3.5.2 Analysing financial performance

• Breakeven is when the total revenue is equal to the total costs
• Most businesses make a goal to breakeven apart from new businesses

  Breakeven charts assume you sell everything its not guaranteed sales
• The margin of safety is the difference between actual output and the breakeven output
• What's the formula for margin of safety?

  actual output - breakeven output
• If a business is breaking even it is neither making a profit nor a loss, to calculate how many units a business must sell to break even, they must first calculate their contribution per unit. This is the average selling price minus the variable costs per unit.
• Break even output is calculated by?

  fixed costs / contribution per unit
• The higher the firms fixed costs the greater the break-even output will be, margin of safety refers to the difference in output between the break-even output and the number of units sold
• Contribution is the difference between sales revenue and variable costs, there are several ways of using contribution
• The formula for contribution is?

  Sales revenue - total variable costs = contribution
• What is the formula for contribution per unit?

  selling price per unit - variable costs per unit
• What's the formula for total contribution?

  Contribution per unit X units sold

  OR

  Total sales revenue - total variable costs
• How do you know if you have made a profit or loss?

  Total contribution - fixed costs

  A positive means a profit

  A negative means a loss
• Breakeven is when total contribution = fixed costs
• What are the benefits of break even?

  Focuses on what output is required before a business reaches profitability

  Can use break even to calculate the margin of safety

  It shows how much a sales forecast can prove over-optimistic before losses are included
• What are the drawbacks of break even?

  Unrealistic assumptions - products are sold at different levels of output, fixed costs do vary when output changes

  Sales are unlikely to be the same as output - it does not guarantee you will sell all your units
• What is cash flow?

  The movement of money in and out of a business.
• Cashflow is a record of all the money coming into and out of a business over a period of time
• Profit and cash flow are not the same thing
• What are some inflows into a business?

  Loans

  Investments

  Grants

  Shareholder funds
• What are some outflows in a business?

  Loan repayments

  wages

  Raw materials

  Tax

  Dividends
• When inflows > outflows there is a positive cash flow

  When outflows > inflows there is a negative cash flow
• Why should businesses produce a cash flow forecast?

  Advanced warning of cash shortages so the business can obtain loans or overdrafts

  Makes sure businesses can afford to pay suppliers and employees

  Spots problems with customer payments
• Net cash flow = inflows - outflows
• Closing balance = opening balance + net cash flows
• Receivables is a term that describes the time taken by a businesses customers to pay for the products it has supplied
• Payables refer to the length of time taken by as businesses to pay suppliers and other creditors
• What are the main causes for cash flow problems?

  Allowing customers too long to pay

  Seasonal or unpredictable demand fluctuations

  Excess inventories held

  Too much production capacity is held but not used

  Overtrading - growing the business too fast
• Accounts receivables is the money that is bought from the sale of products and services

  Accounts payables is the money you owe to suppliers and vendors
• Budgeting is a financial plan for the future concerning the revenues and costs of a business
• Why do businesses use budgeting?

  To control expenditure - by allocating who can spend what

  Measure weather key objectives and targets are being achieved

  Provide direction which can motivate workers

  Management can monitor actual results against budget and communicate them to stakeholders
• Where do you get budget information from?

  Basing the budget on last years spending or revenue or profit

  Competitors

  Basing expenditure budget in a percentage of sales revenue
• Characteristics of historical budgeting?

  Uses last years data

  More accurate

  Does not encourage efficiency

  Circumstances may change
• Characteristics of zero budgeting?

  Costly and time consuming

  Based on new proposals

  More complicated

  Involves lots of research
• What is variance analysis?

  Calculating and investigating the difference between actual results and the budget
• Favourable means that is spending was good for the business, they spent less than forecasted
• Advisable means its bad for the business, they spend more than forecasted
• What are the different types of budget?

  Income budget

  Expenditure budget

  Profit budget
• What are some ways to measure profit?

  Profit in absolute terms e.g. numbers

  Profit in relative terms e.g. profit margins
• Gross profit = sales revenue - direct costs
• Gross profit margin = gross profit / revenue x 100