Financial Planning and Control

103

Chapter 11

Financial Planning and Control

An adequate background of the basic financial statements of an entity like a university, college or school will help you go through this chapter. Basically this chapter will inform you about financial planning and control processes:

1.  Break even Analysis

2.  Operating Leverage

3.  Cash Breakeven Analysis

4. 
The Cash Budget

But before we go to the intricacies of computing the above mentioned processes, let us define some important terms.

What is financial planning and control?

Financial planning involves the projection of revenues, income and assets based on alternative production and marketing strategies, as well as the determination of the resources needed to achieve these projections.

Financial control is the phase in which financial plans are implemented and deals with the feedback and adjustment processes required to assure adherence to plans or modification of plans because of unforeseen changes.

Having these definitions in mind we can now proceed with the necessary processes for financial planning and control.

1.  Break-even analysis – is an analytical technique for studying the relationship between fixed costs, variable costs, sales volume, and profits

Break-even Point in units is computed as follows:

Break even Chart – to graphically view the break even point in units and sales amount a chart was presented below. The vertical axis represents sales and cost amount while the horizontal axis represents the volume or quantity of units produced and sold. The break even point is the intersection of sales and costs.

REVENUES (P) TOTAL REVENUE/SALES

UNIT PRODUCED AND SOLD (Q)

Illustration of Break even point Analysis

1. 

Break even point in units

Proof:

Sales (7,500 units x P 370) P2,775,000.00

Less – Variable Costs (7,500 units x P170) 1,275,000.00

Gross Margin P1,500,000.00

Less-Fixed Costs 1,500,000.00

BEP P xxxxxxxx

2. 





Break even point in sales

3. 

Break even point in sales where the desired profit is P3,500,000 before income tax

Proof:

Sales (25,000 units x P370) P9,250,000

Less-Variable Costs (25,000 units x P170) 4,250,000

Gross Margin 5,000,000

Less-Fixed Costs 1,500,000

Net Margin or Desired Profit P3,500,000

4. 



Break even point in units where the desired profit after 40% tax is P4,200,000.

= 42,500 units

Proof:

Sales (42,500 units x P370) P15,725,000

Less-Variable Costs (42,500 units x P170) 7,225,000

Gross Margin P 8,500,000

Less-Fixed Costs 1,500,000

Net Margin subject to tax P 7,000,000

Less-40% tax 2,800,000

Net Margin or Profit After tax of 40% P 4,200,000

2.  Operating Leverage – the extent to which fixed costs are used in a firm’s operations. This means a high degree of operating leverage, other things held constant, means that a relatively small change in sales will result in a large change in operating income. If a high degree of a firm’s total cost are fixed, the firm is said to have a high degree of operating leverage.

2.1  Degree of operating leverage

To measure the effect of a change in volume on profitability, the degree of operating leverage is calculated.

Percentage Change in EBIT

Degree of operating leverage = or

Percentage Change in Sales

D EBIT

DOLB = or

EBIT

D Q

Q

Q (P-V)

DOLB =

Q (P-V) – F

DERIVATION OF THE ABOVE FORMULA:

D Q (P-V)

% D EBIT =

Q (P-V) – FC

D Q

Q

Q (P - V)

DOLB =

Q (P - V) - FC

Sample Computation

1.  Operating Leverage University A University B University C

Tuition Fee per Unit P400 P400 P400

Fixed Costs P1,000,000 P1,500,000 P2,000,000

Variables Cost per unit P250 P175 P100

Based on the computations presented, University C has the highest amount of fixed cost but the lowest in variable cost per unit because of the use of machineries thus eliminating the variable costs in human labor. This in effect gives the university a big edge over other universities using more variable costs in terms of human labor. However a higher fixed costs amount is expected because of the depreciation of expensive machineries.

2.  Degree of Operating Leverage

15,000 (P400 - 250)

AU % D EBIT =

[120,000 (P400 - 250)] – 1,000,000

P2,250,000

=

17,000,000

= .13235 or 13.24 %

15,000 (P400 - 175)

BU % D EBIT =

[120,000 (P400 - 175)] – 1,500,000

P3,375,000

=

25,500,000

= .13235 or 13.24%

15,000 (P400 - 100)

CU % D EBIT =

[120,000 (P400 - 100)] – 2,000,000

4,500,000

=

34,000,000

= .13235 or 13.24%

Notice that the degrees of operating leverage are the same for all 3 universities brought about by the same amount of difference in the selling prices and fixed costs.

Let’s take a look at another sample where the degrees of operating leverage are different.

U N I V E R S I T I E S

X Y Z

Tuition fee per unit P2,000 P2,000 P2,000

Variable Cost per unit 800 550 300

Fixed Cost P20,000,000 P35,000,000 P55,000,000

2. Degree of Operating Leverage

50,000 (P2,000 - 800)

UX % D EBIT =

[150,000 (P2,000 - 800)] – 20,000,000

P60,000

% D EBIT =

P160,000,000

= .375 or 37.50%

50,000 (P2,000 - 550)

UY % D EBIT =

[150,000 (P2,000 - 550)] – 35,000,000

P72,500,000

% D EBIT =

P 182,500,000

= .3973 or 39.73%

50,000 (P2,000 - 300)

UZ % D EBIT =

[150,000 (P2,000 - 300)] – 55,000,000

P85,000,000

% D EBIT =

P 200,000,000

= 42.5 or 42.50%

3.  Cash Break even Point

The break even point analysis formulas may also be used except that fixed costs will be decreased by the amount of non-cash outlays like amortization, depreciation, depletion and the like.

Sample illustration for cash break even analysis

Fixed Cost P3,500,000

Depreciation Charges 750,000

Selling Price P2,500

Variable Costs per unit 1,000

Cash Break even Point

P 3,500,00 – 650,000

CBEP =

P2,500 – 1,000

P2,850,000

=

P1,500

= 1,900 units

Proof:

Sales (1,900 x P2,500) P4,750,000

Less – Cost of Sales (1,900 x P1,000) 1,900,000

Gross Margin P2,850,000

Less-Fixed Cash Outlay 2,850,000

Cash Break even point xxx

Compared to the Break even point that cash break even point in units is smaller by 433 units

P3,500,000

BEP =

P2,500 – 1,000

= 2,333 units

4.  Cash Budget

To properly plan for future cash receipts and disbursements, there should be a cash budget wherein all sources of cash will be shown and all capital and revenue expenditures will be considered to arrive at a desired cash balance at the end of a certain period.

Consider the following cash budget prepared for the 4 quarters of the fiscal year which started in June 2002. This budget was based on the given information for Mount Carmel University.

Mount Carmel University has on the average 2,000 students in all levels per semester and each student enrolls on the average 21 units at P600 per unit. Miscellaneous, laboratory, athletics, library and other important fees amount to P4,800. Based on experience, the collection of tuition fees is summarized as follows:

20% of the enrollees pay cash in full on the day of enrollment in June.

30% of the enrollees pay 40% down and the balance is paid in 4 equal monthly installments on the first week of each month.

40% of the enrollees pay 30% down and the balance is paid in 4 equal monthly installments on the first week of each month.

6% of the enrollees are scholars paying only 50% of the total amount and only 10% of this amount is paid during enrollment, the balance is paid in 4 equal installments on the first week of each month.

4% of these enrollees are full scholars of the provincial government and payment is made 5 times in a semester on the first week of each month starting June.

Computations of cash to be received for 2 regular semesters. Summer classes collections will be discussed later.

20% x 2,000 = 400 x 21 x P600 = P5,040,000

400 x P4,800 = 1,920,000

P6,960,000 June Nov.

30% x 2,000 = 600 x 21 x P600 = P3,024,000

600 x P4,800 = 2,880,000

P5,904,000

40% x 2,000 = 800 x 21 x P600 = P10,080,000

800 x P4,800 = 3,480,000

P13,560,000

6% x 2,000 = 120 x 21 x P600 = P1,512,000

120 x P4,800 = 576,000

P2,088,000

4% x 2,000 = 80 x 21 x P600 = P1,008,000

80 x P4,800 = 384,000

P1,392,000

For summer classes only 20% of the total regular semestral enrollees is registered. Of this total summer enrollees only 40% pays in full cash and the rest pay 35% down and the balance is payable on the first week of the month following the month of enrollment. Enrollment for summer classes starts April and summer classes end May 31, 2003. An average of 12 units can be enrolled in summer.

Computation of Summer Collections

20% x 2,000 = 400

40% x 400 = 160 x 12 x P600 = P1,152,000

160 x P4,800 = 768,000

P1,920,000 April

60% x 400 = 240 x 12 x P600 = P1,728,000

240 x P4,800 = 1,152,000

P2,880,000