Analysing Financial Performance

Question 1

Types of budgets

Answer 1

• Revenue or earnings budgets- These set out the business’s expected revenue from selling its products.
• Expenditure budgets- Also called cost/production budgets. These set out the expected expenditure on a monthly basis for these items.
• Profit budgets.

Question 2

How to construct a budget

Answer 2

• Business objectives- Information to prepare budgets can be gained by analysing markets and reviewing previous budgets.
• Construct sales budget showing revenue from planned sales.
• Draw up production budgets showing costs incurred in meeting sales targets.
• From this a business can compare sales and production budgets to give a figure for planned profits/losses.

Question 3

Difficulties in constructing budgets

Answer 3

• It may be difficult to forecast sales accurately.
• The risk of unexpected changes.
• Decisions by governments and other public bodies.

Question 4

Variances- Favourable and adverse

Answer 4

• Positive/Favourable- Better than expected. Might mean costs are lower than expected in the budget or revenue/profits were higher than expected.
• Adverse- Worse than expected. Might arise because costs were higher than expected or revenue/profits were lower than expected.

Question 5

Advantages of budgeting

Answer 5

• Control finances effectively and enable managers to make informed and focused decisions to improve financial performance.
• Allow senior managers to direct extra funds into important areas of the business.
• Can be used to motivate staff.
• Revenue budgets can also be used as targets for employees.

Question 6

Disadvantages of budgeting

Answer 6

• If a business intends that some of its employees should manage budgets, then training will be required.
• Allocating budgets fairly and in the best interests of the business is difficult.
• Budgets normally relate to the current financial year only.

Question 7

Why might a manager forecast the cash flow for a business

Answer 7

• To support applications for loans.
• To help avoid unexpected cash flow crises.

Question 8

Payables and receivables

Answer 8

• Payables is a term that relates to the amount of time taken by a business to pay its suppliers and other creditors.
• Receivables is a matching term that relates to the time taken by a business’s customers to pay a business for the products that it has supplied.

Question 9

Why would managers use break even analysis

Answer 9

• To help to decide whether the business idea will be profitable and whether it is viable.
• To help to decide the level of output and sales necessary to generate a profit.
• To asses the impact of changes in the level of production on the profitability of the business.
• To assess the effects of different prices and levels of costs on the potential profitability of the business.

Question 10

How to construct a break even chart

Answer 10

• Label horizontal axis to show all levels of production. Scale of this axis should range from zero to maximum level of output.
• Label vertical axis with values for costs and revenues. Values recorded should range from zero to the maximum possible revenue.
• Draw a horizontal line to represent fixed costs.
• Add variable costs. This line will start at the origin. Calculate variable costs at maximum output and mark on graph. Connect the twi points with a straight line.
• Add together fixed and variable costs. Add the values at zero output: the answer will equal fixed costs, as variable costs are zero at this output. Next add together fixed and variable costs at maximum output and mark result on graph. Join the two points together.

Question 11

Advantages of break even

Answer 11

• A business can forecast the effect of varying numbers of customers on its costs, revenues and profits.
• It is a simple technique allowing most managers to use it without the need for expensive training.
• It is a technique that can be completed quickly providing immediate results.
• It’s use can be of value in supporting a business’s application to a bank for a loan.

Question 12

Disadvantages of break even

Answer 12

• It says nothing about the level of sales a business might achieve.
• It is a simplification of the real world.
• The technique is also difficult to use when a business sells a number of different products.
• Costs do not rise as steadily as the technique suggests.

Question 13

The use of data for financial decision making and planning

Answer 13

• Using data to support decisions has also become more straight forward and cost effective due to developments in technology.
• Managers and other stakeholders use this information to make judgements about the future viability of a business or a specific project.
• Break even analysis could provide important evidence to assist managers in deciding whether to increase prices or to continue production.