Flashcards in Section E - Break-even and cash flow forecasts Deck (50):
A healthy cash flow means...
A business will have enough cash at any one point in time to be able to meet demand for short-term cash outflows.
By forecasting cash flow in advance, a business can...
identify where there might be shortages and either try to prevent this from happening or put plans in place to deal with it.
What are cash inflows or receipts?
Are the money coming into the business from various sources.
What are the sources of cash inflows or receipts?
Sale of assets
Bank interested received
What is capital introduced?
Money invested from entrepreneurs or shareholders when a business is first set up or looks to expand
What is outflows/payments?
Are the money going out of the business for various purposes.
What are the sources of outflows/payments?
Purchases of assets
Value added tax
Bank interest paid
What is value added tax
Businesses that are VAT registered must pay VAT to HM revenue & Customers, and this should be shown in the cash forecast.
What is the VAT threshold as of 2015?
What happens if a business with sales in excess of the VAT threshold.
They must registers itself with HMRC and then record VAT received on sales and paid on purchases. A business must then work out whether it has paid or received more money in VAT, then claim a refund or make a payment as appropriate.
What is the formula to calculate the closing balance?
Opening balance + Cash inflows - Cash outflows = Closing balance
What do credit periods affect in a business?
Credit periods affect the ability of the business to gain credit from its suppliers. If a business can secure supplies on credit, then this will slow down the flow of cash out of a business. The longer the credit period, the later the cash flows out.
What is the key purpose of a cash flow forecast.
Is to highlight in advance any months where there is a risk of a negative cash flow, as this allows the business to make arrangements.
A cash flow forecast can help identify...
Where there are potential shortfalls but might also indicate where there are large amounts of cash left at the end of a month or year.
What is a problem that occurs with cash flow.
Problems occur with cash flows when the business's outflows are greater than the opening balance plus the inflows, as this will result in a negative closing balance. This means that the business will not have enough cash to meet payments that are due.
What are some solutions to cash flow problems?
1) Overdraft arrangements
2) Negotiating terms with creditors
3) Reviewing and rescheduling capital expenditure
Explain overdraft arrangements
A business with a fluctuating cash flow cycle should be able to show the forecast to the bank and make arrangements for periods of negative cash flow.
What are creditors?
Creditors are people or businesses that a business owes money to, normally because goods or services have been bought on credit as opposed to cash purchases.
Explain negotiating terms with creditors.
A business with cash flow problems could try negotiate a longer payment term with its suppliers
Explain reviewing and rescheduling capital expenditure.
Having identified cash flow problems, the owner or manager could review what cash outflows were being spent on. Such a review might identify areas of expenditure that could be cut or postponed.
What are the benefits of cash flow forecast
1) Encourages planning for cash inflows and outflows.
2) Enables cash flow to be monitored and corrective action taken if necessary
3) Can be used as part of a business plan to help raise finance.
4) Identifies in advance times of negative closing balances allowing the business to plan for these.
What are the limitations of cash flow forecast.
1) Based on forecasts and therefore may be inaccurate.
2) Cannot plan for unexpected events such as a rise in the cost of raw materials
3) Time taken to produce a cash flow forecast could have been spent on other tasks.
What is break-even?
Break-even is the point at which a business is not making a profit or a loss.
What are the categorise of costs to a business.
1) Variable costs
3) Fixed costs
4) Total costs
What are variable costs?
Vary with the level of output, for example raw materials
What is semi-variable?
Part of the costs stays the same and part varies in relation to the degree of business activity, for example a worker may be paid a fixed rate of pay but at busy times earn additional payments for working overtime.
What is fixed costs
Do not vary with output, for example rent
What is total costs?
fixed costs + variable costs.
What is total revenue?
The total amount of money coming in from sales, calculated as quantity sold multiplied by selling price.
What is total sales?
The amount of sales made in a set time period, for example a year; this can be expressed as value or volume.
What is selling price per unit?
The amount a customer pays for each unit bought
What is sales in value?
Sales expressed in monetary value, for example £s, calculated as quantity sold multiplied by selling price per unit.
What is sales in volume?
Sales expressed as a quantity, for example tons or unit.
Break even is the point where...
Total revenue (TR) = Total Costs (TC)
What is the formula for break-even point
Fixed costs / Contribution per unit.
What is the formula for contribution per unit
Selling price - variable costs per unit
What is the formula for total contribution
Sales revenue - total variable costs
What is the formula for total variable cost
Variable cost per unit * quantity
Contribution per unit * number of units sold
What is margin of safety
Is the actual number of units sold over and above the break-even point
What is the formula for margin of safety?
Actual sales in units - break even level of output.
What is the formula for break even level?
break even point = fixed costs / contribution per unit
What is the formula for contribution per unit?
Contribution per unit = selling price - variable costs
What are the benefits of contribution per unit?
1) Straightforward to calculate
2) Allows for the calculation of break-even level of output
3) Can be used to inform decisions, e.g. what price to charge
4) Can be used to carry out what-if analysis
What are the limitations of contribution per unit?
1) Does not take into account fixed costs
2) Assumes that price remains constant
3) Does not take into account any unexpected changes to variables, e.g. selling price and variable costs can fluctuate.
How is break-even used for planning?
1) Set budgets for the amount of sales necessary and costs
2) Forms part of business plan to show at what point the business will start to make a profit
3) Informs pricing decisions
How is break-even used for monitoring?
• Monitor progress towards achieving break-even point.
• Identify changes to selling price of costs.
• Take corrective action if targets look unlikely to be met.
How is break-even used for control?
• Keep costs within budget.
• Motivate employees.
• Manage sales accounts.
How is break-even used for target setting?
• Set sales targets for individual employees, teams or products.
• Set expenditure budgets.
• Set profit budgets based upon sales targets and cost targets.
What are the advantages of break-even?
• The business knows how many items it must sell in order to break-even
• Informs decisions on what price to charge
• Can set targets
• Identifies fixed and variable costs
• Can identify if costs are too high allowing the business to look for ways of lowering costs
• Can set targets which will motivate employees
• Easy way to calculate profit for loss at different levels of output