Analysing Financial Performances

Cash-Flow

Businesses can use cash-flow forecasts to estimate their total cash inflows and their total cash outflows for a future period of time.

Cash-flow forecast

Cash-flow forecast

• Total inflows include all cash inflows coming into the business during the period.

• Total outflows include all cash outflow leaving the business during the period.

• Net cash flow is the difference between total inflows and total outflows.

• The opening balance is the balance at the start of the month and is the same as the closing balance of the previous month.

Cash-flow problems

• Businesses that are profitable but have cash-flow or liquidity problems can become bankrupt as they lack short-term cash to pay short-term debts.

Improving cash-flow

• Money owed to the business is known as a receivable and businesses can reduce the trade credit period given to increase how quickly they receive their receivables, which improves cash-flow.

• Money owed by the business to others is known as a debtor (or payables) and a business can ask others for longer trade credit to reduce how quickly they must pay payables, which improves cash-flow.

Budgets

Businesses can use budgets to forecast revenue, expenditure, and profit during a period.

Revenue budgets

• A revenue budget forecasts expected revenues for a business during a period. If actual revenue is higher than the forecast, we call this 'favourable variance'. If revenue is less than expected, we call this 'adverse variance'.

Expenditure budgets

• An expenditure budget forecasts expected costs for a business during a period. A higher actual cost than forecast is an adverse variance, and a lower actual cost than forecast is a favourable variance.

Profit budgets

• Revenue and expenditure budgets can be used to create profit budgets. If overall profit is higher than forecast, there is a favourable variance. If overall profit is lower than forecast, there is an adverse variance.

Advantages of budgeting

• Budgets help businesses achieve targets and objectives.

• Budgets help managers and leaders focus on cost control which can increase profit.

• Budgets can be used to motivate staff by providing spending authority to individual departments and teams.

  • For example, many hospitals assign budgets to individual departments and this motivates department managers and staff within departments as they are given authority to place orders.

Break-Even Analysis

Businesses can use breakeven analysis to predict the level of output at which total costs and total revenues will be the same.

Contribution per unit

• Contribution per unit is the amount of revenue which contributes to covering a business' fixed costs after the variable cost per unit has been taken away from revenue per unit.

Calculating contribution per unit

• Contribution per unit is calculated as the selling price per unit – variable costs per unit.

Total contribution

• Total contribution is the amount of revenue from the sale of all products which contributes to fixed costs once total variable costs have been taken away.

Calculating total contribution

• Total contribution is calculated as total revenue – total variable costs.

Profitability Analysis

Businesses can analyse their profitability using gross profit, operating profit, and profit for the year objectives.

Gross profit

• Gross profit targets involve the amount of profit remaining once direct costs (cost of sales) have been paid by the business.

  • Gross profit margin = (gross profit ÷ sales revenue) × 100

• For example, a supermarket may use gross profit margin targets to compare performance across years. A decrease in gross profit margins may lead the supermarket to focus on reducing the supermarket's cost of sales.

Operating profit

• Operating profit targets involve the amount of profit remaining once direct costs (cost of sales) and indirect costs (expenses) have been paid by the business.

  • Operating profit margin = (operating profit ÷ sales revenue) × 100

Profit for the year

• A profit for the year target involves the amount of profit remaining once all costs and financing fees have been considered.

  • Profit for the year margin = (profit for the year ÷ sales revenue) × 100