# FINANCIAL PLANNING

cost revenues and profits, break even, cash flow forecast, setting budgest, variances, measuring and increasing profits

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• Created by: mehwisch
• Created on: 07-01-12 15:37

## revenue

- the amount made from sales of a product BEFORE any deductions are made.

FORMULA: selling price x amount sold = revenue

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## fixed or variable costs

FIXED COTS: don't change according to sales or service for example rent, insurance etc.

VARIABLE COSTS: rise and fall according to sales e.g. raw materials, wages etc.

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## profit = revenue - costs

when costs are taken away from revenue what's left is called profit.

NET PROFIT: when you subtract fixed and cariable costs from revenue

FORMULA: revenue - fixed + variable costs.

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## opportunity cost

OPPERTUNITY COST: is the value given on a product or a decision in term of what the business had to give up to have it.

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- the break even point is tbe level of sales a business needs to COVER THEIR COSTS

- when sales are BELOW the break even point then revenue is less then costs - the business is making a loss

- when sales are ABOVE the break even point then revenue is more then costs- the business making profit.

- new businesses should do break even analysis to find their break even point- it tells them how much they will  need to sell in order to break even,

- If they think that the business is unlikely to sell enough to break even, they won't lend their money

-established business preparing to launch new products use break even analysis to work out how much profits they are likely to make, also to predict the impact of activity on cash flow

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## contribution

contribution is the difference between the selling price of a product and the variable costs it takes to product it.

FORMULA: selling price - variable costs = contribution

- contribution is used to pay fixed cost. the amount left over is profit

the break even point is where contribution = fixed costs

break even point is fixed costs divided by contribution per unit

BREAK EVEN = FIXED COSTS/CONTRIBUTION

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## BREAK EVEN CHART

-break even charts show COSTS and REVENUES plotted against OUTPUT. businesses use BE charts to see how costs and revenues vary against different levels of output.

- sales go on the HORIZONTAL AXIS

- costs and revenue go on the vertical axis

- the break even point is where the revenue CROSSES the total costs line.

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## margin of safety

FORMULA: sales - break even

the lower the break even point the greater the margin of safety.

a big margin of safety is useful because it means less risk

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## advantages of break even analysis

- it's easy to do

- it's quick managers can see the break even point and margin of safety instantly and take action to cut costs or increase sales if they need to increase margin of safety.

-charts lets businesses forecast ho variations in businesses will effect cost, sales, revenue, and profits.

- how variances in costs and price will effect how much they need to sell.

- t can be used to help persuade banks to give out a loan

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## disadvantages of break even analysis

- analysis always assumes that variable costs will rise steadily, this isn't always the case discounts and etc means that cost don't go up in direct proportion to output.

- its simple for a single product but most businesses sell lots of different products, so looking at the business as a whole can get more complicated

- if the data is wrong then results will be wrong.

- breakeven analysis only tell you how many units you need to sell to break even- it doesn't tell you how much you will sell.

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## CASH FLOW FORECASTING

- cash flow is money flowing in and out of a business over a period of time

-working capital is money needed to run a business day to day

- it's important to make sure your have enough money to pay suppliers and wages

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## improving cashflow

- try to reduce the time between paying suppliers and getting money from customers.

- try to get their suppliers to give them a longer credit period  - and give their customers a shorter credit period

- businesses can hold less stock so less cash is used in stocks.

- credit controllers keep debtors in control - by setting up credit limits.

- debt factoring gives instant cash to the business. it's for those customers who have not payed back their loans so the bank acts as a debt factoring agent. the agent pays about 80% of the money back in instant and the agent gets the customer to pay up, and then keeps about 5% out of what's owed to the business. - dect factoring costs money and agents need to make a living.

- sales and lease back is when businesses sell equipment to raise capital, and then lease the equipment back. that way they get a large sum of money for selling it and pay a little bit of money each month for the lease back.

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## cash flow forecast help to make decisions

- cash flow forecast

- cash flow forecast show the amount of money that managers expect to come in to the business and flow out, over a period of time in the future.

- managers can use cash flow forecast to make sure they always have enough cash to pay suppliers and employees. they can predict when they'll be short of cash and arrange a loan or an overdraft in time.

- businesses can show cash flow forecasts to banks and venture capitalists when trying to get loans and other finance,  - cash flow forecasts proves that the business has an idea of where its going to be in the future.

- establishes firms base forecasts on past experiences.

- new firms have no past data so they need to consider the business' capacity, experiences of similar firms and trends shown by market research

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## cash flow forecasting isn't always accurate

- forecast can be based on false assumptions about what's going to happen.

- circumstances can change suddenly after the forecast's been made, costs can go up, machinery can break down, competitor pricing can change which affects the business.

- good cash flow needs lots of experience and research (can be expensive)

- forecast can have disastrous results. a business that runs out of cash can go bankrupt.

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## setting budgets

budgets- businesses set targets for how much they're going to earn and spend in the future, this i then checked to see if it's done. - there are three types of budgets:

INCOME BUDGETS: forecast the amount of money that will come into the company  as revenue - in order to do this the company needs to predict how much it will sell and at what price. managers estimate this using sales figures from previous years and market research

EXPENDITURE BUDGETS: predict what the business' total costs will be for the year, taking into account fixed and variable costs. (variable costs can change so managers predict what it will depending on how much they expect to sell)

PROFIT BUDGETS: use the totals from the income and expenditure budgets to calculate what the expected profit or loss will be for the year.

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## how budgets affect businsess

- the expenditure budgets forecasts total expenditure, this is broken down into department expenditure budgets - each department is given a certain amount of money to spend.

- department expenditure budgets are broken down into budgets for specific activities with the the department.

- budget holders are people responsible (usually managers of the department) for spending or generating the money for each budget.

- master budgets help businesses understand their cash flow situation as a whole, and the department and activity budgets help local managers control and co-ordinate their work.

- budgets set targets and that can be used to control or motivate staff, depending on management style.

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## budgets: research and negotiation

- to set income budgets, businesses research and predict how sales are going to go up or down the year, so they can make good prediction of sales revenue.

- to set expenditure budgets for product businesses research how labour costs, raw material costs, taxes, inflation are going to go up or down over the year. they can figure out the costs of producing the amount of product that they think they're going to sell.

- annual budgets are usually agreed by nedotiation -- when budget holders have a say in setting their budgets - their motivated to achieve them.

- budgets should stretch the abilities of the business, but they must be achievable. unrealistic budgets demotivate staff.

- once they budgets are agreed and set, budget holders keep checking the performance against the budgets variance analysis.

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- budgets help control the income and expenditure. they show where the money goes.

- budgeting forces managers to review their activities.

- budgets let head of department delegate authority to budget holders. getting authority is motivating.

- budgets allow departments to co-ordinate spending.

- budgets help manager either control or motivate staff. meeting a budget is satisfying.

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- can cause resentment and rivalry between staff because they have to compete for money.

- budgets can be restrictive so opportunities could be lost, or slow response to changing conditions in the market.

- budgets is time consuming, managers can get too caught up in setting and reviewing budgets and forgetting to focus on the real issues understanding the customer, winning the business etc.

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## setting budgets

- start up businesses have to develop their budgets from scratch (zero budgeting) - this is difficult because they don't have enough information to base their decisions on on - they can't take into take into account previous years expenditure and income, this means their budgets are likely to be inaccurate.

- after the 1st year, a business must decide whether to follow to the HISTORICAL BUDGETING METHOD or continue using zero budgeting.

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## zero budgeting

- budget holder start a budget of £0 and have to get approval to spend money on activities.

- they have to plan all the year's activities, ask for money to spend on them and justify their requests. - budget holders need good negotiating skills for this.

- zero budgeting takes longer to complete than historical budgets

- if it's done properly its more accurate

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## budgets affect how flexible a business can be

- fixed budgets provide discipline and certain. this is important for a business with liquidity problems. - fixed budgets can help control cash flow

- fixed budgeting means budgets holders have to stick to their plans throughout the year - even if conditions change - this prevents reaching new opportunities or threats that they don't know about when they set the budget.

- flexible budgeting allows budgets to be altered in response to significant changes in the market or economy.

- zero budgeting gives a business more flexibility than historical budgeting.

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## increasing profit

- businesses exist to make a profit - if a business makes large profits its successful

- increasing prices if the demand for their product is realistic - or reducing prices to increase demand. they could also reduce their costs and use marketing to to increase, to sell more, to make profit.

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## variances

- variance is the difference between ACTUAL figures and BUDGETED figures.

- a variance means the business is performing either better or worse then expected.

- a FAVOURABLE VARIANCE: leads to increased proft - if the revenue is more then the budget says it's going to be/ costs are lower then expected that's a favourable variance

- ADVERSE VARIANCE: is a difference that reducess profits - selling fewer items than income budget or spending more than the expenditure budget.

- variances add up and this is called CUMULATIVE VARIANCE

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- when variances occur it means what happend is not what the business expected - so they need to know about variances to find out why they're occurred.

- it's very import to note adverse variances as soon as they occurr - to find out which holder is responsible and to fix the problem.

- its also important to investigate favourable variances, this means budgeted target wasn't stretched enough- so the business needs to set more difficult targets- the also need to understand why the performance is better then expected - if one department does something right the business can spread this through out the organisation.

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## internal and external variance factors

- EXTERTNAL FACTORS CAUSING VARIANCES: - competitor behaviour and changing fashions increase or reduce demand for products.

- changes in the economy can change how much worker's wages cost to the business

- the cost of raw materials could go up

- INTERNAL FACTORS CAUSING VARIANCES: - improving efficiency causes favourable variances

- a business might over estimate the amount of money it can save

- a business might under estimate the cost of making a change to the organisation

- changing the selling price changes sales revenue - this creates variances if it happens after the budget's been set

- internal variances can be concerning- it means that internal communication need improvement.

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## variance analysis

- various analysis means spotting variances and finding out why they've happened.

- small favourable variances can motivate staff to keep doing what they were doing to cause favourable variances.

- large vairnaces can demotivate staff so they dont work hard if there are large favourable variances - adverse variances makes them feel its impossible to acheive their targets so they give up

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- when variances occur businesses can either change what their doing to make it fit the budget pr change the budget to make it fit with what their doing. three factors need to be taken into account

- businesses need to be aware of chopping and changing too much

- changing the budgets removes certainty - which removes one of the big benefits of budgets.

- altering budgets can make them less motivating - when staff expect managment to change budgets instead of performance they won't try anymore.

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- they can change the marketing mix - cutting prices will increase sales - only if the demand is price elastic - updating the product might make it more attractive to customers, businesses can also look for a new market.

- promotional strategy

- streamlining products- makes the business more efficient so this reduces costs

- motivate employees to work harder

- try cut costs by asking their suppliers for a better deal.

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## variances

- variance is the difference between ACTUAL figures and BUDGETED figures.

- a variance means the business is performing either better or worse then expected.

- a FAVOURABLE VARIANCE: leads to increased proft - if the revenue is more then the budget says it's going to be/ costs are lower then expected that's a favourable variance

- ADVERSE VARIANCE: is a difference that reducess profits - selling fewer items than income budget or spending more than the expenditure budget.

- variances add up and this is called CUMULATIVE VARIANCE

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## fixing favourable variances

if the favourable variance is caused by a negative budget - they set more ambitious targets for next time

- if the variances is because of increased productivity on one part of the business - they try to get everybody else to be responsible for their imporvement and set hight targetd in the nexy budget.

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- when variances occur it means what happend is not what the business expected - so they need to know about variances to find out why they're occurred.

- it's very import to note adverse variances as soon as they occurr - to find out which holder is responsible and to fix the problem.

- its also important to investigate favourable variances, this means budgeted target wasn't stretched enough- so the business needs to set more difficult targets- the also need to understand why the performance is better then expected - if one department does something right the business can spread this through out the organisation.

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## increasing profits

- increasing prices increases profit

- reducing prices to increase demand

- measure profits on a regular basis to see see progress and how more can be achieved.

- worknig out percentage increase or decrease in profits from year to year makes it esay to see how well they are performing compared to other years.

FORMULA: change in proft

current year's profit - previous years profit / previous year's profit x 100 = change in profit

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## internal and external variance factors

- EXTERTNAL FACTORS CAUSING VARIANCES: - competitor behaviour and changing fashions increase or reduce demand for products.

- changes in the economy can change how much worker's wages cost to the business

- the cost of raw materials could go up

- INTERNAL FACTORS CAUSING VARIANCES: - improving efficiency causes favourable variances

- a business might over estimate the amount of money it can save

- a business might under estimate the cost of making a change to the organisation

- changing the selling price changes sales revenue - this creates variances if it happens after the budget's been set

- internal variances can be concerning- it means that internal communication need improvement.

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## variance analysis

- various analysis means spotting variances and finding out why they've happened.

- small favourable variances can motivate staff to keep doing what they were doing to cause favourable variances.

- large vairnaces can demotivate staff so they dont work hard if there are large favourable variances - adverse variances makes them feel its impossible to acheive their targets so they give up

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- when variances occur businesses can either change what their doing to make it fit the budget pr change the budget to make it fit with what their doing. three factors need to be taken into account

- businesses need to be aware of chopping and changing too much

- changing the budgets removes certainty - which removes one of the big benefits of budgets.

- altering budgets can make them less motivating - when staff expect managment to change budgets instead of performance they won't try anymore.

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- they can change the marketing mix - cutting prices will increase sales - only if the demand is price elastic - updating the product might make it more attractive to customers, businesses can also look for a new market.

- promotional strategy

- streamlining products- makes the business more efficient so this reduces costs

- motivate employees to work harder

- try cut costs by asking their suppliers for a better deal.

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## fixing favourable variances

if the favourable variance is caused by a negative budget - they set more ambitious targets for next time

- if the variances is because of increased productivity on one part of the business - they try to get everybody else to be responsible for their imporvement and set hight targetd in the nexy budget.

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## increasing profits

- increasing prices increases profit

- reducing prices to increase demand

- measure profits on a regular basis to see see progress and how more can be achieved.

- worknig out percentage increase or decrease in profits from year to year makes it esay to see how well they are performing compared to other years.

FORMULA: change in proft

current year's profit - previous years profit / previous year's profit x 100 = change in profit

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## gross profit and net profit

- gross profit is the amount left over when the cost of making the products is taken away.

FORMULA: gross profit = revenue - variable costs.

- net profit is the cost of producing each producr and the fixed costs involved in running the business

FORMULA: revenue - (fixed + variable) = net profit

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