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Finance - Using Budgets

A budget is an agreed plan establishing in numerical or financial terms the policy to be persued and the anticipated outcomes of that policy.They also include targets for revenue and output or sales volume.The key types of budget are:

  • Income Budget - This shows the agreed planned income of a business over a period time.
  • Expenditure Budget - This shows the agreed planned expenditure of a business over a period time.
  • Profit Budget - This shows the agreed planned profit of a business over a period time.

BENEFITS                                                                        DRAWBACKS

  • To establish priorites                                                      Inncorrect allocations
  • To provide direction and coordination                               External factors
  • To assign responsibility                                                  Poor communication
  • To motivate staff
  • To improve effiency
  • To encourage forward planning
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Finance - Using Budgets

Budgetary Control

Budgetary control is the establishment of the budget and the continuous comparison of actual and budgeted results in order to ascertain variances from the plan and to provide a basis for revision of the objective or strategy.

Variance Analysis - A variance represents the difference between the planned standard and the acutal performance. If the variance reveals a poorer perfomance than planned it is known as adverse. If it shows a better variance it is known as favourable.

Causes of variances

  • Storage and wastage of material
  • Material costs
  • Efficiency changes
  • Efficiency of staff
  • Wages
  • Quality of material
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Finance - Using Budgets

Improving cash flow

Cash flow management involves careful control of cash in the short term in order to ensure liquidity. A business sustaning losses will fail, but even a profitable firm can fold if it is unable to pay a creditor who required payment in cash.

Cash flow forecast - This enables the business to identify any potential problems before hand and taking action eg (bank overdraft).

Causes of cash flow problems

  • Over investment in fixed assets, leaving no money to pay bills.
  • Overtrading - producing too many goods and running out of money.
  • Credit sales - increasing sales and therefor expenses, but with no cash recieved until later.
  • Stockpiling - tying up assets in stock.
  • Seasonal factors - low sales revenue or  high costs during part of the year.
  • Changing tastes - products do not sell.
  • Management errors - poor market research or budgetary control leading to cash shortages.
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Finance - Using Budgets

Methods of improving cash flow

Bank overdraft benefits - easy to organise, it is flexible, cheaper than a loan.                            Drawbacks - Interest rates are flexible making it hard to budget accurately.                        

Short term loan/ Bank loan benefits - A bank loan may be set up for a significant period of time to suit the needs of a business.                                                                                              Drawbacks - Interest is paid on the whole of the sum borrowed.

Factoring (debt factoring) - When a company buys the right to collect the money from the credit sales of an organisation.                                                                                                         Benefits - There is reduced risk of bad debts.                                                                                             The firm gains improved cash flow in the short term                                                   

Drawbacks - The main problem is the cost to the business which will lose between 5% and 10% of its revenue.                                               

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Finance - Using Budgets

Methods of improving cash flow

Sale of assets - This process can improve cash flow by converting an asset such as property or machinery into cash which can then be used to ease the cash flow problem by repaying a debt or building up a bank balance.                                                          Benefits: The sale of fixed assets can raise a considerable sum of money.Sometimes the asset may no longer be needed and is just adding to costs unnecessarily.                                        Drawbacks: Assets such as buildings and manchinery may be difficult to sell quickly.

Sale and leaseback of assets - Assets that are owned by the firm are sold to raise cash and then rented back so that the compnay can still use them for an agreed period of time.             Benefits: This will overcome the cash-flow problem by providing an immediate inflow of cash.    Owning an asset can distract a business from its core activity.                                          Drawbacks: The rent paid is likely to exceed the sum recieved, eventually. The firm now owns fewer assets that can be used as security in the future.                         

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Finance - Using Budgets

Measuring & Increasing Profit

Distinction between cash and profit - Cash is the money coming into the business in the form of sales revenue. However not all cash will turn into profit as a business has to pay for the cost of sales (including raw materials) and other costs such as (rent).

Sales revenue - costs = profit  (net profit)

Positive cash flow is the most important factor. A business can look very profitable on paper, with full order books, but until that money is recieved the liquidity of the business may be threatened e.g. if the business has to pay suppliers for raw materials up front there are delays to recieving money for finished goods.

Net profit margins - Expresses profit as a proportion of the leel of sales (turnover).If a business has £18,000 in sales, variable costs of £8,000 and fixed costs of £6,400 then the net profit will be £18,000 - (£8,000 + £6,400) = £3,600

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Finance - Using Budgets

Return on capital - Capital is the money put into a business by the owner/owners when it is first established, or in order to buy new equipment or machinery, or to invest in a new project. It is important that this capital brings in a suitable return for the business. Return on capital means the percentage return on this capital investment.

Improving profits/ Profitability - There are many methods a bysiness can utilise to try to improve profitability. These could include:

  • Increasing prices, to widen the profit margin
  • decreasing costs by:
  • sourcing cheaping supplies
  • employing fewer people
  • outsourcing production to a country with cheaper labour costs
  • reducing other costs, e.g. cutting back on advertising
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