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  • Created by: carasym
  • Created on: 18-05-16 17:50

Using budgets & Benefits

3 Types of budget:

  • Income budget - agreed, planned income of a business over a period of time 
  • Expenditure budget - agreed, planned expenditure of a business over a period of time
  • Profit budget - the agreed, planned profit of a business over a period of time

Benefits of using budgets

  • Establish priorities by indicating the level of importance attached to a particular policy or division
  • To provide direction and coordination by ensuring that spending is geared towards the firms aims
  • To assign responsibility by identifying the person who is directly responsible for any success/failure
  • To motivate staff by giving them greater responsibility & recognition when they meet targets
  • To improve efficiency by investigating reasons for failure & success by studying possible outcomes 
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Drawbacks of using budgets

Can be certain undesirable consequences that occur if budgets are too rigid. Factors that may affect the efficacy of a budget include: 

  • Incorrect allocation - A budget  that is too generous may encourage inefficiency. A budget that is insufficient will demotivate staff and hinder progress through a lack of money for example NHS
  • External Factors - Changes outside the bidget holders' control may affect their ability to stick to the plan 
  • Poor communication - Budgets must be agreed between people who understand the area in question and also other factors that might influence the budgets 

Budgetary control - The establisment of the budgeted 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

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Variance Analysis

A variance represents the difference between the planned standard and the actual performance.

*If the variance reveals a poorer performance than planned, it is known as an adverse or unfavourable variance, eg higher costs or lower sales revenue.

*If the variance shows a better performance than planned it is known as a favourable variance, eg lower costs or higher sales revenue

A variance can be caused by changes in

  • storage and wastage of material
  • material costs (cheaper or dearer)
  • efficiency changes
  • morale and efficiency of staff
  • wages
  • quality of material
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Improving cash flow

  • Too much cash means a firm will have less machinery and stock than it can afford and so makes less profit
  • Too little cash will threaten survival if a bill cannot be paid
  • In order to maintain the right balance, a firm plans its cash holdings by compiling a cash flow forecast
  • This enables the organisation to identify potential problems and take appropriate action (eg arranging a bank overdraft)
  • Only way to solve a cash flow problem is increase sales revenue or reduce costs

Causes of cash flow problems 

  • Over investment in fixed assets leaving no money to pay bills
  • Over trading producing too many goods and running out of cash
  • Management errors - poor market research or budgeary control leading to cash shortages 
  • Seasonal factors - low sales revenue or high costs during part of the year eg ice cream
  • Credit sales - increasing sales & thus expenses, but with no cash received until a later date
  • Stockpiling - tying up assets in stock
  • Changing tastes - products do not sell
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Methods of improving cash flow

Bank overdraft- only for short term

  • Easy to organise
  • Very flexible
  • Often cheaper than a loan bc interest is only paid only on the amount overdrawn and the time the overdraft is used
  • Interest rates are flexible, making it difficult to budget accurately
  • The rate of interest charged on a overdraft is usually significantly higher than that of a short term bank loan = more expensive

Short term loan/bank loan

  • Fixed rate of interest, simple to budget for loan repayments
  • Cheaper solution than an overdraft as interest is less
  • Can be used for a specific amount of time to suit the needs of the business
  • Interest is paid on the whole of the sum borrowed even if the business can repay the loan earlier a loan penalty charge may be imposed 
  • Business will need to provide the bank with security (collateral) in order to secure the loan
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Methods of improving cash flow

Factoring - is when a company usually a bank buys the rights to collect the money from the credit sales of an organisation (selling off your debts)

  • The firm gains improved cash flow in the short term 
  • Administration costs are lower bc the factoring company chases any bad debts
  • Reduced risk of bad debts 
  • Main problem is the cost to the business, which will lose between 5%-10% of it revenue
  • The factoring company will charge more for factoring than it would for a loan
  • Customers may prefer to deal directly with the business that sold them the product

Sales of assets- short term

  • The sale of fixed assets can raise a considerable sum of money, particularly in the case of large asset ie a building
  • Sometimes the asset may no longer be needed and is adding unnecessarily
  • Assets such as buildings & machinery may be difficult to sell quickly 
  • Fixed assets enable a firm to produce the goods & services that create its profit
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Methods of improving cash flow

Sale and leaseback of assets

  • This will overcome the cash flow problem by providing an immediate inflow of cash usually of quite a significant level
  • Ownership of fixed assets can lead to a number of costs, ie maintenance. For leased assets, the company leasing them does not have to pay these costs 
  • Owning an asset can distract a business from its core activity
  • The rent paid is likely to exceed the sum received, eventuallly
  • The firm now owns fewer assets that can be used as security against future loans
  • The business may eventually lose the use of the asset when the lease ends

Integration opportunities:

  • Controlling stock carefully to reduce the costs incurred in holding in too much
  • diversifying its product portfolio to create a range that sells throughout the year
  • Anticipating change beter through improved decision making procedures, planning, monitoring and control and more thorough market research and intelligence.
  • Setting aside a contingency fund to allow for unexpected payments or cope with lost income.
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Distinction between cash and profit

Cash = money coming into the business in the form of sales revenue

*HOWEVER not all that cash turns into profit as the business has to pay for the costs of sales and other overheads *

  • Sales revenue - costs = profit (net profit)
  • Short term - positive cash flow is the most important factor

A business can look very profitable on paper but until that money is received the liquidity of the business may be threatened eg if the business still has to pay suppliers for raw materials up front but there is a delay to receiving money for the finished goods off the customer.

Improving profitability

  • Increasing prices to widen profit margin - However depends on deman/price elasticity
  • Decreasing costs - sourcing cheaper suppliers, employing fewer people, outsourcing production to a country with cheaper labour costs, reducing other costs eg cutting back on advertising, retrenchment - However depends on will the quality be reduced/ reputation damaged.
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Net Profit Margin & ROC

Net profit margins

  • This expresses profit as a proportion of the level of sales
  • Net profit margin = net profit / sales (turnover) x 100 
  • The bigger the profit margin the better the company is peforming

Return on capital

  •  Return (net profit) / capital investments x 100
  • A business may see a lower % as too low as it can get low % from the bank so opportunity cost plays a part here
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