Budgeting and decision making

Question 1

Analysis

Answer 1

The process of breaking down something complex into simpler, smaller parts.

Question 2

Interpretation

Answer 2

The process of explaining the meaning of a financial item or analytic ratio.

Question 3

3 types of analysis

Answer 3

• Vertical analysis
• Horizontal analysis
• Combined analysis

Question 4

Gross profit margin

Answer 4

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.

Question 5

Common size statements

Answer 5

Reports that use percentages rather than dollar values, allows easier comparison of results.

Question 6

Vertical analysis

Answer 6

Breakdown of an accounting report into percentages in a vertical fashion on the page.

Question 7

Horizontal analysis

Answer 7

Comparison of financial results across the page, usually by reporting on several consecutive trading periods.

Question 8

Combined analysis

Answer 8

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.

Question 9

Trend analysis

Answer 9

Measuring the change in a financial item or an indicator over several periods.

Question 10

Analytic ratio

Answer 10

A comparison of 2 related items in order to analyse an aspect of business performance.

Question 11

Benchmark

Answer 11

Tool used to measure performance by comparing financial results against some established criteria.

• Previous periods results
• Industry averages
• Budget estimates

Question 12

4 main financial indicators

Answer 12

• Profitability indicators
• Stability indicators
• Liquidity indicators
• Operating efficiency indicators

Question 13

Profitability indicators

Answer 13

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.

Question 14

Stability indicators

Answer 14

Financial stability of a business.

Reflects the financial risk that is being taken by the business owner.

Question 15

Liquidity indicators

Answer 15

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)

Question 16

Operating efficiency indicator

Answer 16

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.

Question 17

Budgeting

Answer 17

The process of predicting/estimating the financial consequences of future events.

Question 18

Budgeted reports

Answer 18

• Budgeted cash flow statement
• Budgeted income statement
• Budgeted balance sheet

Question 19

Budgeted cash flow statement

Answer 19

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.

Question 20

Budgeted income statement

Answer 20

A report that shows all expected revenues + expenses for a period.
Expected gross profit, adjusted gross profit and net profit.

Question 21

Budgeted balance sheet

Answer 21

A report that shows all expected assets, liabilities and owners equities at some point in the future.

Question 22

Budgeting should be a continuous process

Answer 22

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Question 23

Qualitative characteristic

Answer 23

Going concern, businesses are assumed to be continuous so therefore the budgeting process should be continuous too.

Question 24

Liquidity in terms of budgeting

Answer 24

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.

Question 25

Operating activities in terms of budgeting

Answer 25

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.

Question 26

Ways to generate cash inflows

Answer 26

• 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.

Question 27

Ways to reduce cash outflows

Answer 27

• 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.

Question 28

Investing activities in terms of budgeting

Answer 28

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.

Question 29

Financing activities in terms of budgeting

Answer 29

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.

Question 30

Relationship between investing activities + financing activities

Answer 30

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).