2.2 Financial Planning

• why might a business want to forecast with accuracy

  • future sales of products
  • the effect of promotion on sales
  • possible changes in the size - nature of the market in the future
  • changing consumer trends and tastes
  • cash flow
  • external factors - interest rates and inflation
  • the way sales fluctuate at different times of the year
• sales forecasting

  the process of estimating the volume or value of future sales often based on previous sales data
• sales volume

  the number of units sold of a particular product/service
• sales value

  the sales revenue of a particular product or service by £ or $ value
• main uses for sales forecasts

  • to avoid cash flow problems
  • to free up management time
  • to manage production capacity
  • to employ more workers
  • to start a promotional activity
• purpose - avoid cash flow problems

  accurately forecasting the sales and building a sales plan can help the business to manage their production, state and financing needs more effective and possibly avoid unforeseen cash flow problems

  a sales forecast will help a business to write the income part of the cash flow forecast
• purpose - frees up management time

  a well-constructed sales forecast can allow the business owners to spend more time developing their business rather than responding to day-to-day developments in sales and marketing

  manager will have more time to focus on the rest of the business
• purpose - production capacity

  can use a sales forecast to estimate if they need to increase or decrease production - help to see if they have enough production capacity to deal with expected demand

  business may need to buy or rent new premises if there is a huge increase in sales forecast
• purpose - employ more workers

  if the business has high sales forecasts for a new product or service it may need to take on new employees to cope with new levels of demand

  failure to meet required staffing levels could result in poor reviews or customer service and this may impact future sales
• purpose - to start a promotional activity

  if sales are forecasted to be very low and the product or service is not in the decline phase of the product lifecycle, the business may decide to try and increase sales through promotion and marketing

  sales forecasts can also direct a business to a specific season or month when promotion activity would be likely to net the most sales revenue - christmas
• factors affecting sales forecasts

  consumer trends

  • seasonal variations
  • fashions
  • long term trends

  economic variables

  • economic growth
  • interest rates
  • inflation
  • unemployment
  • exchange rates
  • external shocks

  competition
• time series analysis

  a method that allows a business to predict future levels from past figures

  describes what is happening to data or predicts what will happen to it

  business is assuming that past figures are a useful indicator of what will happen in the future - likely if trading conditions are stable or if the business needs to forecast trends in the short-term, use of past data to predict the future is called extrapolation
• what does a business want to identify in a time series data

  • the trend - e.g. sales of new products may peak then flatten (product life cycle)
  • seasonal fluctuations - large sales at times but not others (impact on cash flow)
  • cyclical fluctuations - highs and lows linked to trade cycle
  • random fluctuations - 'freak' figures from one off events (festivals, uncharacteristic weather conditions)
• what might be the difficulties of sales forecasting

  • historical data may not reflect future performance
  • seasonality may affect sales
  • natural disasters cannot be foreseen
  • fluctuations in demand due to sales promotion, fashion, shortages etc
  • a new business will have no historical data to look at, will have to use market research data
  • subjective expert opinion
  • a product whose demand is highly sensitive to changes in price/income
• terms used for sales value

  • sales revenue
  • revenue
  • income
  • turnover
• sales volume

  the number of units sold by a business, can be measured if different ways depending on the size of the business
• sales revenue

  the value of the output sold by the business

  can be measured in pounds, euros, dollars etc

  usually counted for a specific time period - a week, month, year

  sales revenue is the same as total revenue
• sales revenue formula

  price x quantity of output
• sales value formula

  sales/selling price
• fixed costs

  a cost that doesn't change as a result of a change in output in the short run
• variable cost

  a cost that rises as output rises
• total cost

  fixed costs + variable costs

  entire cost of producing a given level of output
• average cost (unit cost)


  cost of producing on unit

  total cost/output
• profit

  profit = total revenue - total costs
• factors of production (factor inputs)

  • land - natural resources available for production (trees, oil, land)
  • labour - the human input into the production process
  • capital - goods used in the supply of other products (machines, factories)
  • entrepreneurship - entrepreneurs have ideas, organise factors of production and take risks
• short-run costs

  the time period where at least one factor of production is fixed
• long-run costs

  the time period where all factors of production can vary
• break-even

  the point at which a business is not making a profit or a loss

  total costs are the same as total revenue
• break-even output

  the number of items that a business must sell to reach break-even

  before reaching break-even a business is operating at a loss

  after reaching break-even each additional unit sold will contribute towards profit
• when businesses sell a product or service, they pay for its own variable costs and then contribute towards the fixed costs, until there are enough contributions to cover all the fixed costs, the business cannot start to make a profit
• contribution per unit formula

  selling price per unit - variable costs per unit

  expressed in pounds
• total contribution formula

  total sales revenue - total variable costs
• break-even point formula

  fixed costs/contribution per unit
• margin of safety

  range of output between the break-even level and the current level of output, over which a profit is made
• margin of safety formula

  actual output level - break even level of output

  shows the number of sales that could be lost before the business makes a loss
• break-even charts: fixed costs

  fixed costs stay the same - horizontal line

  
• break-even charts: variable costs

  change in relation to the number of items produced - starts at zero and slopes upwards

  
• break-even charts: total costs

  start at the point of the fixed costs amount and then slop upwards at the same gradient as variable costs

  
• break-even chart

  variable cost is not usually added to a break-even chart

  
• break-even

  businesses should treat it with a degree of caution

  based on assumption that costs and revenue will be static