Revision
Formulae
Accounting
F292
Revenue and variance
Budget
Definition:
A forward financial plan usually involving a cash flow forecast, forecast sales and forecast costs. The budget is a kind of route map that should have been set in the light of the company’s objectives for the period. Divergences from a budget figure can be analysed by variance analysis. Budgets can be used as a discipline, a coordinator, a motivator, a monitoring and control device and a trigger for remedial action, as well as a test of forecasting ability.
Revenue and Variance
Sales Revenue
Number of sales x price of each
OR
Output x price
Definition: Earnings from sales.
Variance (sales, cost, or profit)
(year on year)
Actual sales – forecasted sales
Actual costs – forecasted costs
Actual profit – forecasted profit
Definition: The difference between the predicted or budgeted figure and the actual figure achieved,
Variance as a percentage:
Actual X100
Expected
Cash Flow Forecast
Definition: prediction of cash movements in and out of the business.
Inflows:
Sales Revenue, loans
Outflows:
Materials, wages, expenses (bills)
Opening balance:
amount of money the business starts with at a given point in time.
Closing balance:
Amount of money a business ends with at the end of a given period.
Net cash flow
= Total Inflows – Total Outflows
Cash Flow Statement
Definition: a record of the actual amount of inflows and outflows. This can be compared with the forecast.
Costs
Fixed costs
Definition: costs that are not directly related to the level of output (e.g they do not increase if production or sales increase).
Variable costs
Definition: costs that are directly related to the level of output (e.g. they increase if sales increase – for example, the cost of ketchup if more hot dogs are sold).
Costs
Total Costs
= Fixed costs + Variable costs
Unit Cost
= total costs
output
Definition: The cost of producing one unit. (this considers all the costs of producing one unit, including fixed and variable costs – because total costs have been considered).
Costs
Marginal Cost
Fixed cost + (variable cost per unit x number of units plus one)
minus
Fixed cost + (variable cost per unit x number of units)
Definition: the cost of producing one additional, or extra good/unit. This is the change in the total cost of a product or service which resuts from changing output by one unit more (or less).
Only variable costs can be altered in the short run so marginal cost in the short run is entirely variable cost.
Social Cost
= Internal costs + External costs
Definition: this measures the cost to the whole of society of a production process or business decision. This accounts for both the firms internal costs and also the costs imposed on society as a consequence of the action, such as pollution or unemployment, which are external to the business.
Opportunity Cost
The next best alternative that had to be given up or foregone, in order to spend the money on the first choice.
It may not be measured in money terms. The opportunity cost of an evening studying might be the missed opportunity of watching a film.
Contribution
Contribution or marginal costing:
Contribution per unit
Contribution = price – direct or
per unitvariable costs
Definition: how much each unit of production is contributing to overheads.
Costs
Total Contribution
= Contribution XSales
per unit
Definition: how much in total is being contributed to overheads from sales.
To Calculate profit using contribution:
Profit = total contribution – overheads or fixed costs.
OR
Profit = revenue – overheads
Overheads definition: indirect or fixed costs – those that do not change when output changes.
Breakeven Analysis
Breakeven: the point at which total revenue is equal to total costs (TR = TC) and all costs have been covered.
Breakeven output level:
Breakeven = total fixed costs
outputcontribution per unit
Remember:
contribution per unit = price – variable costs
Margin of safety:
= Actual Output – Breakeven level of output
Definition: the difference between the actual level of output and the breakeven level of output.
Investment Appraisal
Investment appraisal: methods of assessing whether an investment is a feasible option.
Investment appraisal terms:
Payback: an investment appraisal technique used to assess the amount of risk involved, by calculating how long it takes to recover the cost of the investment.
Accounting Rate of return (ARR): an investment appraisal technique used to assess the profitability of an investment by measuring the profit generated from an investment as a percentage of the investment.
Alternative names for this technique include annual average rate of return and average rate of return.
Net cash inflow
= revenue – direct costs
Definition: the likely return on the investment per year.
ROI = return on investment
EOY = end of year
EOY 0 = start of investment
Payback method:
Calculating payback period is shown like this: (negative numbers are in brackets)
Year / A: Net Cash Inflow(received from investment) / B: Cumulative Cash inflow (total spent minus total received so far)
(B – A)
EOY 0 / 0 / (60,000) initial
investment
EOY 1 / 20,000 / (40,000)
EOY 2 / 20,000 / (20,000)
EOY 3 / 20,000 / 0
Payback period for this investment is 3 years.
ARR Method:
Investment Appraisal: Calculating Accounting Rate of Return (ARR)
Step 1:
Total Profit=
Total cash inflows – Investment cost
Step 2:
Annual average profit =
Total profit
Number of years
Step 3:
Return on Investment:
Annual average profit
Original cost of investment
ARR Example
An investment has been made for £ 60,000. It takes 5 years to gain a profit of £20,000 on this investment.
Step 1: Total Profit =
Total cash inflows – Investment cost
= 80,000 – 60,000
= £20,000
Step 2: Annual average profit =
Total profit
Number of years
= 20,000
5
= £ 4,000
Step 3: Return on Investment/ Annual rate of return=
Annual average profit
Original cost of investment
= £ 4,000
£ 60,000
= 0.066
= 6.67%
Remember: ARR always measured as a percentage.
Profit and Loss Account
Profit and Loss Account:
A statement recording all a firm’s revenues and costs within a past trading period.
Gross profit:
Sales revenue – cost of sales
Operating profit:
Gross profit – fixed costs (including expenses)
Net profit:
Operating profit – interest paid
Retained profit:
Net profit – tax and dividends
Balance Sheets
Balance sheet
A statement about the value of a business at a given point in time, showing what it owns (assets) and what it owes (liabilities)
All private and public companies issue balance sheets for their shareholders.
Fixed assets – items of value which have a long term function and can be used repeatedly. Examples are land, buildings, equipment and machinery. Fixed assets are not only useful in the running of the firm but can also provide collateral for securing additional loan capital.
Depreciation – the fall in the value of fixed assets due to wear and tear over time. Businesses allocate the cost of the asset, minus the final value at the end and spread this across its estimated useful life.
The calculation of depreciation on the balance sheet does not represent the movement of cash, but a reduction in the value of the assets owned by the business.
Balance Sheet items: Assets
- Fixed Assets - items of value which have a long term function.
- Current assets – those assets that are not fixed assets
- Net current assets :
Current assets – Current liabilities
- Net assets :
Net current assets + fixed assets - long term liabilities
- Capital employed or shareholders’ funds – value of funds tied up in the business as shares and retained profit.
- Cash
- Stock
- Debtors – money owed to the business.
Balance Sheet items: Liabilities
- Current liabilities - what is owed by the business
- Overdraft - short term loan for less than 1 year
- Long-term liabilities - loans for longer than 1 year