ACCT1101 Lecture Two
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What is a business plan?
"An evolving report that describes a compaies goals and its current plans for acheiving those goals"
Who uses a business plan?
- Internal users - management (build and use)
- Some external users - eg bank
What is included in a business plan?
- company description
- marketing plan
- description of operations
- financial plan
Why is planning important?
- reduces uncertainty by defining goals (decrease risk of failure)
- helps identify scope of operations and interrelate sections of the business (departments can cooperate and share resources)
- serves as a benchmark (evaluate business performance)
- used to obtain financing (bank loans, government grants)
- evaluate and identify risk and potential return
Business Plan Structure: Company description
- how the business is organised
- target customers - current and potential
Business Plan Structure: Marketing Plan
- evidence of demand
- market research
Business Plan Strategy: Operating Plan
- how will the business develop and enhance products
- relationships with suppliers and customers
Business Plan Strategy: Financial Plan
- identify capital requirements
- sources of capital
- projected financial performance
- support with CVP analysis
What is Cost-Volume-Profit analysis?
- It shows how profit is affected by:
- changes in sales volume (activity level)
- selling prices of products
- various costs of the company (fixed and variable)
What is the purpose of CVP analysis?
"To help managers predict the outcomes of decisions they make on profit" (good/bad? how to maintain or improve profit)
Assumptions of CVP analysis: (4)
- All costs can be divided into fixed costs and variable costs
- Fixed costs remain the same regardless of activity levels
- Variable costs can vary with activity level, but are constant per unit of output
- Efficiency and productivity remain the same
What is cost behaviour?
"The behaviour of cost in response to specified drivers (eg volume of sales) for a time period"
Cost behaviour: Fixed Costs
- - TFC remains constant with changes in sales volume
- - Unit cost changes
eg. TFC = $1million if only sell one unit, unit cost = $1million if sell 2 units, unit cost = $500,000 etc
Cost behaviour: Variable Cost
- - VC changes in propertion to sales volume change
- - Unit cost reamains constant
- eg. variable cost per unit = $1 if 10 units sold, V = $10 if 20 units sold, V = $20
- (V = total variable cost, vc = variable cost per unit)
Cost behaviour: Total Costs
Sum of the fixed costs and variable costs at the same volume
TC = FC + V = FC + (vc*n)
Issues re: Cost behaviour (8)
- cost behaviours are specific to the situation (could be fixed or variable depending)
- estimation = inaccuracies
- need to remember relevant range
- prices change for inputs and outputs
- advancement of technology - adapt
- cost drivers change
- need to predict using info sytems to avoid human error
- enhance reliability by using large observations/data
How do you calculate Net Profit?
Net Profit = Revenues - Expenses
What is the Contribution Margin?
"How much of the selling price will contribute towards covering fixed costs"
Total contribution margin = ?
TCM = R - V
Unit contribution margin = ?
UCM = p - vc
Contribution margin ratio = ?
CMR = TCM / Sales
CMR = UCM / p
What is the breakeven point?
- where there is no profit and no loss
- when the company earns back what it has initially paid
- when total sales = total costs (R = TC)
What are the conditions of the breakeven point? (3)
- R = TC = FC + V
- R - TC = $0
- CM = FC
What are the three CVP methods to calculate the breakeven point?
- Graphical (Profit graph and CVP graph)
- (Profit) Equation Method
- Contribution Margin Method
CVP Methods: Graphical (Profit Graph) - 4 steps
- 1. FC line
- 2. V line
- 3. TC line
- 4. Sales line (rate x volume)
CVP Methods: Graphical (CVP Chart) - 2 steps
CVP Methods: Profit eqaution method - what is the equation?
q(BEP) = FC / (p - vc)
- q = (FC + Profit) / (p - vc)
- at BEP, Profit =0
CVP Methods: Contributin Margin method
How do you calculate the BEP in units, sales, and with target profit?
units: BEP(q) = FC / UCM where UCM = p - vc
sales: BEP($) FC / CMR where CMR = TCM / sales or UCM / p
target profit: target(q) = (FC + target Profit) / UCM
What is a margin of safety?
"The amount by which sales can fall before incurring a loss and can therefore measure the risk associated with business operations"
How do you calculate the margin of safety? (2)
MOS = sales ($) - BEP($)
MOS ratio = MOS ($) / Total Sales ($)
What is operating leverage?
"A measure of the realtionship between profit and cost behaviour"
"The use of FC to increase profit as sales increase"
(higher operating leverage = higher risk and higher potential profits)
How do you calculate operating leverage?
Operating leverage = FC / TC
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