Professional Documents
Culture Documents
A Budget is a forecast of costs and / or incomes Costs and Incomes must relate to a particular purpose Individual budgets must be based on a variety of different elements Individual budgets are brought together into a master budget which is for the organization as a whole
PURPOSE OF BUDGET:
To plan - they help businesses control their finances as they plan expenditures over a period of time To control - help to ensure that businesses dont spend more than they should
PROBLEMS OF BUDGET:
Incorrect allocations External factors Poor communication These problems can be overcome by flexible budgeting Some firms adopt zero budgeting to ensure allocations are not excessive
ADVANTAGES OF BUDGET:
It indicates priorities It provides direction and co-ordination It assigns responsibility It can act as a motivator It should improve efficiency
DISADVANTAGES:
Training requirements staff need to be trained to set budgets and manage them Allocation of funds managers may find it hard to allocate funds fairly and in the businesses best interests Short term vs. Long term planning budgets usually only look at an annual plan therefore may fail to take a longer term view
VARIANCE ANALYSIS:
Adverse (or unfavourable) variances - when actual performance is poorer than budgeted performance Favourable variances where variance represents a better performance than planned
Identification of the cause of a variance can allow a company to: - Identify the responsibility - Take appropriate action
If revenues are greater than budgeted Favourable variance If revenues are less than budgeted Adverse variance If costs are greater than budgeted Adverse variance If costs are less than budgeted Favourable variance
If businesses regularly analyse variances it allows them to notice if financial plans are inaccurate If businesses fail to analyse variances on a regular basis they will not be aware of their financial performance compared to what is budgeted
ZERO BUDGETING:
This is where the budget is stet at zero and budget holders have to bid for any monies and justify the reasons why These can be good for new businesses / new ventures
SUMMARY:
Budgets are financial plans showing expected costs and revenues over a period of time Purposes of budgets they help the business plan and control finances Problems with budgets external factors, poor communication, incorrect allocations Advantages allows to prioritise, provides direction, can motivate Disadvantages need to train staff, can be short term not long term Calculating variances look at costs and revenues if they are adverse (negative) or favourable (positive) Zero budgeting all areas start off with nothing and have to bid for money
CASH FLOW
A Forecast is a prediction of what may happen in the future A cash Flow Forecast is therefore a prediction of the inflows and outflows of cash in the future Businesses use past figures and experiences to predict forecasts A Cash Flow statement differs from a forecast. It detailed what has happened in the business, i.e. the money that has flowed in and out of the business
WORKING CAPITAL:
Working capital measures the amount of money the business has to pay day-to-day expenses Working capital = current assets current liabilities Businesses need to be aware of their working capital and ensure that they have enough cash to survive
WINDOWS DRESSING:
These improve the appearance of a companies balance sheet Can borrow money for a short period of time to improve cash position just before date of balance sheet Use sale and leaseback Include intangible assets e.g. goodwill / brands on balance sheet Capitalise expenditure including things as assets that could be classified as expenses
Ratios allow a business to identify aspects of their performance to help decision making Ratio Analysis allows you to compare performance between departments and over time Four different types of ratios can be used to measure: 1. Profitability how profitable the firm is 2. Liquidity the businesses ability to pay 3. Investment/shareholders allows businesses to look at risk and potential earnings of investments 4. Gearing looks at the balance between loans and shares in a business EFFICIENCY RATIO: ASSETS TURNOVER RATIO: Looks at a businesses sales compared to the assets used to generate the sales Asset turnover = sales (turnover) / net assets Net assets = Total assets current liabilities The value will vary with the type of business: - Businesses with a high value of assets who have few sales will have a low asset turnover ratio - If a business has a high sales and a low value of assets it will have a high asset turnover ratio - Businesses can improve this by either increasing sales performance or getting rid of any additional assets DEBTORS COLLECTION PERIOD: This is another efficiency ratio T his looks at how long it takes for the business to get back money it is owed Debtors collection ratio = debtors x 365 / turnover The lower the figure the better as get cash more quickly However sometimes need to offer credit terms to customers so this may increase it Need to ensure keep track of any changes in credit terms as these should impact this ratio GEARING: This is an efficiency ratio Looks at the relationship between borrowing and fixed assets Gearing Ratio = Long term loans / Capital employed x 100 The higher it is the greater the risk the business is under if interest rates increase STOCK TURNOVER RATIO:
Another efficiency ratio Looks at how efficiently a company converts stock to sales Stock turnover ratio = cost of sales / stock High stock turnover means increased efficiency However it depends on the type of business Low stock turnover could mean poor customer satisfaction as people might not be buying the stock LIQUIDITY RATIO: ACID TEST RATIO: Acid test ratio is another way of looking at liquidity It has been argued that stock takes a while to convert to cash so a more realistic ratio would ignore stock (Current assets stock) : liabilities 1:1 seen as ideal Again if it is too high means that the business is very liquid may be able to use the cash for other activities to increase performance If it is too low then the business may face working capital problems Some types of business need more cash than others so acid test would be expected to be higher CURRENT RATIO: Current ratio looks at the liquidity of the business Looks at the ratio between Current Assets and Current Liabilities Current Ratio = Current Assets : Current Liabilities Ideal level approx 1.5 : 1 Need enough current assets to cover current liabilities If its too high means too many current assets e.g. might have too much stock, could use the money tied up in current assets more effectively If its too low you run the risk of not being able to meet current liabilities and you could have liquidity problems PROFITABILITY RATIO: GROSS PROFIT RATIO: Profitability measures look at how much profit the firm generates Profit is the number one objective of most firms Gross profit = total revenue variable costs (cost of sales)
Gross profit looks at how much of the sales revenue is converted into profit Gross Profit Margin = Gross profit / turnover x 100 The higher the better Allows the firm to assess the impact of its sales and how much it cost to generate (produce) those sales A gross profit margin of 35% means that for every 1 of sales, the firm makes 35p in gross profit NET PROFITS RATIOS:; Net profit looks at how much of the sales revenue is left as net profit Net Profit = Gross profit overheads Net Profit Margin = Net Profit / Turnover x 100 Includes overheads / fixed costs Net profit is more important than gross profit for a business as all costs are included A business would like to see that this ratio has improved over time RETURN ON CAPITAL EMPLOYED RATIO: Another profitability ratio Looks at operating profit and capital employed by the business Return on Capital Employed (ROCE) = Profit / capital employed x 100 Typically should be 20-30% Need to compare to previous years and competitors to get a clear picture Can improve this by increasing profits without increasing fixed assets / capital SHAREHOLDER RATIO: Shareholders are interested in the following ratios: Dividends per share Total dividends / number of shares issued A higher figure means the shareholder got a larger return Good to compare with competitors Businesses can improve this themselves by increasing dividend payments Dividend yield Ordinary share dividend / market price x 100 Compares the return amount with what would be needed to purchase a share
The higher the better This ratio varies daily with changes to a companies share price LIMITATIONS WITH RATIO ANALYSIS: To be most beneficial the results need to be compared with other data including: - The results for the same business over previous years - The results of ratio analysis for their competitors - The results of ratio analysis for other firms in other industries OTHER FACTOR TO CONSIDER: The market the business is trading in The position of the firm in the market The quality of the workforce and management The economic environment
SUMMARY:
Ratios are used to look at the performance of a business Liquidity ratios look at the firms ability to meet its debts Current ratio = current assets current liabilities Acid test ratio = current assets - stock : current liabilities Shareholder ratios these are ratios that shareholders would be interested in Dividends per share = total dividends / number of shares issued Dividend yield = ordinary share dividend / market price x 100 Efficiency ratios are how well the business is operating Gearing = Long term loans / Capital employed x 100 Stock turnover ratio = cost of sales / stock Asset turnover = sales (turnover) / net assets Debtors collection period debtors x 365 / turnover Profitability ratios assess the profitability of the business Gross profit = Gross profit / turnover x 100 Net profit = Net profit / turnover x 100
Return on capital employed = Profit / capital employed x 100 Limitations of ratio analysis need to be able to compare figures over time and between companies to be most effective