Diverse Business Application

Date: Nov 8, 2018

Introduction

The majority of companies take decisions on input and output in compliance with their desire to maximize profits. In order to generate more output, the business has to utilize more inputs. The profit margin functions as one of the essential indicators of the financial health and efficiency of the firm. Inputs and outputs feature prominently in diverse business applications, including financial accounting, budgeting, valuation, cost accounting, and valuation. Business processes such as budgeting give insight into the firm’s financial circumstance in an operational way, and supports managers in planning and control procedures. Since all organizations manifest structure of control, it is essential that the budgetary system fits the structure in order to reflect the responsibilities of every concerned manager.

The Processes Involved in Establishing Cost and Profit

All factors of production manifest costs and may encompass labor, capital, and fixed assets. In order to compute the expenses, a business must be aware of two aspects: the volume and the combination of inputs required to produce the products and the cost of the inputs. Sometimes the relationship between costs of input and units of output may not be readily quantifiable or observable (Besanko, Braeutigam & Gibbs 2011, p. 384). Essentially, overhead costs result in the largest fraction of total expenses and usually remain static despite changes in output. Variable costs, on the other hand, constitute expenses that peg the intensity of production and usually fluctuate as per changes in output. Material and labor costs are characteristic variable costs that grow with an increase of the production. Costs associated with pricing can be categorized as either direct or indirect based on whether the expenses can be linked to the production of goods, services, or departments. Direct costs’ details trace to the production of the goods such as the purchase of equipment and tools (Tucker 2011, p. 200). Indirect costs, one the other hand, represent expenses that influence the entity as a whole and not merely the product. Therefore, indirect costs represent expenses that cannot be practically or accurately traced to the individual activities, products, or departments. In case a company employs a full cost accounting system, all the manufacturing expenses, including overhead ones(inclusive of static and flexible costs), are viewed as product costs charged against the inventory. In order to be profitable, the companies must control costs providing that the high expenses undercut profit margins and weaken the competitiveness of business (Sahaf 2009, p. 4).

Variables Related to Cost and Profit Margins

Profit margin represents the ratio of profitability computed as net income divided by revenues, the net profits divided by the sales, or the percentage profit that a business derives from the sale. Some of the variables that affect cash flows include the volume of units sold, operating costs, sale price, amount of working capital, and foreign exchange rate (Siddaiah 2009, p. 282). The other variables that influence profit margins include the inventory numbers, changes in overhead costs, such as rent expenses and depreciation costs, and variable costs such as taxation of raw materials (influence net income). The qualitative variables affecting the level of profit margins include market share, sales policies, consumer preferences, competition strength, effectiveness of advertising, and the level of training on marketing procedures for the employees.

Cost control represents the practice of managing and minimizing business expenses. Firms can establish monitor cost and profit margins through simple benchmarking by utilizing typical profit and cost percentages for analogous businesses. Gross profit analysis shows occasional changes of the gross profit margin, which can be caused by alterations in sales prices, unit volume sales and the mix of products produced (Hansen, Mowen & Guan 2009, p. 607). Firms can improve their profit margins by increasing pricing efficiency, minimizing cost of sales via efficient purchasing, decreasing direct costs, including payroll, minimizing fixed and variable costs, and maximizing income by selling high-margin products.

Cash flow forecast constitutes an invaluable tool for financial management of a firm. The focus centers on maximizing the value of surplus cash assets. As a planning, tool, the cash flow identifies when extra finance may feature and the excess funds may be accessible to investment (Fight 2006, p. 6). Every manager knows that the business will grow if the manager purchases more materials or additional equipment to meet the demand, especially if the firm has adequate cash flow. Therefore, the manager at JNL Company Ltd can explore options such as optimizing revenue opportunities, streamline the costs, and pursue outside capital or financing if necessary. The surplus or idle funds can be used to invest in additional machinery to increase production capacity.

Break-Even Analysis

Break-even analysis gives insight into the margin of safety, which is central to the controlling, planning, and decision-making process. Break-even analysis represents the association between cost volume and profits at the diverse levels of activity, with considering the break-even point. Break-even analysis allows a business organization to evaluate profit and losses at diverse levels of sales and production, and to forecast the impact of changes in the price of sales (Alnasser, Shaban & Al-Zubi 2014, p. 626). Break-even analysis helps evaluate the association between variable and fixed cost and allows a firm to predict the impact on profitability due to the shifts of cost and efficiency. The processes associated with break-even analysis support make or buy decisions, inform production planning, facilitate cost control, and shape financial structure based on the understanding of profits relative to output. Break-even analysis constitutes a useful benchmark through which a firm’s short-term goals can be tracked or measured. Break-even analysis is a crucial tool for making decisions after a shift in the environment (changes in the cost or price), which impact on the profitability of the firm (Rajasekaran & Lalitha 2011, p. 743).

The Strengths and Weaknesses of Break-Even Analysis

Break-even analysis is a crucial tool for financial management and control presenting a helpful mechanism to show the top management that challenges intrinsic to cost-volume-profit relationships. The core strength of break-even analysis lies in the fact that the approach elaborates on the relationship between production volume, cost, and returns. Break-even analysis is highly useful in the application of capital budgeting techniques (Dransfield & Needham 2005, p. 115). Break-even analysis is simple to undertake and understand. The reason is that the approach demonstrates profit and loss at diverse levels of output. Moreover, break-even analysis can deal with the shifting circumstances occasioned by the changes in the business environment. The core break-even formula manifests serious limitations imposed by the many assumptions involved. The weaknesses of break-even analysis result from the fact that the approach assumes the selling of all output at a guaranteed price, which may be incorrect. In addition, break-even analysis presumes that production and sales are analogous (Cafferky & Wentworth 2010, p. 111). Indeed, there may be an inclination to continue utilizing the analysis even after an alteration of cost and income functions. In addition, the approach assumes that costs grow continuously and do not benefit from the economies of scale.

The Aims, Objectives and Processes of Budgeting

Budgeting represents the process of measuring and adapting plans for the utilization of real (physical resources) into financial values. The budgeting process allows managers to plan the future operations of the firm, modify existing strategic plans, and consider their correspondence to the shifting circumstances (Albrecht 2007, p. 877). The budgeting process also fosters coordination and consolidation and directs the actions of the diverse parts of the organization into a joint plan.

There are several approaches to budgeting. Historical approach provides more simplicity and flexibility at the level of control exercised over resource utilization according to the level of the expenses. The historical budget increases organizational control and fosters the accumulation of spending data at all functional levels. Nevertheless, line budgeting is unsuitable for particular organizational environments since it presents minimal useful information to decision makers on the activities and functions or organizational units. The performance budgeting is considered superior to the historical approach since it provides more crucial information for administrators’ evaluation (Needles, Powers & Crosson 2010, p. 968). However, performance budgeting manifests limitations due to the lack of reliable standard cost information intrinsic within organizations. The central tenet of zero-based budgeting centers on the notion that the production activities and services must be justified yearly in the course of the budget development. Consequently, the costs of goods and services are linked to each decision package depending on the intensity of production. The driving thrust of zero-based budgeting is the elimination of obsolete efforts and expenditures and focus resources where they are most productive (Balakrishnan, Sivaramakrishnan & Sprinkle 2009, p. 279).

Types of Budgets and Relevance to Business Contexts

Budgets qualify as plans for the future and act as planning tools since the budget estimates possible income and expenditures for a firm over a particular period. In addition, budgets form the basis for a performance criteria and foster coordination in the firm. The various budget formats within managerial accounting impact on the process of forecasting. The master budget represents a comprehensive estimation showing how the management anticipates undertaking all elements of business over the budget period or fiscal year. A master budget embraces the effect of both operating and financial decisions (Singla 2008, p. 162). The master budget captures the estimated activity due to the cash budget and budgeted balance sheet. Master budget is relevant to businesses that feature interrelated budgets from diverse departments. Operational budgets feature a statement that presents the financial plan for every responsibility center during the budget period and reflects operating activities in the business. The most prominent types of operating budgets include expense, profit, and revenue budgets. They capture income and expenditures related to the daily core business of the company (Singla 2008, p. 162). The role of the manager, in this case, is to compare the ongoing results and budget throughout the year, planning and modifying differentials in revenue. A cash flow budget mainly investigates the inflows and outflows of cash within the firm on a daily basis. The monitoring of cash flow budgets aid to highlight shortfalls between sales and expenses, especially when financing is required to cover the overheads. Cash flow budgets also inform production cycles and inventory levels to ensure that the firm’s resources are accessible for business activities, rather than staying idle in the warehouses (Singla 2008, p. 162). The financial budget necessarily illuminates the way a business receives and spends resources on a corporate scale detailing revenue from core business and income coupled with costs of the capital expenditures. The financial budget is relevant to businesses since the management of assets presents significant impacts on the financial situation of the firm. Managers utilize financial budgets to leverage financing and value of the company, especially during mergers and public offerings of stock. A static budget features elements, in which expenditures remain rigid with despite changes in sales levels. However, the budgets are not limited to the conventional overhead expenses. The flexible budget, on the other hand, represents performance evaluation tool that modifies the static budget for the precise level of output (Jackson, Sawyers & Jenkins 2009, p. 6). The flexible budget variance captures the difference between the line items within the budget and the equivalent line item from the statement of actual results. Zero-based budgeting, in which financing begins from a zero base, demands the justification of each budget item for every period. Zero-based approach allows the execution of top-level strategic objectives in the budgeting process by linking them to the certain functional areas of the firm, in which the costs are first classed, and appraised against previous outcomes and present expectations (Kimmel, Weygandt & Kieso 2008, p. 1008). Zero-based budgeting is relevant to businesses since it can reduce costs by averting blanket increases or decreases in the last budget. The capital expenditure budget highlights the amount of money that a firm will invest in the projects and long-term assets.

Budgetary Responsibility

Budgeting is formed according to the firm’s long-term strategic plan and capital budget. Several behavioral factors are essential for the effective operations of the budgeting process, including the support of top management and the engagement of all managers in the budgeting process (Wu 2013, p. 705). It is also essential to address deviations from the budget in a positive and constructive way. The budget management team is in core leadership position, whose main responsibility is organizing the personnel in order to attain target profits, coordinate, and balance the budgeting items (Rajasekaran & Lalitha 2011, p. 591).

Responsibility centers act as the core building blocks for controlling and analyzing the budget control system. Budget responsibility relates to the capability to effectively utilize the budget and report on the progress of the budgetary process (Daft 2011, p. 511). For example, in a cost center, the manager bears the responsibility for the control of cost inputs in the form of standard expenses (engineered costs) or discretionary cost center in the budgetary performance. In a revenue center, the budgetary performance is gauged essentially by its capability of generating a set level of income. In a profit center, the manager is charged with measuring the differential between costs and revenues. In an investment center, the budgetary performance is based on the return of investment.

Preparation of a Cash Flow Forecast

Cash flow forecasting is a crucial management tool in any business providing that around 80% of businesses collapse due to the cash flow problems. The cash flow highlights the possible future movement of receipts and payments for the purpose of investment control and management of the liquidity needs (Fight 2006, p. 2). The golden rules applicable to the application of cash flow forecasting encompass the following actions: being realistic; including every item; planning for multiple scenarios; factoring in fixed and variable costs; planning for seasonality (Shah 2007, p. 53). The core aim of the cash flow forecast is to help business managers to utilize the available information to project the amount of money the company will record coming in and out at any given time. The initial stage during the creation of the cash flow forecast draws from the formation of suitable assumptions to the business. The assumptions may be based on the past performance, correspondence with suppliers and clients as well as market environment and industry publications. Some of the components of the cash flow forecast include sales growth forecasts, provisions for salary and wage increases, effect of seasonality, and provisions for general cost increases (Shah 2007, p. 53). The second step in cash flow forecasting entails the preparation of expected sales income. It may be difficult to predict the sales; therefore, it is advisable to rely on the previous year’s sales in order to map the trends. The past year’s trends should inform adjustments factoring in increase or decrease of sales. It is equally important to identify internal (price increases) and external factors (economic) most likely to affect the current period and implement the necessary adjustments. The third step entails the compilation of a list of all expected cash inflows to ensure that the cash flow forecast is complete. The capital inflows may feature elements such as sales, license fees, cash from asset investment, tax rebates and refunds, government grants, and loan proceeds. The fourth step encompasses the preparation of a list, which includes estimated direct and indirect expenses. Therefore, the manager should highlight all the expenses required to operate a business and anticipate the timing of every payment. Furthermore, cash outflows associated with financing and investing activities should be included such as loan repayments, purchase of new assets, wages, and salaries (Shah 2007, p. 53). The fifth step entails summing up the cash flow forecast in a rolling calculation based on opening cash position, addition of capital inflows and deduction of cash outflows to lead to a closing cash position. Lastly, it is essential to review the estimated cash flows to the actual ones for the corresponding period and identify any differences between the projected and actual cash flows.

The Benefits of Cash Flow Forecasts

Cash flow forecasting helps to minimize stress and pressure since it gives the manager an opportunity to map the trends and anticipate potential liquidity crunch. The cash flow forecast is helpful, since the earlier the manager can anticipate the cash flow period, the more time he has to implement contingency actions such as pursuing extended lines of the credit. Therefore, cash flow forecasting allows managers to prevent immediately the problems through minimizing the costs, stock as well as maximizing sales margin and volume (Fight 2006, p. 6). The cash flow forecasting can also allow the company to access extra funding such as an overdraft, invoice discounting, and factoring. Forecasting also allows managers to identify problems with customer payments and ensure that the business can have sufficient money to pay suppliers and employees (Moyer, Mcguigan & Kretlow 2009, p. 311). Cash flow forecasts have a central role in business management, especially in financial planning to ensure that the company runs smoothly and enjoys a healthy financial position (Fight 2006, p. 7). For example, a cash flow forecast can inform the manager whether the recruitment of an additional employee will help the company to gain a stronger financial position. Financial planning is central to the firm’s operations since it avails road maps for guiding, controlling and coordinating the firm’s actions to attain the set objectives. Cash flow forecast is central to financial planning by acting as budgets that capture the firm’s planned cash inflows and outflows. As a planning tool, cash flow forecasts provide time to the managers to pursue possible ways aimed at mitigating the problems or minimizing their impact (Heitger, Mowen & Hansen 2008, p. 511). Cash flow forecasts allow managers to be aware when the expenditures are high or when the manager will have to incorporate short-term investments in order to address the liquidity surplus.

The Use of Cash Flow Forecasting in Financial Planning

The cash flow forecast projects cash inflows and outflows for JNL Company Ltd, a firm that engages in the production of Polyvinyl Chloride (PVC) pipes. The demand for PVC products has witnessed a double-digit growth in the last decade. The hypothetical cash flow forecast illuminates the time, quantity and the extent of cash surplus or deficit for the entity during the period ranging from April to September. The hypothetical cash flow assumes that the company will maintain the current product lines and the sales forecasted on the grounds of units sold. Mostly, the industry that JNL Company Ltd serves does not manifest any significant seasonality in sales. The hypothetical assumption is realistic and in alignment with the typicality of the industry, in which the small manufacturing firm operates.

Hypothetical Cash Flow Forecast for JNL Company Ltd for the Months ranging from April (2014) to September (2014)
  April May June July August September Total
Sales 22000 22000 22000 25000 25000 25000 139000
Refund and rebates     5000        
Total Receipts 22000 22000 27000 25000 25000 25000 146000
Direct Costs
Material 12000 5500 6500 5500 5500 6000  
Packaging 1000 1000 1500 1000 1000 2000  
Stock 2600 2500 2000 2000 2000 2000  
Overheads
Rent 100 100 100 100 100 100  
Insurance 1000 500 500 500 500 500  
Power 600 550 550 550 550 550  
Depreciation 150 100 100 100 100 100  
Marketing 400 500 500 500 500 500  
Telephone 150 150 150 150 150 150  
Salaries and Wages 1000 1000 1000 1000 1000 1000  
Administration and Distribution 6100 3000 3000 3000 3000 3000  
Freight 100 120 120 120 120 120  
Total costs 25200 15020 16020 14520 14520 16020 101300
Monthly Surplus/Deficit -3200 6980 10980 10480 10480 8980 44700
Opening Bank Balance 5000 1800 8780 19760 30240 40720  
Closing Bank Balance 1800 8780 19760 30240 40720 49700  

Cash flow forecast constitutes an invaluable tool for financial management of a firm. The focus centers on maximizing the value of surplus cash assets. As a planning, tool, the cash flow identifies when extra finance may feature and the excess funds may be accessible to investment (Fight 2006, p. 6). Every manager knows that the business will grow if the manager purchases more materials or additional equipment to meet the demand, especially if the firm has adequate cash flow. Therefore, the manager at JNL Company Ltd can explore options such as optimizing revenue opportunities, streamline the costs, and pursue outside capital or financing if necessary. The surplus or idle funds can be used to invest in additional machinery to increase production capacity.

Conclusion

Budgets serve several core purposes central to the company’s success including planning, evaluation, coordination, communication, control, and motivation. Budgeting process functions as a tool for establishing whether to allocate funds for the diverse activities. Furthermore, break-even analysis provides firm managers with a sound rational basis for the decisions meant to enhance profitability, monitor cost and strengthen the efficiency of the business. The practice of assigning responsibility (that act as placed in control) and accountability for revenue and costs provides an opportunity to evaluate regularly and continuously the performance of each manager. Cash flow forecasts play a central role in the management process in the same way as the business budgets. A successful budget manifest draws from an efficient cash flow management designed to guarantee that the firm runs smoothly. Cash flow forecasting helps business managers to understand and enhance the cash flow cycle (period between income and payments), which should be as short as possible in order to minimize costs and increase profits.

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