Budgeting and decision making Flashcards
Analysis
The process of breaking down something complex into simpler, smaller parts.
Interpretation
The process of explaining the meaning of a financial item or analytic ratio.
3 types of analysis
- Vertical analysis
- Horizontal analysis
- Combined analysis
Gross profit margin
The percentage of the sales dollar remaining after cost of goods sold has been taken into account.
Should be compared against a benchmark such as previous periods gross profit margin or the budgeted gross profit margin.
Common size statements
Reports that use percentages rather than dollar values, allows easier comparison of results.
Vertical analysis
Breakdown of an accounting report into percentages in a vertical fashion on the page.
Horizontal analysis
Comparison of financial results across the page, usually by reporting on several consecutive trading periods.
Combined analysis
Combination of both vertical and horizontal analysis, can be used to examine businesses performance over several reporting periods.
Identify changes in revenue and expenses over time.
Essential to use comparative data over time as one years data may not show us the whole picture.
Trend analysis
Measuring the change in a financial item or an indicator over several periods.
Analytic ratio
A comparison of 2 related items in order to analyse an aspect of business performance.
Benchmark
Tool used to measure performance by comparing financial results against some established criteria.
- Previous periods results
- Industry averages
- Budget estimates
4 main financial indicators
- Profitability indicators
- Stability indicators
- Liquidity indicators
- Operating efficiency indicators
Profitability indicators
How profitable a business has been during a period.
Measured by comparing profit with an investment, by looking at what happened to the sales dollar during a period.
Stability indicators
Financial stability of a business.
Reflects the financial risk that is being taken by the business owner.
Liquidity indicators
Investigate the ability of a business to meet its short term debts as they fall due.
Based on short term events (items relevant to the next 12 months)
Operating efficiency indicator
How efficiently management uses the available assets.
Investment on inventory, accounts receivable, current asset and non current assets can all be examined in terms of how efficiently they have been used.
Budgeting
The process of predicting/estimating the financial consequences of future events.
Budgeted reports
- Budgeted cash flow statement
- Budgeted income statement
- Budgeted balance sheet
Budgeted cash flow statement
A report that shows ALL expected cash inflows + cash outflows.
The actual cash at bank at the beginning of a period and the estimated cash at bank at the end of a period.
Budgeted income statement
A report that shows all expected revenues + expenses for a period.
Expected gross profit, adjusted gross profit and net profit.
Budgeted balance sheet
A report that shows all expected assets, liabilities and owners equities at some point in the future.
Budgeting should be a continuous process
/Users/madisoncocking/Documents/Screen Shot 2019-09-06 at 2.04.52 pm.png
Qualitative characteristic
Going concern, businesses are assumed to be continuous so therefore the budgeting process should be continuous too.
Liquidity in terms of budgeting
A business must have sufficient cash in order to survive and “meet its short term debts as they fall due”.
(wages, rent, payment to Accounts Payable, loan repayments and advertising)
The budgeted cash flow statement attempts to predict all future cash inflows + outflows thus estimating the bank balance at the end of a period so the owner can assess the firms ability to meet its short term debts/obligations as they fall due.
Operating activities in terms of budgeting
Ideally budgeted net cash flows from operations will be POSITIVE, meaning that the business is expected to generate enough cash to meet its debts/obligations.
Therefore the owner will be warned if the operating cash flows is expected to be negative.
This means that the owner can then take action to boost cash inflows and minimise cash outlaws before there is a cash shortage.
Ways to generate cash inflows
- Increase sales revenue by moving the inventory around, changing the selling price or improving customer service.
- Increase receipts from accounts receivable by sending reminders, offering discounts for early payment or doing better credit checks.
Ways to reduce cash outflows
- Defer payment to accounts receivable and utilise the full length of the credit terms.
- Find a cheaper supplier, change the staff roaster, replace pricy non-current assets and even move to a cheaper premises.
Investing activities in terms of budgeting
Investing activities are ALL cash flows relating to the purchase or sale of non-current assets.
Given that non-current assets are generally expensive and the sale of non-current assets are rare it is common that the budgeted net cash flows for investing activities will be NEGATIVE.
Financing activities in terms of budgeting
Financing activities are ALL cash flows that are the result of changes in a firms financial structure.
Net cash flows being NEGATIVE or POSITIVE will depend of wether the business is expanding or just continuing on its normal operations.
Relationship between investing activities + financing activities
Negative INVESTING cash flows (due to the purchase of a non-current asset) could be financed by positive FINANCING cash flows (in the form of a loan or capital contribution).
