Analysing financial performance
Budgeting
A budget is a financial plan of action covering a specific time period.
Advantages of budgets:
Budget allows managers to monitor the businesses performance against the
predicted. Allows the firm to identify when sales are growing more/less than usual.
Can motivate staff if they are paid through performance related pay.
Managers can ignore areas where there it little or no variance and can focus their
efforts on areas that require attention, i.e., where there is large variance.
Disadvantages of budgets:
Budgeting is time consuming and is an opportunity cost as time could be focused
better elsewhere.
Budgeting can result in a business making short-term decision to keep within the
budget rather than making the right long-term decision which exceeds the budget.
E.g., buying large capital will be expensive in the short-term but will increase
productivity and will decrease marginal cost allowing you to make larger marginal
profit which in the long-term will lead to large profits.
Budgets need to be changed as circumstances change, in order for it to be realistic.
This can be time consuming.
Employees excluded from the budgeting process can feel demotivated and can lead
to decreased productivity.
Managers need to know when money is coming into and out of the business. Failure to do
so can result in cashflow difficulties. Main causes for small businesses, are late or failed
payments from customers, weak sales and unexpected increase in costs.
Variance is the difference between the budgeted figure and the actual figure.
The variance can be positive or negative depending on whether it’s about revenue/sales,
costs or profit.
For revenue if the actual figure > budgeted figure its variance is favourable,
because actual revenue is greater than expected.
For revenue if the actual figure < budgeted figure its variance is adverse, because
actual revenue is less than expected.
For costs if the actual figure > budgeted figure its variance is adverse, because
actual costs are greater than expected.
For costs if the actual figure < budgeted figure its variance is favourable, because
actual costs are less than expected.
The most importance variance is: Profit variance = sales variance – costs variance
Favourable sales variance:
, Advertising – help create awareness of products and can increases sales
Fashion and trend changes – if it becomes more fashionable
Population increases
Weather/season
Substitutes price
Complements price
Economic boom
Adverse sales variance:
Bad advertising – impact brand name, decrease sales
Fashion and trend changes – if it becomes less fashionable
Population decreases
Weather/season
Substitutes price
Complements price
Economic recession
Favourable cost variance:
Costs may decrease, materials costs or rent costs
Increased productivity
Improved currency exchange rate – will make purchasing materials cheaper, will
make selling abroad cheaper as delivery will be cheaper.
Cheaper suppliers
Adverse cots variance:
Strikes by workers
Bad weather
Decreased currency exchange rate – will make purchasing materials more expensive,
will make selling abroad more expensive as delivery will become more expensive.
Unexpected rise in raw materials prices
Balance sheets
A balance sheet is a statement of a business’s assets (what a business owns) and liabilities
(what a business owes) at a specific point in time.
Assets
Non-current assets (fixed assets) – includes land, buildings, machinery and vehicles.
Budgeting
A budget is a financial plan of action covering a specific time period.
Advantages of budgets:
Budget allows managers to monitor the businesses performance against the
predicted. Allows the firm to identify when sales are growing more/less than usual.
Can motivate staff if they are paid through performance related pay.
Managers can ignore areas where there it little or no variance and can focus their
efforts on areas that require attention, i.e., where there is large variance.
Disadvantages of budgets:
Budgeting is time consuming and is an opportunity cost as time could be focused
better elsewhere.
Budgeting can result in a business making short-term decision to keep within the
budget rather than making the right long-term decision which exceeds the budget.
E.g., buying large capital will be expensive in the short-term but will increase
productivity and will decrease marginal cost allowing you to make larger marginal
profit which in the long-term will lead to large profits.
Budgets need to be changed as circumstances change, in order for it to be realistic.
This can be time consuming.
Employees excluded from the budgeting process can feel demotivated and can lead
to decreased productivity.
Managers need to know when money is coming into and out of the business. Failure to do
so can result in cashflow difficulties. Main causes for small businesses, are late or failed
payments from customers, weak sales and unexpected increase in costs.
Variance is the difference between the budgeted figure and the actual figure.
The variance can be positive or negative depending on whether it’s about revenue/sales,
costs or profit.
For revenue if the actual figure > budgeted figure its variance is favourable,
because actual revenue is greater than expected.
For revenue if the actual figure < budgeted figure its variance is adverse, because
actual revenue is less than expected.
For costs if the actual figure > budgeted figure its variance is adverse, because
actual costs are greater than expected.
For costs if the actual figure < budgeted figure its variance is favourable, because
actual costs are less than expected.
The most importance variance is: Profit variance = sales variance – costs variance
Favourable sales variance:
, Advertising – help create awareness of products and can increases sales
Fashion and trend changes – if it becomes more fashionable
Population increases
Weather/season
Substitutes price
Complements price
Economic boom
Adverse sales variance:
Bad advertising – impact brand name, decrease sales
Fashion and trend changes – if it becomes less fashionable
Population decreases
Weather/season
Substitutes price
Complements price
Economic recession
Favourable cost variance:
Costs may decrease, materials costs or rent costs
Increased productivity
Improved currency exchange rate – will make purchasing materials cheaper, will
make selling abroad cheaper as delivery will be cheaper.
Cheaper suppliers
Adverse cots variance:
Strikes by workers
Bad weather
Decreased currency exchange rate – will make purchasing materials more expensive,
will make selling abroad more expensive as delivery will become more expensive.
Unexpected rise in raw materials prices
Balance sheets
A balance sheet is a statement of a business’s assets (what a business owns) and liabilities
(what a business owes) at a specific point in time.
Assets
Non-current assets (fixed assets) – includes land, buildings, machinery and vehicles.
