Planning
The business will have it's long term plans in place, the annual budget breaks these plans down further into operational plans which concern the day to day running of the business. Managers will be required to plan operations taking into account factors both internal and external which may impact on the business and how the business will respond to these factors.
Communication
A business needs clear lines of communication, everyone needs to know what is expected of them and the part they play in achieving the annual budget. The budget is the process were senior management communicates it's expectations to managers so that everyone has a clear understanding of what needs to be achieved.
Coordination
The budget brings together all aspects of the business to ensure they are working towards an agreed plan, if no budget were in place managers could be working hard but towards different objectives which could be wasting money and effort.
Motivation
If managers are involved in producing the budget rather than having it imposed on them then they will be motivated to achieve the budget.
Evaluation
A managers performance could be partly evaluated by measuring their actual performance against budget, this is only feasible if the manager had been involved in setting the budget.
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Monday 18 June 2012
Sunday 12 September 2010
Understand the Balance Sheet
Part of the monthly management accounts will be a balance sheet, whilst the profit and loss account is a measure of trading activity over a period of time (usually a month for management accounts)the balance sheet is a snap shot of the business at one point in time (the last day of the period). Whilst the balance sheet on it's own provides important information about the business if the report also includes the budgeted balance sheet figures and the previous months figures this provides additional information as you can compare your actual balances to your budget and look to understand the causes of any meaningful variances. By also having last months figures you can look for movements in the balances and seek explanations for any concerning movements. Some of the movements may be quite easily explained as timing differences, for example if the creditors balance is much higher than normal as at June 30th a large payment run of creditors paid on July 1st would quickly explain the movement and the balance would be back to an expected level, however not all movements can be explained so easily and a greater degree of investigation may be required.
Here are a few examples of items needing to be investigated:-
Fixed asset values increase - what has been purchased?, has the correct proceedure for asset purchase been followed?, was the purchase agreed in the budget?
Stock - increases in the amount of stock held can quickly soak up cash, so any increase in stock levels needs to be monitored closely. Compare the stock level to budget and look at the stock balance over the last few months to see if there is a rising trend.
Debtors - increases in debtors could suggest customers are taking longer to pay, check the budgeted figure and the investigate the reason for the increase.
Creditors - increases in creditors could mean you are not paying suppliers on time leading to the posibility of production being held up because of supply shortages and possible loss of reputation.
Bank - increases in bank overdrafts need to be investigated, ideally you should have sufficient control over your day to day cash situation so that you are fully aware of your cash position before you see the month end balance sheet.
Previously in the blog we have looked at some balance sheet ratios which give important information about asset usage and the liquidity of the business, these ratios should also be compared to budget and the previous months position.
Here are a few examples of items needing to be investigated:-
Fixed asset values increase - what has been purchased?, has the correct proceedure for asset purchase been followed?, was the purchase agreed in the budget?
Stock - increases in the amount of stock held can quickly soak up cash, so any increase in stock levels needs to be monitored closely. Compare the stock level to budget and look at the stock balance over the last few months to see if there is a rising trend.
Debtors - increases in debtors could suggest customers are taking longer to pay, check the budgeted figure and the investigate the reason for the increase.
Creditors - increases in creditors could mean you are not paying suppliers on time leading to the posibility of production being held up because of supply shortages and possible loss of reputation.
Bank - increases in bank overdrafts need to be investigated, ideally you should have sufficient control over your day to day cash situation so that you are fully aware of your cash position before you see the month end balance sheet.
Previously in the blog we have looked at some balance sheet ratios which give important information about asset usage and the liquidity of the business, these ratios should also be compared to budget and the previous months position.
Friday 27 August 2010
How Good Is Your Business At Collecting It's Debts??
In any business cash is extremely important, so you will need to know how effective your business is in collecting it's debts. The debtors turnover ratio will give you the average number of days credit taken by customers and this can be compared to previous periods to see if performance has improved or worsened.
Example
For the year to 31/12/08 a business has a turnover of £1,300,000 and it's debtors at that date were £125,000.
For the year to 31/12/09 the business has a turnover of £1,500,000 and it's debtors at that date were £190,000.
125,000
1,300,000 x 365 = 35.10 days for 2008
190,000
1,500,000 x 365 = 46.23 days for 2009
So from the example you will see that the business has become less effective in collecting it's debts, it is taking an extra 11 days to collect money from it's customers. Assuming the credit period allowed is 30 days then something needs to be done to correct the situation and bring it back into line, if the situation is allowed to deteriorate it could cause cash flow issues.
Example
For the year to 31/12/08 a business has a turnover of £1,300,000 and it's debtors at that date were £125,000.
For the year to 31/12/09 the business has a turnover of £1,500,000 and it's debtors at that date were £190,000.
125,000
1,300,000 x 365 = 35.10 days for 2008
190,000
1,500,000 x 365 = 46.23 days for 2009
So from the example you will see that the business has become less effective in collecting it's debts, it is taking an extra 11 days to collect money from it's customers. Assuming the credit period allowed is 30 days then something needs to be done to correct the situation and bring it back into line, if the situation is allowed to deteriorate it could cause cash flow issues.
Monday 16 August 2010
Are You Using Your Kit Efficiently?
Most businesses have to invest in fixed assets in order to produce goods/services, to determine how efficient the business is in using those fixed assets you can use the following calculation.
sales revenue / nbv of fixed assets = fixed asset turnover ratio
sales revenue (turnover)
nbv fixed assets net book value is cost of fixed assets less accumulated depreciation
the nbv value used is the average of the value at the start and end of the year
Example
Year 1
sales revenue £100,000
nbv fixed assets £12,000
fixed asset turnover ratio 8.33
Year 2
sales revenue £120,000
nbv fixed assets £16,000
fixed assets turnover ratio 7.50
In the example turnover has increased by £20,000 but an extra £4,000 of fixed assets has been required to produce it (fixed asset turnover ratio of 5.00), further investigation would be required to understand why the ratio has fallen from 8.33 to 7.50.
As well as comparing results year on year it would also be useful to benchmark against other comparable businesses to see how the ratio compares.
sales revenue / nbv of fixed assets = fixed asset turnover ratio
sales revenue (turnover)
nbv fixed assets net book value is cost of fixed assets less accumulated depreciation
the nbv value used is the average of the value at the start and end of the year
Example
Year 1
sales revenue £100,000
nbv fixed assets £12,000
fixed asset turnover ratio 8.33
Year 2
sales revenue £120,000
nbv fixed assets £16,000
fixed assets turnover ratio 7.50
In the example turnover has increased by £20,000 but an extra £4,000 of fixed assets has been required to produce it (fixed asset turnover ratio of 5.00), further investigation would be required to understand why the ratio has fallen from 8.33 to 7.50.
As well as comparing results year on year it would also be useful to benchmark against other comparable businesses to see how the ratio compares.
Tuesday 3 August 2010
What's My Break Even Point And How Do I Calculate It?
Talk to business owners and one of the key pieces of information they require is to know the break even point of their business, that is the volume of sales it needs to achieve to cover costs. By having this information managers/owners will get some idea of the performance of the business in that period plus they will have the comfort of knowing at what point all the periods costs have been covered.
How do you calculate it?
The key to determining the break even point of a business is to understand the behaviour of costs, it needs to establish what it's variable costs are (those costs which move in line with operational activity eg. material costs, direct wages etc..)and what it's fixed costs are (those that remain static irrespective of changes in activity eg. rent, rates, salaries etc..). Think of your telephone bill, the line rental charge remains static each month irrespective of how much you use the telephone (fixed cost) the calls charge varies depending on how much you have used the telephone (variable cost).
Once you have determined what your variable costs are you subtract the variable cost per unit from the selling price per unit and that gives you the contribution per unit. The next step is to divide the total fixed cost for the period by the contribution per unit, this will give you the break even point
Example
Sell price per unit (£20)- Var.cost per unit (£12)= Contribution (£8)
Total fixed costs for period £12,000
£12,000/£8 = 1,500
By producing 1,500 units @ £8 it will cover the fixed costs of £12,000 and the business will be in a break even position.
How do you calculate it?
The key to determining the break even point of a business is to understand the behaviour of costs, it needs to establish what it's variable costs are (those costs which move in line with operational activity eg. material costs, direct wages etc..)and what it's fixed costs are (those that remain static irrespective of changes in activity eg. rent, rates, salaries etc..). Think of your telephone bill, the line rental charge remains static each month irrespective of how much you use the telephone (fixed cost) the calls charge varies depending on how much you have used the telephone (variable cost).
Once you have determined what your variable costs are you subtract the variable cost per unit from the selling price per unit and that gives you the contribution per unit. The next step is to divide the total fixed cost for the period by the contribution per unit, this will give you the break even point
Example
Sell price per unit (£20)- Var.cost per unit (£12)= Contribution (£8)
Total fixed costs for period £12,000
£12,000/£8 = 1,500
By producing 1,500 units @ £8 it will cover the fixed costs of £12,000 and the business will be in a break even position.
Tuesday 27 July 2010
Keeping A Close Eye On Stock Levels !!
Cash management is a vital part of every business, in the current economic climate it has grown even more in significance and stock is an area which needs to be closely monitored as it can soak up a large part of the businesses working capital. The management of stock appears to tread a fine line between having the right stock/quantity available to meet production requirements and minimising the stock held, the cost of holding too much stock against the cost of production downtime through not having stock available.
Businesses can measure aspects of their stock management by using two ratios, one will show how many times the business has sold the value of it's stock during the year,the higher the figure the better as this means that money is tied up for less time.
cost of goods sold = stock turnover ratio
av. stock during period
The second ratio gives the average number of days that money is tied up in stock, the lower the number of days the better for the business.
av. stock during period = stock turnover ratio (days)
cost of goods sold / 365
By calculating these ratios they can be used to measure movement over periods (is the ratio getting better or worse) it can also be used to benchmark against other businesses in the same industry.
Possible causes of low stock turnover :-
- too much stock being carried
- low volume of business
- poor inventory management
- holding obsolete stock
Businesses can measure aspects of their stock management by using two ratios, one will show how many times the business has sold the value of it's stock during the year,the higher the figure the better as this means that money is tied up for less time.
cost of goods sold = stock turnover ratio
av. stock during period
The second ratio gives the average number of days that money is tied up in stock, the lower the number of days the better for the business.
av. stock during period = stock turnover ratio (days)
cost of goods sold / 365
By calculating these ratios they can be used to measure movement over periods (is the ratio getting better or worse) it can also be used to benchmark against other businesses in the same industry.
Possible causes of low stock turnover :-
- too much stock being carried
- low volume of business
- poor inventory management
- holding obsolete stock
Sunday 11 July 2010
What is Gross Profit Margin and what can it tell you?
Gross profit is income less cost of sales, the gross profit margin is simply the gross profit expressed as a percentage of sales.
Gross profit x 100 = Gross profit margin
Sales
Once you have established the gross profit margin what does it tell you? Well it allows you to benchmark your business against similar businesses to see how your gross profit margin compares. If their gross profit margins are higher than yours you need to understand the reasons for that and if possible take the appropriate actions (you need to ensure that you are comparing like for like, for example you may be including costs in your cost of sales which others are including elsewhere in their accounts).
The gross profit margin needs to be monitored each month and any variations understood, some changes can be explained quite simply as variations due to the mix of products in the month (the gross profit margin may well vary from product to product and an increase in the amount of low margin products sold in the month may well impact on the margin).
However any unexplained variances or trends need to be investigated as they could be due to:-
- increase in material costs
- increase in labour costs
- decrease in sales prices
- efficiency problems
- material wastage
Looking at the gross profit margin each month and understanding changes can help identify problems at an early stage and by benchmarking against competitors it can provide important information which could be used in your overall business strategy.
Gross profit x 100 = Gross profit margin
Sales
Once you have established the gross profit margin what does it tell you? Well it allows you to benchmark your business against similar businesses to see how your gross profit margin compares. If their gross profit margins are higher than yours you need to understand the reasons for that and if possible take the appropriate actions (you need to ensure that you are comparing like for like, for example you may be including costs in your cost of sales which others are including elsewhere in their accounts).
The gross profit margin needs to be monitored each month and any variations understood, some changes can be explained quite simply as variations due to the mix of products in the month (the gross profit margin may well vary from product to product and an increase in the amount of low margin products sold in the month may well impact on the margin).
However any unexplained variances or trends need to be investigated as they could be due to:-
- increase in material costs
- increase in labour costs
- decrease in sales prices
- efficiency problems
- material wastage
Looking at the gross profit margin each month and understanding changes can help identify problems at an early stage and by benchmarking against competitors it can provide important information which could be used in your overall business strategy.
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