output varies
• lower risk for a start-up: no sales= no variable costs

e.g. raw materials, wages based on hours worked or produced

Question 12

What are fixed costs?

Answer 12

• costs which do NOT change when output varies
• fixed costs increase the breakeven output

e.g. rent, salaries

Question 13

How do you calculate total costs?

Answer 13

Total costs (TC) = Fixed costs (FC) + Variable costs (VC)

Question 14

How can costs change with output?

Answer 14

as output rises, total costs can be expected to increase. However, as output rises, fixed costs are spread over more units produced, resulting in lower unit costs.

Question 15

How do you calculate profit?

Answer 15

Profit= Total revenue - Total costs

OR

Profit= Contribution - Fixed costs

Question 16

What is contribution?

Answer 16

• looks at the profit made on individual products
• it is used in calculating how many items need to be sold to cover all the business’ total costs
• contribution is the difference between sales and variable costs of production

Question 17

What is break-even?

Answer 17

when a business is earning enough sales to cover all its costs.

Question 18

What is the break even point?

Answer 18

the breakeven point happens when total sales= total costs

basically the business isn’t making a profit but it isn’t making a loss either

Question 19

How do you calculate break-even?

Answer 19

breakeven = fixed costs/ contribution per unit

Question 20

What is the margin of safety?

Answer 20

the margin of safety is the difference between actual output and the break even output

Question 21

What are the strengths of break-even analysis?

Answer 21

• focuses on what output is required before a business reaches profitability
• helps management and finance providers better understand viability and risk of a business or idea
• margin of safety shows how much a sales forecast can prove over-optimistic before losses are incurred
• illustrates the importance of keeping fixed costs down to a minimum
• calculations are quick and easy

Question 22

What are the limitations of break-even analysis?

Answer 22

• unrealistic assumptions
• sales are unlikely to be the same as output
• variable costs do not always stay the same
• most businesses sell more than one product
• a planning aid rather than a decision making tool

Question 23

What is a budget?

Answer 23

a financial plan for the future concerning the revenues and costs of a business.

Question 24

Why is the preparation of budgets an important business process?

Answer 24

• the process by which financial control is exercised in a business
• budgets for revenues and costs are prepared in advance and then compared with actual performance to establish any variances
• managers are responsible for controllable costs within their budgets

Question 24

What are the principles of effective budgeting?

Answer 24

• managerial responsibilities are clearly defined
• managers have a responsibility to adhere to their budgets
• performance is monitored against the budget
• corrective action is taken if results differ significantly from the budget
• unaccounted for variances are investigated
• departures from budgets are permitted only after approval from senior management

Question 24

What are the two main approaches to budgeting?

Answer 24

HISTORICAL budgeting:

• using last yrs figures as the basis for the budget
• realistic as it is based on actual results
• circumstances may have changed (e.g. new product, lost customers)
• does not encourage efficiency

ZERO budgeting:

• budgeted costs and revenues are set to zero
• budget is based on new proposals for sales and costs
• makes budgeting more complicated and time consuming, but potentially more realistic

Question 25

What are the 3 main types of budget?

Answer 25

Revenue (income) budget:

• expected revenues and sales
• broken down into more detail (products, location etc)

Cost (expenditure):

• expected costs based on sales budget
• overheads and other fixed costs

Profit budget:

• based on the combined sales and cost budgets
• of great interest to stakeholders
• may form basis for performance bonuses