Analysing financial performance

Define a budget and budgeting as analysing financial performance
Budget - an agreed plan establishing the policy to be pursued and the anticipating outcomes of that policy. Budgeting - the process involved in setting a budget.
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State and define the 3 types of budgets
Income budget - includes the incoming revenue and sources. Expenditure budget - includes all different times of expenditure that are needed to produced a product. Profit budget = Income budget - Expenditure budget. Must be scrutinised carefully.
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Explain the process of setting budgets
1) Set objectives 2) carry out market research 3) carry out research into costs 4) complete the income budget 5) construct expenditure budget 6) create an overall profit budget 7) draw up divisional/departmental budgets 8) summarise detailed budgets
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How do you analyse budgets
Variance analysis - process by which the outcomes of budgets are examined+compared with the budgeted figures. VA = Budget figure - Actual figure
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Define the two types of variances
Favourable - when costs are lower or revenue is higher than expected. Adverse - costs are higher or revenue is lower than expected.
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State the reasons for setting budgets
To gain financial support. ensure that a business does not overspend, establish priorities, assign responsibility, encourage delegation to motivate staff, improve efficiency.
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State the problems of setting budgets
Managers may not know enough about the division or department, problems in gathering info, unforeseen changes, levels of inflation are unpredictable, budgets may be imposed (misunderstanding the needs for the certain area being budgeted).
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State features of good budgeting
Consistent with their aims of the business, based on the opinions of as many people as possible, challenging but realistic targets (SMART objective must set an achievable budget), be flexible (allows for changing circumstances), monitored regularly.
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What is a cash flow cycle and a cash flow forecast
A regular pattens of inflows and outflows of cash within a business. Forecast is the process of estimating the expected inflows and outflows over a period of time.
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Describe the structure of a cash flow forecast
Inflows, outflows, net was flows (inflows-outflows), opening balance and closing balance.
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Why do businesses forecast cash flow
To see how liquid they are (ability to turn an asset into cash without loss or delay). To manage their cash+working capital to ensure survival. To foresee times in the future when the business will be short of liquidity (can try prevent the shortage)
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Benefits of forecasting cash flow
identifying potential cash flow problems in advance, provides evidence for a source of finance, makes sure they have enough cash to pay creditors, suppliers etc. Guiding the firm towards appropriate action, and avoiding liquidation.
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Problems associated with forecasting cash flow
changes in the economy, changes in consumer taste, inaccurate market research (might target wrong group of customers or be biased in their questions), competition, uncertainty (estimate of costs for new firms+projects are often incorrect).
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How to analyse timings of cash inflows and outflows
Through studying the working capital cycle (the main elements are): inventories, receivables (debtors), and payables (creditor). From a cash flow perspective the business wants low inventory, quick receivables paying debts, and LT period for payable.
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State the factors influencing the length of the working capital cycle
Nature of the product, durability of the product, efficiency of suppliers, lead time (how long it takes to make a product+there time in inventory), customer expectations, competition.
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Factors influencing the time taken for receivables to be paid
Nature of the market (i.e. commercial products - sold to other firms - are usually sold on credit with 28/30 days to pay back), type of product, bargaining power (offer of credit may depend on the relative bargaining power of the supplier and buyer).
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Define contribution in terms of break even and its equation
Contribution per unit = selling price per uint - variable cost per unit. It looks at whether an individual product is helping the business to make a profit. Contribution ignores fixed costs. If total contribution exceeds FC the firms made a profit.
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State the two total contribution formulas
1) Contribution per unit X Number of units sold 2) Sales revenue - Total variable costs
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Define break-even output and its formula
The level of output at which total sales revenue = total of production. Break even output = fixed costs / contribution per unit. A business can use break-even analysis to discover its break-even output.
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What are the 3 ways to calculate break-even output
Using a table showing revenue and costs over a range of output levels, using a formula to calculate the break-even quantity, or a graph showing revenue+costs over a range of output levels.
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What is the margin of safety when constructing break-even charts
Its the difference between the actual output and the break-even output. VC will vary directly with output. FC+VC the TC of product at different levels of output can be calc'ed. Revenue and cost lines it enables the break-even point to be discovered.
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How do you calculate profit on a break-even chart?
Profit = TR-TC. You need to read off the TR and TC figures for the actual level of output.
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What is the strengths of break-even analysis
Can calculate how long it will take to reach the level of output needed to make a profit, shows whether a business plan is likely to succeed financially, used to plan 'expected' results, allows a firm to use 'what if?' analysis.
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What are the weaknesses of break-even analysis
Information may be unreliable, sales are unlikely to be exactly the same as output, the selling price may change as more is sold, FC may not stay the same as output changes, assumes that VC per unit are always the same but ignores bulk buying.
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Define profitability and the 2 ways to measure it
The ability of a business to generate profit or the efficiency of a business in generating profit. Measurements = sales revenue and capital employed (adding up the money that has been invested into the business by owners).
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State the ways to calculate and understand profitability
GP Margin = GP/Rev X 100 - measures how efficiently the firm transforms raw materials into products. OP Margin = OP/Rev X 100 -measures how much the firm is making a profit. PY Margin = PY/Rev X 100 - measures how much shareholders benefit.
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What comparisons come from profitability?
Comparisons to competitors (if the profit margin exceeds that of its competitors), Comparisons over time (if theres improvement in profitability), Comparisons to a standard (standard level that represents an acceptable level of performance).
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State the two different purposes for the financial department to use data
Management accounting - creation of financial information for use by internal users, to predict, plan, review and control finance. Financial accounting - provision of financial info to show external users their financial position (historical data).
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State examples of management accounting data and financial accounting data
MA- Rev, costs+profit objectives, decision trees, investment data, break-even charts, budgets, cash flow forecasts. FA- cash flow statements, data on profitability, income statements, balance sheets, capital structure data+sources of finance.
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Other cards in this set

Card 2


State and define the 3 types of budgets


Income budget - includes the incoming revenue and sources. Expenditure budget - includes all different times of expenditure that are needed to produced a product. Profit budget = Income budget - Expenditure budget. Must be scrutinised carefully.

Card 3


Explain the process of setting budgets


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Card 4


How do you analyse budgets


Preview of the front of card 4

Card 5


Define the two types of variances


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