Costs
the amount of money that a company spends on the creation or production of goods or services
Revenue
Income from sales
Profit
a financial gain, especially the difference between the amount earned and the amount spent in buying, operating, or producing something. (Total revenue - total costs) or (margin of safety x contribution)
Total cost
Total cost refers to the total expense incurred in reaching a particular level of output. (Fixed costs + variable costs)
average cost
Production cost per unit of output, computed by dividing the total of fixed costs and variable costs by the number of total units produced (total output)
fixed cost
business expenses that are not dependent on the level of goods or services produced by the business
variable cost
a cost that varies with the level of output
total revenue
total receipts from sales of a given quantity of goods or services. total revenue of a business is calculated by multiplying the quantity of goods sold by the price of the goods
price
the value of the good
average revenue
revenue generated per unit of output sold. It is obtained by dividing the total revenue by the number of units sold
direct costs
costs which are directly accountable to a cost object.
indirect costs
Indirect costs are costs that are not directly accountable to a cost object
overhead costs
all ongoing business expenses not including direct labour or materials used to create a product or service.
break-even
the point of balance making neither a profit nor a loss
margin of safety
the difference between actual output and break-even output
target level of profit
(Units to be sold x expected contribution margin) - expected fixed costs
stepped fixed cost
A type of expense that is more or less constant over a low level shift in activity, but which changes incrementally when activity shifts substantially
break-even graph
contribution
how much of a company's revenues will be contributing (after covering the variable expenses) to the company's fixed expenses and net income. Total Contribution is the difference between Total Sales and Total Variable Costs.
Contribution = selling price pe
How to lower break-even point
reducing fixed costs, reducing variable costs per unit, increasing selling prices so long as the number of units sold will not decline significantly.
Benefits of Break-Even Analysis
Easy to interpret tables & diagrams, aids decision making process, shows level of profit at given level of output , shows margin of safety,
Negatives of break-even analysis
Based on predicted figures, variable costs may change, doesn't take scale economies into consideration, increase in price may not increase revenue
cash flow
the difference between cash coming in and cash going out of a business
Benefits of cash flow forecasts
valuable planning procedure, helps business set prices, looked at by potential investors & suppliers
Limitations of cash flow forecasts
Changes to interest rate, change in economic policy, it's only an estimate, world events, competitors' behaviour, changes in technology
How to improve cash flow
Increase sales, reduce stock levels, factoring, leasing, loans, changing creditor/debtor days, cut operating costs
Budget
a financial plan prepared and agreed in advance covering a specific time period i.e a year. It helps business control their income and expenditure to ensure business survival
Variance
difference between a budgeted, planned, or standard cost and the actual amount incurred/sold
Working Capital
the capital of a business which is used in its day-to-day trading operations, calculated as the current assets minus the current liabilities.
(current assets - current liabilities)
working capital cycle
The period of time between spending cash on the production process and receiving cash payments from customers
Favourable variance
When costs are lower than expected or revenue is higher than expected
Adverse variance
When costs are higher than expected or revenue is lower than expected
Historical budgeting
Using last year's figures as the basis for the next year's budget
Zero budgeting
Setting budgets to zero each year and budget holders have to argue their case to receive any finance
flexible budget
allow targeted figures for revenues or expenditure to change as circumstances change
purposes for budgeting
Plan expenditure, effective allocation of resources, sets targets, co-ordination, monitoring
Investment appraisal
Financial decision-making tool that helps managers to assess whether certain investment projects should be undertaken based mainly on quantitative techniques
Payback Period
the amount of time required for an investment to generate cash flows sufficient to recover its initial cost
payback period formula
full no. years, (investment missing/income from next year) x 12
Average rate of return (ARR)
measures the annual profitability of an investment as a percentage of the initial investment
Average rate of return (ARR) formula
(Average annual profit/initial investment) x 100
Present Value (PV) formula
Inflow x Discount rate
Present Value (PV)
the current value of future cash flows discounted at the appropriate discount rate
Net Present Value (NPV)
Calculates how much future money is worth today
Net Present Value (NPV) formula
PV - Initial investment
net current assets formula
current assets - current liabilities
net assets and equity
are equal