finacial planning

Sales forecasting

Process of forecasting a business’s future sales

Factors that affect sales forecasting

Consumer trends

Demand in many markets changes as consumer tastes, fashions and buying habits change. Changing consumer trends can therefore lead to an increase or decrease in sales.

Economic variables

The sales of a business may be affected by economic variables such as interest rates, inflation and exchange rates.

For example, an increase in the rate of interest could lead to the sales of some products falling and the sales of other products increasing.

Actions of competitors

Competitor actions can have a major impact on the sales of a business. For example, a competitor launching a new product, promotional campaign or price reduction, could reduce the sales of the business. A new competitor entering the market could lead to a decrease in sales whereas a competitor exiting the market could lead to an increase.

Difficulties of forecasting

• Dynamic markets. Many businesses operate in markets that are subject to continuous and rapid change. This can make sales forecasting difficult

• Past performance is no guarantee of future performance. Just because sales have been increasing in the past, does not mean that sales will increase in the future. External shocks, competitor actions, economic variables and changing consumer trends can make it difficult to accurately predict future sales

What is sales volume and calculation

Sales volume refers to the number of units/items sold. Sales volume can be calculated as follows:

Sales volume = Sales revenue/Selling price

What is sales revenue and calculation

Calculation of sales revenue

Sales revenue refers to the value of the units/items sold by a business. Sales revenue can be calculated as follows:

Sales revenue = selling price x sales volume

What are fixed costs

A fixed cost is a cost that doesn't change in relation to output/sales. Examples of fixed costs include:

• Rent

• Salaries

• Interest on a loan

• Insurance

What are variable costs

A variable cost is a cost that changes in relation to output/sales. Examples of variable costs include:

• Raw materials

• Packaging

• Commission payments

What is contribution and calculation for contribution per unit

Contribution (per unit) is the difference between the selling price per unit of a product and the variable cost per unit of making that product. Contribution per unit is calculated as follows:

Contribution per unit = selling price per unit - variable cost per unit

Total contribution / number of units sold

Contribution per unit "contributes" to the total fixed costs of a business. Once the total fixed costs of a business have been covered, then contribution per unit "contributes" towards the profit of a business.

Total contribution = contribution per unit x total number of units sold

Or

Total contribution = total revenue - total variable costs

It is important to note that total contribution is not profit. Profit can be calculated by deducting the total fixed costs

from total contribution (total contribution - total fixed costs = profit).

What is break even and calculation

The level of output where the total revenue is equal to the total cost.

The formula for calculating break-even using contribution is:

Fixed costs/Contribution per unit

What is Margin of safety and calculation

The margin of safety is an important concept in break-even as it shows a business how much output can reduce/fall before reaching the break-even point. The margin of safety can be calculated as follows:

Actual or current level of output - break-even output

Break even chart

Break even limitations and benefits

Break-even charts, and break-even in general, has several benefits, for example:

• It can allow a business to identify the level of output needed to make a profit and it is, therefore, useful for setting targets and planning future output

• Allows "what if" analysis, for example, to assess the effect of changes in selling price and costs on the break-even point

• For a start-up, allows the entrepreneur to see how much needs to be sold to break-even

• Can be used as part of a business plan to help the business obtain finance

• Illustrates the importance of keeping costs low

Limitations of break-even analysis

Whilst break-even analysis has several benefits, there are limitations, for example:

• Often based on unrealistic assumptions, such as variable costs remaining the same whatever the output of the business. For example, as output rises the business may benefit from bulk-buying economies of scale which reduces variable cost per unit

• The selling price per unit may also change as some products are not sold at the same price at different levels of output. For example, the business may reduce the selling price per unit for bulk orders

• Sales are unlikely to be the same as output, for example, there may be some build up of stocks or wasted output

• Most businesses sell more than one product, therefore, break-even becomes harder to calculate

What is a budget why it is needed

A budget is a future financial plan concerning the revenues and costs of a business. Budgets have several purposes:

• Planning, for example, establishing priorities for the business

• Forecasting outcomes

• Communication, for example, communicating revenue and expenditure targets

• Assigning responsibilities

• Allocating resources

• Controlling expenditure

• Motivating employees, for example, employees may be motivated to achieve specific budget targets

• For a start-up, a budget may be a key element of a business plan and help it obtain finance

Two types of budgeting

Historical budgeting

• Uses last year's (historic) figures as the basis for the budget, but, considers future actions/circumstances such as an increase in production or changes to costs and prices

• Is realistic given that it's based on actual, past results

Zero based budgeting

• Budgeting costs and revenue are set to zero

• Budget is based on new proposal for sales and costs i.e. the budget is built from the bottom up

• All elements of the budget must be justified and set for the new budgeting period

What is variance and the types

Variance analysis involves calculating and investigating the differences between actual results and the budget.

Variances can be either:

• Favourable (better than expected

• Adverse (worse than expected

Favourable variance

A favourable variance might mean that:

• Costs were lower than expected in the budget

• Revenue/profits were higher than expected

Adverse variance

An adverse variance might arise because:

• Costs were higher than expected

• Revenue/profits were lower than expected

Difficulties of budgeting

Whilst budgets are widely used in business, there are limitations, in particular, budgets:

• Are only as good as the data being used to create them. Inaccurate or unreasonable assumptions can quickly make a budget unrealistic

• Can lead to inflexibility in decision-making

• Need to be changed as circumstances change

• Can take significant time to prepare. In large businesses, whole departments are sometimes dedicated to budget setting and control

• Can result in short-term decisions to keep within the budget, rather than the right long-term decision which exceeds the budget

• Managers can become too preoccupied with setting and reviewing budgets and forget to focus on the real issues of winning customers

Budgets can also create some behavioural challenges in a business:

• Budgeting has behavioural implications for the motivation of employees

• Budgets may be de-motivating if they are imposed rather than negotiated

• Setting unrealistic targets adds to de-motivation

• Budgets may contribute to departmental rivalry, for example, battles over budget allocation

• Spending up to budget. Budgets can result in a "use it or lose it" mentality, for example, spending up to the budget to preserve it for next year

• A "name, blame and shame" culture can develop, although, managers should be answerable only for variations that were under their control