Financial Forecasting For Businesses PDF

BTEC – Level 2 Financial Forecasting For Businesses Lesson 1  Business Costs * 1 - Setup Costs 2 - Operating Costs  Business Costs * 1 - Setup Costs (or Start up Costs): It is the cost that is required to start a business  * Business Costs * 1 - Setu...

BTEC – Level 2 Financial Forecasting For Businesses Lesson 1  Business Costs * 1 - Setup Costs 2 - Operating Costs  Business Costs * 1 - Setup Costs (or Start up Costs): It is the cost that is required to start a business  * Business Costs * 1 - Setup Costs (or Start up Costs):  It is the cost that is required to establish a business before starting generating money (income)  Business Costs * 1 - Setup Costs (or Start up Costs):  It is the cost that is required before starting business activity (trading)  Business Costs * 1 - Setup Costs (or Start up Costs):  It is the cost that is required to establish a business before starting generating money (income)  Business Costs * 1 - Setup Costs (or Start up Costs):  These costs can be acquired from different sources, like saving, loan, from family and friends  Business Costs * 1 - Setup Costs (or Start up Costs):  These costs are usually paid once!  Business Costs * 2 – Operating Costs (Running Costs):  These costs are required to keep the businesses running on a day-to-day basis  Business Costs * 2 – Operating Costs (Running Costs):  These costs are required to keep the businesses running on a day-to-day basis  Business Costs * 2 – Operating Costs (Running Costs):  These costs are usually paid regularly (more than once)  Business Costs * Exercise: List all Set-up Costs & Operating Costs for the following businesses Business Costs ~ Ice Cream Van ~  Business Costs ~ Bakery / Print Shop ~  * Business Costs * Types of Operating Costs * 1. Fixed Costs (Indirect):  Costs that have to be paid with no regards of how much you produce, how much you sell, or how many customers do you have  * Business Costs * Types of Operating Costs * 1. Fixed Costs (Indirect):  These costs are called “Indirect” because there is no direct connection between amount of business you do and these costs  * Business Costs * Types of Operating Costs * 1. Fixed Costs (Indirect):  Examples: rent, utilities, insurance, building tax…  * Business Costs * Types of Operating Costs * 2. Variable Costs (Direct):  Costs that have to be incurred and directly correlated to the amount of business you do (or the amount of sale you make).  * Business Costs * Types of Operating Costs * 2. Variable Costs (Direct):  Examples: costs of running material – like ingredients for a product ( flour for bakery, petrol for taxi, bags for gift shop…)  * Business Costs * Types of Operating Costs * * Commission:  A fee that a business pays for a salesperson (broker/agent) in exchange for their services of enabling or completing a sales transaction.  * Business Costs * Types of Operating Costs * Is “Commission” considered fixed or variable cost?  * Business Costs * Types of Operating Costs  * Business Costs * Types of Operating Costs * Expenditure (term)  Money spent by a business (all money)  * Calculating Total Costs* Total Costs  is the sum of all costs of running a business through a period of time  * Calculating Total Costs* In another way… Total Costs = Fixed Costs + Variable Costs  * Calculating Total Costs* Bare in mind that Variable Costs (Direct) can be different to each product you sell.  * Calculating Total Costs* For instance; Bakery that sells different kinds products (e.g.: bread, cookies, pastries) each item could have different ingredients.  * Calculating Total Costs* To calculate Variable Cost; we need to multiply each item with costs associated with it, then sum them up for “Total Variable Costs”  * Calculating Total Costs* Example: Fixed Costs: - Insurance = 100 JDs. - Rent = 150 JDs. - Wages (Salaries) = 200 JDs. - Utilities (Water, Electricity, …) = 50 JDs Calculate Total Costs  * Business Costs * Exercise (Home work)   Homework 1: Imagine you run a small manufacturing business that produces 500 units of a product each month. Your costs are: Rent: $2,000 per month Salaries: $3,000 per month Insurance: $500 per month. It also costs you $10 for raw material for each unit, and $4 of labour costs per unit   Calculate: 1. Total Fixed Costs per month. 2. Total variable Costs per month. 3. Total Costs per month. 4. Total Costs annually. Fixed Costs: These are costs that remain the same regardless of the level of production. Examples include rent, salaries, and insurance: Rent: $2,000 per month Salaries: $3,000 per month Insurance: $500 per month Total Fixed Costs = Rent + Salaries + Insurance  $2,000 + $3,000 + $500 = $5,500 Variable Costs: These are costs that change with the level of production. They include costs like raw materials, utilities, and labor that vary with output: Cost of raw materials per unit: $10 Labor per unit: $4 Total Variable Costs = (Cost of raw materials per unit + Labor per unit) × Number of units  ($10 + $4) × 500  $14 × 500 = $7,000 Total Costs : The total cost is the sum of fixed and variable costs  $5,500 + $7,000 = $12,500 Homework 2: You own a printing business, producing flyers (4000 flyers per month). Your costs include: Fixed Costs: Printer Lease: $1,200 per month. Rent: $800 per month. Utilities (fixed rate): $200 per month. Each flyer will costs: Paper and ink per flyer: $0.20. Labor per flyer: $0.10. Packaging: $0.20.  Calculate total costs for 6 months.  Calculate variable costs (only) for one year. z 1. Fixed Costs Calculation (6 months) Printer Lease: $1,200 per month Rent: $800 per month Utilities: $200 per month Total Fixed Costs per month = $1,200 + $800 + $200 = $2,200 For 6 months: Total Fixed Costs for 6 months = 2,200×6 = 13,200 2. Variable Costs Calculation (per flyer): Paper and ink per flyer = $0.20 Labor per flyer = $0.10 Packaging per flyer = $0.20 Total variable cost per flyer = $0.20 + $0.10 + $0.20 = $0.50 per flyer You produce 4,000 flyers per month, so the total variable cost per month is: Variable Costs per month = 4,000×0.50 = 2,000 For 6 months: Total Variable Costs for 6 months=2,000×6=12,000. Total Costs (fixed + variable) for 6 months: Total Costs for 6 months=Fixed Costs for 6 months + Variable Costs for 6 months = 13,200+12,000 =25,200.  * Calculating Revenues* Revenues are the total money coming into the business (cash-in-flow).  * Calculating Revenues* There are several types of Revenues: 1. Sales Revenue: Money coming from directly selling products and/or serviecs  * Calculating Revenues* There are several types of Revenues: 2. Interest Revenue: Money earned from interest rates on funds deposited in banks (saving account).  * Calculating Revenues* There are several types of Revenues: 3. Income from renting a property or income from leasing resources (land, vehicles,…)  * Calculating Revenues*  * Calculating Revenues* Revenue = Unit Sale Price * Number of Units sold  * Calculating Revenues*  Example: You own a coffee shop that sells cups of coffee for $5 each. Last month, you sold 500 cups of coffee.  * Calculating Revenues* Answer: Revenue = Price per unit × Number of units sold Calculation: Revenue = $5 × 500 Revenue = $2,500  *Calculating Profits*  What is a “Profit”? When revenues of a business is greater than its Expenditure, then profits can be made.  *Calculating Profits*  But what is a “Expenditures”? Business expenditures are money spent or paid (costs) when doing business or through doing business. Examples: rent, utilities, salaries, insurance, transportation, packaging… Total Expenditures includes: Fixed costs (e.g., rent, salaries, utilities).Variable costs not included in the cost of sales. Other operating expenses.  *Calculating Profits* In other words… Revenues > Expenditures  Profit. Revenues < Expenditures  Loss.  *Calculating Profits*  There are 2 types of profits: 1. Gross Profit. 2. Net Profit.  *Calculating Profits* 1. Gross Profit = Total Sale Revenue – Cost of Sale. 2. Net Profit = Gross profit – all expenditures.  *Ways to maximize (increase) Profits* 1. Reduce Costs: a. Using less expensive raw materials. b. Changing Suppliers. c. Negotiating better deals with current suupliers. d. Increase quality of products, which could increase number of units sold  increase volume of sale  increase revenues  increase profits. e. Increase product selling prices (careful for a reverse effect on volume)  *Ways to maximize (increase) Net Profit* 1. Reduce expenditures! *Example*  *Example 1* 1. For a local Gym:  Monthly membership fees: $20,000  Equipment maintenance: $3,000  Utilities: $2,000  Staff salaries: $5,000  Advertising: $1,500 Calculate Gross Profit and Net Profit.  *Example 1* Gross Profit: =Total Sale Revenue−Cost of Sale =20,000−(3,000+2,000+5,000) =20,000−(3,000+2,000+5,000) =$10,000  *Example 1* Net Profit =Gross Profit− Expenditures =10,000−1,500 = $8,500.  *Example 2* 2. For an Online Retail Store  Total sales revenue from products = $50,000  Cost of Sale = $65,000  Shipping costs: $5,000  Utilities Cost (Electricity) = $1000 Calculate Gross Profit and Net Profit.  *Example 1* Gross Profit: =Total Sale Revenue−Cost of Sale =50,000−70,000 = -$20,000  Net loss = - $20,000.  *Example 1* Net Loss =Gross loss− Expenditures = - 20,000 – 1,000 = $ - 21,000  Break-Even Analysis Definition: 1. A beak-Even is the stage where a business makes neither a profit nor loss. 2. The point where revenues = expenditure. 3. Break-Even Point is the point at which a seller needs to sell a specific number of units to cover all his costs.  Break-Even Point Calculation Break-Even point of a product (# of units to be sold to have 0 profit or 0 loss) = Fixed Costs / (Selling price per unit – Variable Cost per unit. Note: Selling Price per unit – Variable Cost per unit is usually called “Contribution Margin” Break-Even Point Calculation Example: Break-Even Point Calculation Example: Break-Even Point Calculation Example 3: Break-Even Alysis  Break-Even Alysis https://www.youtube.com/watch? v=6akbg2HTn5I  What is Margin of Safety (or Safety Margin)?  It is the difference between the break-even point and the estimated or actual sales output.  It is the amount by which sales could drop before break even point is reached.  It is the amount of sales you can go down by before start making loss!  Why Margin of Safety is important? The larger the safety margin  lower risk of loss. The larger the gap between the safety margin and the break even point  lower risk of loss. And vice versa!  Why Margin of Safety is important? The larger the safety margin  lower risk of loss. The larger the gap between the safety margin and the break even point  lower risk of loss. And vice versa! https://www.youtube.com/watch? v=s8b34mO0b0I  Why Margin of Safety is important? The larger the safety margin  lower risk of loss. The larger the gap between the safety margin and the break even point  lower risk of loss. And vice versa!  Cash Flow Forecasting: Cash Flow Forecasting means: estimating future sales and expenses. Cash Inflow: Money a business receives. Cash Outflow: Money a business pays out Cash Inflow also known as “positive cash flow”, and Cash Outflow as “negative cash flow”  Cash Flow Forecasting: Cash Flow Forecasting means: estimating future (within a specific time frame) sales and expenses. Cash Inflow: Money a business receives. Cash Outflow: Money a business pays out Cash Inflow also known as “positive cash flow”, and Cash Outflow as “negative cash flow”  Advantages of Cash Flow Forecasting: 1. Identify how much money the business expects to have at the end of each specific period of time (week, month, quarter of a year, semi annaully, annually,…)  If this figure is +  Business can pay its bills   If this figure is -  Business in trouble  Advantages of Cash Flow Forecasting:  Problems of Mismanaging Cash Flow : 1. Customers NOT paying for products or services bought from business.  ((( Positive cash outflow, and zero cash inflow)))  Problems of Mismanaging Cash Flow : 2. Customers may DELAY payment for products and services bought from company.  (((Positive cash outflow, negative cash inflow)))  Problems of Mismanaging Cash Flow : 3. Customers may use CREDIT to pay for products and services bought from business.  (((Positive cash outflow, negative cash inflow)))  Cash Inflow Types:: 1. Selling goods and services (obviously). 2. Capital from Investors (Borrowing from investors they receive dividends and/or interest in return)  Selling shares of business to investors (dividends)  Bank loans (Interest).  Rental Income.  Grants (Usually from government/ or NGOs. And usually not paid back (or paid back with affordable interest).  Cash Inflow Types:: 1. Selling goods and services (obviously). 2. Capital from Investors (Borrowing from investors they receive dividends and/or interest in return)  Selling shares of business to investors (dividends)  Bank loans (Interest).  Rental Income.  Grants (Usually from government/ or NGOs. And usually not paid back (or paid back with affordable interest). Cash Outflow Types:: Cash Outflow Types (Quiz): Cash Outflow Types (Examples of different schedules used by business for clash flow):  Preparing Cash Inflow: Cash flow forecasting predicts all the money that is expected to enter and leave a business over a given period of time.   A cash flow forecast shows all expected cash inflows and cash outflows in the month in which they are expected to be received or paid out   Preparing Cash Inflow: The purpose of doing this is to identify how much money the business expects to have at the end of each month. If this figure is positive, then the business can pay its bilis. If the cash flow forecast predicts a negative figure, the business could be in trouble.  Preparing Cash Inflow: Businesses try to avoid this happening because if they have to borrow money to continue trading or to pay debts, they may have to pay interest on any money borrowed. Cash flow forecasts are usually created to cover a full year… But a year is a long time in business and so the forecasts may be broken down into smaller periods, for example, three-month or six-month periods.  Preparing Cash Inflow: Remember that a cash flow forecast is only a prediction of inflows and outflows. The actual inflows and outflows may be greater or smaller than those predicted.  Cash Balance (Net Cash Flows / Closing Balance) Working out the difference inflows and outflows, which is known as the net cash flow. Cash Balance (Net Cash Flows) Opening Balance & Closing Balance Cash Balance (Net Cash Flows / Closing Balance) Cash Balance (Net Cash Flows / Closing Balance) – Quiz!  Benefits of Using Cash flow Forecasting It is a planning tool  Helps predict whether finances will be available to produce new goods or services, expand activities or invest in new resources. Track inflows and outflows and spot times when the business might be short of cash. See the causes of cash flow problems. livery or launching a seasonal product range  Limitations of Cash flow Forecasting 1. This prediction might not be entirely accurate. Sometimes outflows can occur. 2. The business has poor debt collection procedures.  Analysing Cash flow Forecasting If Closing Balance is:  (+)  Business is healthy and can pay its bills.  (+++)  Business enough moey to invest/create new products/R&D. Or means that too much unused resources (money in the bank!)  (-)  Business in trouble, may not be able to pay bills (might look into borrowing money – liability!)  (---)  Business is at risk – immediate action to be taken to reduce outflows or increase inflows  Deficit Vs Surplus Deficit Outflows > Inflows. Surplus  Outflows < Inflows. Liability: What a business owes (loan for example) Last Example!