2.2 Financial Planning

Question 1

What do sales forecasts do?

Answer 1

Predict future revenue based on past sales figures

Question 2

What do sales forecasts focus on?

Answer 2

What will happen in the future to:
- the volume and value of sales
- the size of the market
- sales as a result of promotional activity
- sales as a result of cyclical factors

Question 3

What are sales forecasts important for?

Answer 3

Supporting planning and can improve the validity of cash flow forecasts

Question 4

What do businesses use sales forecasts to do?

Answer 4

Determine resource requirements in a variety of ways, including:
- how many staff will be needed?

• how much stock will be required?
• does the capacity need to be expanded (or reduced)?
• does the equipment need to be upgraded, replaced or increased (or decreased)?
• how much and which type of finance will be required?
• is promotional activity e.g. advertising required - and when?

Question 5

What are the factors affecting sales forecasts?

Answer 5

• seasonal variations (e.g. sales of basic home items increase when students start uni in September)
• fashion
• long term trends (consumer behaviour, attitudes and spending habits change over time)
• economic growth (increased income = higher forecasted sales)
• inflation (reduces consumer spending power)
• unemployment (high = less luxury + normal goods bought
• interest rates (when high borrow more expensive so Businesses that sell products that consumers frequently buy on credit may therefore adjust their sales forecasts downward)
• exchange rates (when the value of the pound falls against other global currencies, overseas consumer will find British exports cheaper)

Question 6

What should sales forecasts consider?

Answer 6

Sales forecasts should consider short-term actions of competitors such as sales promotions as well as longer-term strategies such as changes to product ranges and expansion plans

Question 7

What are the difficulties of sales forecasting?

Answer 7

Effective sales forecasting requires skill, time and the accurate use of timely data, smaller businesses in particular may lack the experience to construct, analyse and interpret sales forecasts

It is difficult to avoid experience bias (e.g. opinions of the future based on experiences in the past)

Sales forecasts will rarely reflect the full range of external influences that can affect future inflows, such as fashions, trends and the actions of competitors

There is a significant amount of data available for businesses to consider when constructing sales forecasts

Internal data, such as previous sales figures, will be a key source of information when constructing forecasts

Selecting the most appropriate external data to support sales forecasts is extremely challenging and will require careful evaluation

Question 8

What is sales volume?

Answer 8

Sales volume is the number of units sold by a business

E.g. the number of Harry Styles album download purchases

Question 9

What is sales revenue?

Answer 9

Sales Revenue is the total value of the units sold by a business

E.g the revenue earned by Apple Music from sales of music downloads

Sales revenue is a key business performance measure and must be calculated to identify profit

Question 10

How is sales revenue calculated?

Answer 10

Selling price x number of units sold

Question 11

What are fixed costs?

Answer 11

Costs that do not change as the level of output changes

E.g. building rent, salaries, insurance

Question 12

What are variable costs?

Answer 12

Costs that vary directly with output

These increase as output increases and decrease as output decreases

E.g. raw material costs

Question 13

What is total costs?

Answer 13

The sum of the fixed + variable costs

Question 14

How is total variable cost calculated?

Answer 14

Variable cost x quantity

Question 15

How is average total cost calculated (cost per unit)?

Answer 15

Total cost/quantity

Question 16

How is variable cost per unit calculated?

Answer 16

Total variable costs/quantity

Question 17

Why does average total costs decrease as output increases until a certain point?

Answer 17

As a firm grows, it can increase its scale of output generating efficiencies that lower its average total costs (AC) of production

These efficiencies are called economies of scale

As a firm continues increasing its scale of output, it will reach a point where its average total costs (AC) will start to increase

The reasons for the increase in the average costs are called diseconomies of scale

Question 18

What is contribution?

Answer 18

A product’s selling price - the variable costs

Question 19

How can contribution be calculated?

Answer 19

Selling price per unit - variable cost per unit

Question 20

Why is contribution called contribution?

Answer 20

It is called contribution as this amount contributes towards paying off the fixed costs of the business

Once the fixed costs have been paid off, then the contribution starts to contribute to the profits of the business

Question 21

What is the break even point?

Answer 21

Where the total revenue earned from a product is exactly equal to the total costs (the business is making neither a profit nor a loss)

Question 22

How is the break even point calculated?

Answer 22

Fixed costs/contribution (Selling price per unit - variable cost per unit)

Always round UP to the nearest whole number because only whole products can be sold

Question 23

What does identifying the break even point allow a business to do?

Answer 23

Understand how many items it needs to produce and sell to cover all costs before it starts to make a profit

Each subsequent unit sold past this point will generate profit for the business

Question 24

What is the margin of safety?

Answer 24

The difference between the actual level of output of a business and its break even level of output

Question 25

How can the margin of safety be calculated?

Answer 25

Actual level of output - breakeven level of output

Question 26

What is a break even chart, and what is it used to identify?

Answer 26

A break even chart is a visual representation of the break even point, it is used to identify: - the fixed costs, total costs and revenue over a range of output - the break even point - where costs = revenue - profit or loss made at each output - the margin of safety

Question 27

Where is the break even point on a break even chart?

Answer 27

The point at which the total costs and the revenue lines cross is the break even point

Question 28

What are the limitations of break even analysis?

Answer 28

Break even analysis is less useful when the business produces more than one product The accuracy of break even analysis relies on the quality of the data used in the break even calculations Break even analysis assumes that all output is sold Break even charts cannot be easily amended when conditions (e.g. costs and selling price) change Revenue and total costs do not always have a linear relationship with output

Question 29

What is a budget?

Answer 29

A financial plan that a business (or department in the business) sets about costs and revenue The budget is usually closely aligned with the business objective

Question 30

Why are budgets used?

Answer 30

Planning + monitoring: Businesses that use budgets are actively planning ahead Therefore problems and their solutions may be considered and solved in advance Control: Frequent monitoring of budgets allows managers to precisely control their functional area, budgets support the setting and review of a company or departments objectives. Coordination + communication: Budgeting requires different parts of a business to operate as part of a coordinated whole Budgets may be communicated throughout the organisation to provide a framework for decision-making and communication Motivation and efficiency: Budgets play an important role in target-setting and performance management, which can be used by managers to measure success The allocation of budgets spreads decision making across the organisation, acting as a motivator to the managers who control them

Question 31

What is a business objective?

Answer 31

Specific, measurable targets that businesses hope to achieve in a given period of time

Question 33

Why may businesses set budgets?

Answer 33

To monitor the financial performance of any aspect of the business

Question 34

What are the 2 methods used to prepare budgets?

Answer 34

- historical figure budgets - zero based budgeting

Question 35

What are historical figure budgets?

Answer 35

Budgets based on historical data (e.g. sales and costs data from previous years) and allow for factors such as inflation and other relevant economic indicators (e.g. exchange rate variations)

Question 36

What are zero based budgets?

Answer 36

Zero budgeting requires all spending to be justified, which means any unnecessary costs can be eliminated However, it can be time-consuming as evidence to support spending decisions need to be collected and presented Zero based budgeting also required skilled + confident employees to make a persuasive case to commence those making purchasing decisions

Question 37

What is a budget variance?

Answer 37

The difference between the figure budgeted and the actual figure spent by the end of the budgetary period

Question 38

What does variance analysis determine?

Answer 38

The reasons for the differences in the actual figures and budgeted figure

Question 39

What is a favourable variance in a revenue or profit budget?

Answer 39

Where the actual figure spent is higher than the budgeted figure.

Question 40

What is a favourable variance in a costs budget?

Answer 40

Where the actual figure is lower than the budgeted figure

Question 41

What is an adverse variance?

Answer 41

Where the actual income is less than the budgeted income

Question 42

What is an adverse variance in a revenue or profit budget?

Answer 42

Where the actual figure is lower than the budgeted figure

Question 43

What is an adverse variance in a costs budget?

Answer 43

Where the actual figure is higher than the budgeted figure

Question 44

What should a business do once variances have been identified?

Answer 44

Carefully investigate the reasons why they have occurred and take appropriate action, such as: Where adverse cost variances are identified, a business may seek alternative suppliers or investigate ways to improve efficiency Where adverse sales variances are identified, a business may review its marketing activities to improve their effectiveness Where favourable cost variances are identified, a business may review key quality indicators such as the volume of returns or waste levels to ensure that output standards are being met Where favourable sales variances occur, a business may reward client-facing staff with performance based incentives

Question 45

What are the difficulties of budgeting?

Answer 45

Budgeting can encourage managers to focus on the short-term rather than long-term performance Unachievable or unambitious budgets can have a negative impact on motivation Budget-setters have significant influence over the setting and review of budgets The budget is only as good as the data used to construct it - inaccurate data makes budgets useless Budgets take time and skill to set, monitor and review The budgeting process can lead to competition and conflict between business functions