UNIT 4- Finance Flashcards
Define breakeven
with formula for units
+contribution and contribution per unit with formula
Not making a profit, but not losing any money often undesirable for companies as it is better to be making a profit and have spare finances
Calculated from fixed cost/ the contribution per unit
Profit after the variable costs have been subtracted that contribute towards fixed costs
Calculated by total sales – total variable costs
contribution per unit is selling price per unit – variable costs per unit
Contribution
+formula x2
+ contribution per unit
Contribution is the money left over from variable costs which contribute to the fixed costs
contribution = total sales – total variable costs
Or contribution per unit x number of units sold
contribution per unit is selling price per unit – variable costs per unit
Break even chart (in notes)
How to change the break even point
Decrease price- business needs to sell more units to break even as the contribution per unit is less therefore break even output increases
increase price- greater contribution per unit so a less number of units need to be sold break even output decreases need to look at the capacity and the elasticity of demand for each product
Increased fix or variable costs- More units must be sold to cover greater costs and therefore there’s an increased break even output
decrease fixed or variable costs- less unit sold to cover lower costs decreased break even output.
The margin of safety
Margin of safety is the difference between actual output and the break even output
Strengths and limitations of breakeven analysis
Strength- focuses on what output is required before a business reaches profitability, helps management and finance providers better understanding the viability and risk of a business or business idea, margin of safety calculations show how much the sales forecast can prove over optimistic before losses are incurred, in the states the importance of keeping fixed costs down to a minimum, calculations are quick and easy
Limitations of break even analysis unrealistic assumptions – products are not sold at the same price at different levels of output and fixed costs do vary when output changes, sales are unlikely to be the same as output. They may be some buildup of stocks or wasted output too, variable costs do not always stay the same for example as output rises the business may benefit from Buying power being able to buy inputs at lower prices. Most, most businesses sell more than one product, a planning aid rather than a decision-making tool.
The stages of price setting
+ financial objectives that may influence price
Develop pricing objectives, financial examples being maximise profit, achieve target level profits, achieve a target rate of return, maximise sales revenue, increased cash flow
Assess target markets ability to purchase determine demand for a product elastic or inelastic, evaluate competitors prices, select pricing strategy and tactics tactical pricing strategies being short term, decide on a price
Financial targets
+ smart acronym
Benefits of using financial objectives
A financial objective is a goal to be pursued by the finance departments
They must be smart to be effective
S specific M measurable A agreed R realistic and T time bound
A focus for the entire business important measure of success or failure, reduce the risk of business failure, provide transparency for shareholders about their investment, help coordinate the different business functions, key context for making investment decisions
The difference between profit and cash flows
Profit is sales/turnover – variable costs plus fixed costs = net profit
Cash flow is cash in flows (price times number of products sold) – cash outflow(fixed+ variable costs) = net cash flow
There is also a timing distance, for example, if a customer buys goods for £50,000 on 60 days credit, sales of £50,000 a recognised immediately whereas a cash flow of £50,000 as recognise when the customer actually pays
Similarly if new factory machinery is bought there is no effect on profit just £150,000 added to the value of fixed assets, however a cash outflow is recognise of £150,000
Therefore a deprecation charge of £100,000 reflecting the use of factory fixed assets in terms of profit is counted as a cost however it has no effect on cash flow flow
The way fixed assets are accounted for
+ distinguishment between fixed and current assets
Payment of fixed asset is treated as a cash outflow the cost of a fixed asset is treated as an asset and not a cost deprecation is charged as a cost when the value of a fixed asset is reduced
Fixed asset = used for longer than 12 months
Current asset = used within 12 months
Cost minimisation objectives
+ benefits
Customisation aims to achieve the most cost-effective way of delivering goods and services to the required level of quality
The key benefits are lower unit costs, higher gross profit margins, higher operating profit, improve cash flow, higher return on investment
Business investment
+ formula for return on investment
Common investment objectives
Business investment is capital expenditure on items such as product machinery, IT systems, buildings, et cetera and it can also be the purchase of other businesses or brands intended to help generate a return over more than one year
Return on investment = operating profit/ Amount of capital invested.
Common investment objectives are level of capital expenditure and return on investment
Internal and external influences on financial objectives
Internal influences include business ownership for example venture capital investor in comparison into a long-standing family ownership, size and status of the business, other functional objectives
External influences include economic conditions as an economic downturn may forced businesses to re-appraise their financial objectives in favour of cost to mini, significant changes in investment rates and exchange rates auto impact, competitive environment affects the achieve ability, social and political change for example, legislation on environmental admissions or waste disposal
Profit and profitability
+ formula for all profitability ratios
Profit is the money made from the business whereas profitability is how efficiently/well a company is at changing cash into profit in relation to the size of the business
The team main ways to measure the size of a business is sales revenue and capital employed (all the money that has been invested in the business by owners) swimming pool
Revenue
– Cost of sales
= Gross profit
– Overhead (advertising, salaries, rent etc)
= Operating profit
– Other costs
= Profit for the year
Gross profit margin
Operating profit margin
Profit for the year margin
Financial ratios that compare each profit with the level of sales
All expressed as percentages
Gross profit margin = gross profit/ sales revenue x 100
Operating profit margin = operating profit/ sales revenue x 100
Profit for the year margin = profit for the year/ sales revenue x 100
The higher the margin the more profitable/the greater profitability
Budgeting
Income, expenditure, profit + zero based budgeting
An income or revenue budget is a financial plan that forecasts and tracks the company is expected revenues for income over specific period
For example, a a software company might budget for a certain amount of revenue from subscription fees and license sales
Expenditure budget outlines a companies plan spending on various items, including labour, raw materials, and other essential costs over a specific period
For example, operating expenses, long-term investments, and cash flow
A profit budget is a financial plan that outlines a company expected income and expenses over a specific period aiming to predict profitability
There based budgeting as budgeting by justifying and approving all expenses for each accounting period rather than basing it on your past spending
Advantages and disadvantages of budgeting
Advantages is that it improves financial planning, allows for better resource allocation, enhanced cash flow management, provides direction and coordination as well as improved efficiency, helps to gain investment/finance from risk of averse companies and investors, allows for accuracy of a contingency fund – the money set aside, allows monitor and review for performance, allows firms to establish priorities, improve staff performance and better accuracy and can also motivate staff through accountability and assigned responsibility
Disadvantages of budgeting could lead to short-term decisions that damage in a long-term, could be imposed by those limited knowledge which can be demotivating, time consuming potentially leading to inflexible decision-making, fostering unrealistic expectations or department rivalry, risk of accuracy or unforeseen changes + risk of opportunity cost
