FINANCE
Business Studies
BS2
Name: _______________________
Outline of Module
Checklist
1. Budgeting
Revision
 Understand the nature and purpose of budgets and their
limitations.
2. Cash Flow Forecast
 Complete and interpret simple cash flow forecasts.
 The benefits and limitations of using cash flow forecasts.
3. Profit and Loss Accounts
 Understand the importance of the main items on a Profit and Loss
Account of sole traders and partnerships.
 Interpret simple Profit and Loss Accounts
Candidates are not expected to construct accounts or use ratio analysis.
4. Balance Sheets
 Understand the importance of the main items on a Balance Sheet
of sole traders and partnerships.
Candidates are not expected to construct accounts or use ratio analysis.
 Interpret simple Balance Sheets.
5. Break Even Analysis
 Classify costs: fixed, variable and semi-variable.
 The nature and significance of contribution.
 Construction and interpretation of break-even charts.
 The impact of changes in costs and revenue on the gross and net
profit of businesses.
 What-if analysis.
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1. Budgeting
1.1
Understand the nature and purpose of budgets and their limitations.
DEFINITION: A budget is a target for costs or revenue that a firm or department must aim to reach over a
given period of time. In other words it is a quantitative economic plan prepared and agreed in advance.
BUDGETARY CONTROL/BUDGETING: This is a business system which involves making future plans,
comparing the actual results with the planned results and investigating any differences/variances.
A budget forecasts future earnings and future spending,
usually over a 12 month period.
Businesses use different
budgets to estimate different things:
o
INCOME/SALES REVENUE: Shows the planned income or revenue for a period of time.
o
EXPENDITURE/TOTAL COST BUDGET: Shows how much money a business is
expected to spend for a period of time.
o
PROFIT BUDGET: Shows the amount of profit a business is expected to make over a
period of time.
o
MASTER BUDGET: A summary statement which brings together information from
budgets.
USING BUDGETS
Budgets are considered to be a management tool and the way in which they are used can tell you a lot about a firm’s
culture. A tightly controlled budgetary system illustrates a top heavy management system where managers will have
budgets imposed upon them and variances will be closely watched by supervisors. Alternatively, organisations with a
more open culture will use budgeting as an aid for discussion and empowerment.
MAIN REASONS BUDGETS ARE USED
o
CONTROL (DELEGATING SPENDING)
o
CO-ORDINATION
o
o
COMMUNICATION
MONITORING PERFORMANCE
o
o
PLANNING
EFFICIENCY
LIMITATIONS:

RESENTMENT: Can cause rivalry between departments if they have to compete for money.

RESTRICTIVE: Fixed budgets can stop firms responding to changing market conditions.

TIME-CONSUMING: Managers can get too preoccupied with setting and reviewing budgets, and
forget to focus on the real business issues.
VARIANCE is the amount by which the actual result differs from the budgeted
figure – it can be either favourable or adverse.
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2. CASH FLOW FORECAST
2.1
Complete and interpret simple cash flow forecasts.
2.2
The benefits and limitations of using cash flow forecasts.
DEFINTION: Cash flow is money flowing in and out of a business.
A
Cash Flow Statement is a plan showing all the expected cash receipts and
cash payments in a firm over a period of time. It is a business’s estimate of the future timing and
source/nature of its income and expenditure.
CASH FLOW IS NOT PROFIT
PROFIT is calculated by recording all
CASH FLOW is all the money flowing into
transactions that will lead to cash going in or
and out of the business over a period of time,
out of the business either at that moment or
calculated at the exact time the cash enters
at some point in the future.
or leaves the bank account/till.
Net Cash
Flow is
Total
Receipts
– Total
Payments
Negative figures
are show in
brackets
Closing
Cash: Net
Cash Flow
+ Opening
Closing Cash for
Cash.
one month is the
opening cash for
the next month…
CASH FLOW DEFINITIONS

CASH INFLOW (RECEIPTS): A flow of cash into the business

CASH OUTFLOW (EXPENSE): A flow of cash out of the business

CASH FLOW FORECAST: A future prediction of how cash might flow into and out
of a business. This may be set out in a chart or graph

CASH SURPLUS: A situation when the cash inflow is greater than the cash outflow

CASH DEFICIT: A situation when a business finds itself short of cash because the
outflow is greater than the inflow
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BENEFITS OF CASH FLOW
A cash flow forecast can help both new and existing businesses in several ways:

It will help a business to plan its financial activities before problems arise and predict when the
business might suffer from cash shortages.

This knowledge should help the business to control its business and financial operations, for
example making sure they have enough cash to pay suppliers.

Identifies times of future cash surpluses so that they can be used to
their best advantage.
LIMITATIONS OF CASH FLOW

Cash flow forecasts can be based on false assumptions about what’s going to happen.

Circumstances can change suddenly after the forecast has been made as costs can rise, machinery
can break down or competitors can affect sales.

A false forecast can have disasterous results as a busienss that runs out of cash can go bankrupt.
ANALYSING CASH FLOW FORECASTS: (QUESTIONS TO ASK YOURSELF)
1. Is it realistic?
2. If there is a surplus (+) there is no problem, if there is a deficit (-) you must be able to
examine the effect of this on the closing cash balance for the month
3. Is there too much credit being given to debtors?
(REMEMBER THE ALPHABET FOR THIS ONE!)
BORROW money (short term loan/overdraft) to cover any cash shortage
CUT DOWN on planned expenditure (non essential items)
DEFER PAYMENTS to creditors
EARN EXTRA INCOME to make up any cash shortfall
FIXED ASSSET sale and leaseback of assets
STUDENT QUESTIONS
 What is a cash flow forecast?
 Why is it important that a business holds sufficient cash but not too much?
 How does a cash flow forecast indicate whether a business faces cash flow problems in the future?
 What are the benefits of a business preparing a cash flow forecast?
 How can you work out a company’s opening balance in any given month?
 What’s the difference between profit and cash flow?
 Discuss the ways in which a business can improve its cash flow?
 To what extent can a business successfully and accurately predict future cash flow? Explain your answer.
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3. Profit and Loss Accounts

3.1
Understand importance of the main items on a P&L Account of Sole Traders/Partnerships.
3.2
Interpret simple Profit and Loss Accounts.
The Profit and Loss Account shows how much money has been coming into the company (revenue)
and how much has been going out (expenses).

Revenue is sales income (turnover) from selling goods and services which includes cash payments and
sales on credit.

Expenses are all the costs of the business which are divided into direct or indirect and fixed or variable.
Trading, Profit and Loss Account for
Company X for year ended 31/12/20-1
£
Sales
£
X
Less Cost of Sales
Opening Stock
X
+ Purchases
X
X
- Closing Stock
(X)
Cost of Sales
(X)
Gross Profit
X
Less Expenses
Light & Heat
X
Advertising
X
depreciation
x
Wages
X
(X)
X
Net Profit
TAX
X
Retained profit
(X)
X
OPERATING PROFIT

TRADING ACCOUNT: Works out gross profit.

PROFIT AND LOSS ACCOUNT: Subtracts overheads to work out
operating profit and net profit.

APPROPRIATION ACCOUNT: Shows what is done with the profits – it is
either distributed to shareholders or kept in the business to invest in future
activities (retained profit).
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Takes into account all
revenues and costs from
regular trading, but not any
revenues and costs from
one-off events – in other
words it only covers
activities that are likely to
be repeated year on year.
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4. Balance Sheets
4.1
Understand the importance of main items on a Balance Sheet of Sole Traders/Partnerships.
4.2
Interpret simple Balance Sheets.
Balance Sheets are a snapshot of a firm’s finances at a fixed point in time. They
show the value of all the assets and liabilities as well as the value of all the capital.
* Consists of 2 Parts: Part 1: Shows what the company owns, its total net assets
Part 2: Shows how the company has been financed
BALance sheet of Company X Ltd
As at 31/12/2009
£
Fixed assets
£
£
Land & buildings
X
Machinery
X
Total fixed assets
X
Current assets
Closing stock
X
debtors
x
Cash in bank
x
x
Current liabilities
creditors
X
overdraft
X
Unpaid tax
x
(x)
Working capital
X
Net Current Assets
X
Long term liabilities
mortgage
X
net assets
x
CAPITAL
Reserves
X
Bank loan
X
drawings
(x)
CLOSING CAPITAL
x
* NET ASSETS and CLOSING CAPITAL figures should be the same!!
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5. Break Even Analysis
5.1
Classify costs: fixed, variable and semi-variable.
5.2
The nature and significance of contribution.
5.3
Construction and interpretation of break-even charts.
5.4
What-if analysis?
5.5
The impact of changes in costs and revenue on the gross and net profit of businesses.
For a product to break-even, i.e. it to be of benefit to a firm, it must earn enough money from sales to cover all of the costs
involved in its production. This method of analysing is called break-even analysis.
Fixed Costs: These costs do not change when output changes, for example the rent of a premises must be
paid even though the factory may be closed due to strike or other unforeseen circumstances. Similarly
insurance on a firms vehicles must be paid regardless of mileage.
Variable Costs: These are costs that change when output changes, for example wages and raw materials.
Semi-Variable Costs:
These consist of a fixed or standing charge plus an extra rate which varies
according to use.
Break Even Point: This is the level of sales at which a firm is breaking even, i.e. neither making a profit or
loss. Total revenue equals total costs.
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Margin of Safety: This is the amount by which a firm’s sales can fall before reaching break-even point.
CONTRIBUTION: This is the difference between the selling
price of a product and the variable costs it takes to produce it.
Contribution contributes towards fixed costs and profit.
UNIT CONTRIBUTION: This is the contribution on the sale of one unit. Say for example
that Mr. Jones, a second hand car salesman, buys a Mini Cooper at an auction for
£3,000 and sells it for £4,000 – in this case his contribution is £4000 - £3000 = £1000.
CONTRIBUTION PER UNIT: Selling Price – Variable Cost
 Calculating contribution can help a business in decision making as they can quickly anaylse what option will
contribute more to fixed costs and profit.
 Some businesses use contribution when setting their price as they base their price at a point that exceeds the
variable cost meaning that each individual product will always make a contribution when sold.
THE BEP is where contribution = fixed costs
EXAMPLE:
Fixed Costs
Contribution per unit
DRAWING A BREAK
EVEN CHART:
1. Draw and label your graph
2. Plot your fixed cost line
(straight line)
3. Plot your total cost line
(starting from your fixed cost line)
4. Plot your revenue line
(starting from 0)
5. Label the Break-Even point,
Profit, Loss and
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Margin of Safety
PRICES
It can show the effect of price change on profits.
COSTS
It can show how a change in costs can affect profits
SALES
It will show the firm’s profits at the different level of sales
MARGIN OF SAFETY It shows the Margin of Safety at each level and allows risk assessment
NEW PRODUCTS It can help a firm decide whether or not to launch new products
FINANCE
Businesses may use BE Analysis to persuade the bank to give them a loan
DISADVANTAGES OF BREAKEVEN CHARTS

It is assumed that the business will sell everything it makes which doesn’t happen in the
real world

It is assumed that the selling price is the same regardless of the amount bought by the
consumer – however, in real life customers who buy in bulk receive a discount

It is assumed that variable costs remain the same regardless of the amount of output –
however, we know that workers get paid overtime to persuade them to work extra hours in
order to increase output
CHANGING COSTS/REVENUE WILL HAVE AN EFFECT ON PROFITS
If faced with a ‘what if’ question, identify if the change
affects costs (as then it will affect BEP) or revenue. You
then need to establish the new situation and the effect
this will have on profits.
STUDENT QUESTIONS
 Write down the formula for contribution, and the formula for break-even output.
 Write down two advantages and two disadvantages of break-even analysis.
 Bob is deciding whether to set up in business selling fishing equipment. Evaluate the value of break-even
analysis in helping Bob to decide whether or not to go ahead with the business.
 Mrs. Jones has a small restaurant. The average price per customer per meal is £13. The variable costs
of materials and labour per meal are £5. The fixed costs of the restaurant are £1,000 per month.
Calculate the break-even number of customers per month.
 What effect will a fall in variable costs have on the break-even level of output?
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 How is break-even price calculated?
GLOSSA RY OF TERMS – FINANCE (BS2)
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