BASIC
QUESTIONS FOR YOUR BUSINESS
Your business
. What is your
business? Why are you in business?
. What factors are
critical for success? Do you analyse these factors?
. Who buys your
products and why?
. Where do your
profits come from?
Your strategy
. What are your
business goals?
. How do you plan
to achieve them?
. How do you
intend to grow?
. What plans do
you have for succession?
The market
. Who are your
customers? Do you have sufficient information on them?
. What are their
needs? How satisfied are they?
. Who are your
competitors? Do you have information on them?
. What is your
market share?
. What sets you
apart from your competitors and makes you so special?
. How long will
you be able to maintain this special market position?
. . and what
happens when you lose this position?
The products
. What are your
key products/services?
. What is your
product (and process) life cycle?
. Is your product
and process technology exclusive (patents), and how long is it
defensible?
. Is the product
range regularly updated in line with market needs?
. Who are your key
suppliers? Do you know enough about them? What kind of relationships do
you have with them (e.g., co-design,
partnership etc.)?
This section
contains fundamental questions that managers of any kind of business
need to ask themselves. Negative answers, or inability to answer because
of lack of information, should serve as warning signals of likely
problems for management to review.
Business plan
. What is your
short-term business plan (of one to two years)?
. Does it have
clear objectives which everyone in the business understands?
. Does the plan
reflect your own ambitions, beliefs and assumptions (even if you
have obtained help from your financial advisers in drawing it up)?
. How does your
plan identify your business opportunities and vulnerabilities, and where
it is strong and weak?
. Are you also
taking a longer-term approach (say three or more years)?
. How do you and
your staff use the plan to guide the business? How regularly is it
reviewed?
. Do you check
performance against plan?
Budgets
. Do you have a
budget and does it link into the business plan?
. Is it an
action plan (e.g., orders, capacity planning, resource balancing)?
. How good is your
budgeting process? Do you have a good early indication of your results,
or do they come as a surprise to you?
. Is performance
against budget checked regularly?
. And is action
taken on variances?
. Do you realise
that a first sign of trouble is when a business drifts off its cash
targets even though it may still be meeting its profit targets?
Performance
reporting
. Do you rely only
on the accounts you prepare for legal and tax reasons to tell you what
is happening?
. Do you have a
monthly financial reporting system?
. Does it provide
information in the same form as the budget?
. Do your
financial and non-financial indicators follow the performance of the
business during the month? How quickly are they produced? Do you use
them?
. In case of
declining results do you know which are the profit sensitive areas,
which areas will affect cash and sales, and where you can act fastest to
reduce costs?
. How do costs run
through your organisation, that is, your fixed and variable costs, your
product costs, the stepped costs caused by expansion when you exceed
current capacity?
. How robust are
the information systems? Are there any 'private' costing and information
systems?
. Are you aware of
the 80:20 rules in managing your information?
The business
plan is described in greater detail in a later section.
Cash
. Cash is king: do
you actively manage all aspects of your cash, from external financing,
through working capital to cash balances themselves?
. Do you
understand the crucial difference between cash in hand (and the bank)
and paper profits? And that you can go bankrupt while seemingly making
profits on paper?
. Do you use
external finance? If so, do you know its cost?
. Do you realise
that over-rapid business growth will put a strain on your cash
resources?
. Do you also
realise that excess cash may stem from a shrinkage in sales?
. Do you prepare
regular cash flow forecasts (possibly with the help of your financial
adviser)?
. How do you
control cash collection from customers and overdue accounts?
BASIC
INFORMATION NEEDED TO RUN THE BUSINESS
Breakeven point
Analysis of
costs
. Fixed costs
. Variable costs
(what they vary with and to what extent)
. Overhead costs
Product costs
. Direct
. Indirect
. Gross margins
Monthly
earnings
Actual revenue
and expenditure compared with budget
Non-financial
indicators
For example,
quantities, number of employees, quality, service, complaints, defects,
rework, scrap, amount of stock
(and location),
its value and salability, labour hours, sales volumes, number of credit
notes
Performance by
product (as applicable)
. Geographical
area
. By business
location
. By customer
(group) if applicable
. By salesperson
Seasonal
factors in sales, costs, purchases
Order book
information
Key suppliers
and customers
Amount owed and
owing (and overdue accounts), how good the debt is
Borrowings (and
repayment terms), cost of borrowing and what the loans are secured on
Investment in fixed assets
This a
general list. While some indicators (such as the breakeven point) apply
to all businesses, others (such as many of the non-financial indicators)
do not. Readers have to determine what information is relevant for them.
If, for instance, seasonal factors are important, they need to be aware
of this so that they can include it in their business information, plan
for it, and benchmark with other similarly placed businesses. All terms
used are explained in the glossary.
RULES OF THUMB
Key figures
which should be updated regularly and be readily available:
. Amounts owed by
third parties (reported on monthly)
. Accounts payable
(reported monthly)
. Cash balance
(and the forward position)
. Short-term
investments
. Short-term
borrowings compared with credit facilities
. Number of
employees
. Order book
. Sales
. Market share
. Customer
satisfaction data
Key ratios (as
applicable to the business in question):
. Profitability
ratios
. Debt/capital
. Debtor days
. Stock days
. Product and
total margins
. Sales/net assets
. Turnover per
employee ( and comparison with competitors if known)
. Liquidity ratio
. Current ratio
The methods
of calculating these ratios are explained in the glossary.
THE BUSINESS
PLAN
1 INTRODUCTION
The business plan
sets out how the owners/managers of a business intend to realise its
objectives. Without such a plan a business will drift. The plan serves
six main purposes.
. It enables
management to think through the business in a logical and structured way
and to set out the stages in the achievement of the business objectives.
. It enables
management to plot progress against the plan.
. It ensures that
both the resources needed to carry out the strategy and the times when
they are required are identified.
. It is a means
for making all employees aware of the business's direction.
. The document is
available for discussion with prospective investors and lenders of
finance (e.g., the bank).
. The plan links
into the detailed, short-term, one-year budget. The purpose of a budget
is:
. To monitor unit
and managerial performance (the latter possibly linking into bonus
arrangements)
. To forecast the
out-turn of the period's trading (through the use of flexed budgets and
based on variance analyses)
. To assist with
cost control
A business plan
has to be particular to the organisation in question, its situation and
time. All that can be done here is to set out generally regarded good
practice. One thing is certain, however: a business plan is not just a
document, to be produced and filed. Planning is a continuous process.
The business plan has to be a living document, constantly in use to
monitor, control and guide progress. That means it should be under
regular review and will need to be amended in line with changing
circumstances.
2 THE
BACKGROUND
Before preparing
the plan management should
. review previous
plans (if any) and their outcome
. be very clear as
to their objectives - a business plan must have a purpose
. set out the key
business assumptions on which their plans will be based (e.g.,
inflation, exchange rates, market growth, competitive pressures, etc.)
. take a critical
look at their business. The classical way is by means of the
strengths-weaknesses-opportunities, threats (SWOT) analysis, which
identifies the business's situation from four key angles. The strategies
will be based on the outcome of this analysis.
3 THE BUDGET
A typical business
plan looks up to three years forward and it is normal for the first year
of the plan to be set out in considerable detail. This one-year plan, or
budget, will be prepared in such a way that progress can be regularly
monitored (usually monthly) by checking the variance between the actual
performance and the budget, which will be phased to take account of
seasonal variations. The budget will show financial figures (cash,
profit/loss, working capital, etc.) and also non-financial items such as
personnel numbers, output, order book, etc. Budgets can be produced for
units, departments, and products as well as for the total organisation.
Budgets for the forthcoming period are usually produced before the end
of the current period. While it is not usual for budgets to be changed
during the period to which they relate (apart from the most
extraordinary circumstances) it is common practice for revised
forecasts to be produced during the year as circumstances change. A
further refinement is to flex the budgets, i.e., to show performance at
different levels of business. This makes comparisons with actual
outcomes more meaningful in cases where activity levels differ from
those included in the budget.
4 WHAT THE
PROVIDERS OF FINANCE WANT TO SEE
Almost invariably
bank managers and other providers of finance will want to see a business
plan before advancing finance. Not to have a business plan will be
regarded as a bad sign. They will be looking not only at the plan, but
at the persons behind it.
. They will want
details of the owner/managers of the business, their background and
experience, other activities, etc.
. They will be
looking for management commitment, with enthusiasm tempered by realism.
. The plan must be
thought through and not be a skimpy piece of work. A few figures on a
spreadsheet are not enough.
. The plan must be
used to run the business and there must be a means for checking progress
against the plan. An information system must be in place to provide
regular details of progress against plan. Bank managers are particularly
wary of businesses that are slow in producing internal performance
figures.
. Lenders will
want to guard against risk. In particular they will be looking for two
assurances (sometimes known as the two 'exits'):
. That the
business has the means of making regular payment of interest on the
amount loaned.
. That if
everything goes wrong the bank can still get its money back (i.e., by
having a debenture over the business's assets).
. Forward-looking
financial statements, particularly the cash flow forecast, are therefore
of critical importance.
. The bank wants
openness and no surprises. If something is going wrong it does not want
this covered up, it wants to be informed - quickly.
5 THE DETAILS
OF THE BUSINESS PLAN
5.1 The basics
. Management
summary, in plain words
. The rationale
behind the proposal
. The
owner's/management's goals and objectives
. Key facts:
figures, history, names, addresses, references
. The marketing
imperative: why this business is different from all the others, and why
it is better
. Assets,
facilities, sensitivities, breakevens, vulnerabilities, SWOT
. Where the money
will come from and how it will be repaid
. The financials:
operating statement, balance sheet, cash flow, costings
5.2 The
classical business plan
The title
pages
. Title
. Summary: one
page, in plain words
. Key facts at a
glance: one page
. Contents page,
with details such as partnership agreements set out in the appendices
. The appendices
and attachments shown separately
Introduction
. Background to
the business: previous years' results if applicable (say three years)
. Background to
the owner(s)/managers if it is a new business
. Key objectives
. Type of
business: e.g., sole trader, partnership, private, public company
. Key assumptions
behind the business plan
The
checklist below is intended to cover as many eventualities as possible.
Obviously, most plans will not be set out in such detail, particularly
for the smaller business. The following should therefore be used as a
checklist for the plan to be based on, with the structure respected, but
without any of the detail that is not applicable.
The
product/service
. Existing
business
. Strengths,
weaknesses, opportunities, and threats
. What makes it so
special: unique features of the business
. Development
Marketing
. The present
market
. Competitors and
prospective competitors: products, prices, locations, likely
developments
. Customers and
prospective customers
. Key customers
and how reliant the business is on them
. Future:
prospective sales and market share
. Any other
aspects, e.g., distribution
Legal
aspects
. Legal form of
the business
. Tax and
liability implications for the owners
Premises,
assets, facilities, and purchasing
. Premises, where
situated, size, how owned, local taxes, planning permission, etc.
. Plant and
equipment
. Purchasing
arrangements if applicable
. Key suppliers
and how dependent the business is on them
People
. Management: with
details of the owners/key managers
. Employees and
terms of employment
. Organisation
chart if applicable
Protecting
the business
. Security
. Insurance
The
financials
. Past accounts
and key performance figures if applicable
. Budgeted profit
and loss account for the current year, plus forward projections
. Cash flow
forecast
. Projected
balance sheets
. Ratios and
comparisons, ideally internally, over periods of time, and externally
. Product/service
costings if applicable
. Breakeven
analysis
. Capital
expenditure programme
. Funding
. Risk,
particularly foreign exchange risk if there is foreign business
Safety net
if it all goes wrong
. What is the fall
back plan?
. . in particular,
what will happen if there is a cash crisis?
. Long-term lines
of credit
. Replacement of a
key employee
NON-FINANCIAL
INDICATORS
Administration
. Number of credit
notes per period (broken down by reason and amount)
. Number of
invoices per period and average invoice amount
. Number of
packing notes per period and average size of packing note
. Telephone
logging: number of abortive calls, time before calls are answered
. Invoicing errors
. Reconciliations
. Accounting
errors and rectifications
Customers/suppliers
. Top (say 20)
customers
. Top (say 20)
suppliers
. Inward quality
failures
. Percentage of
business accounted for by the top customers and by the top suppliers
. Market share
. Complaints
(detailed by cause, unit, person, customer, etc.)
. New customers
(and from which competitor)
. Lost customers
(to which competitor and why)
. Returned goods
(and why)
. Stock errors
. Lead times
. Warranty claims
Distribution
. Delivery times
. Misroutings
. Returns
. Breakages
. Lost deliveries
. Wrong deliveries
. Pilferage
. Out of stock
. Delays
. Chasing
suppliers and expediting
Manufacturing
.
Production/output
. Set up times
. Scrap
. Rework
. Breakdowns
. Downtime
. Cycle times
. Output/head
. Machine
utilisation
. Process yield
Personnel
. Succession plans
. Training
schedules and achievement
. Staff skill base
and gaps against future requirements
. Staff turnover
. Absenteeism
. Staff sickness
. Staff feedback
. Results of exit
interviews
. Third party
opinion (from press comment)
Quality
. Incidence of
non-quality, broken down into prevention, detection, and failure
. Incidence of
failure
. Incidence of
after-sales warranty service and repairs
. Timeliness in
supply
Safety
. Number of
incidents
. Accidents ( the
accident, injury/loss of life, location, time, circumstances, etc.)
Service
. Customer surveys
. Repeat business
. Unsolicited
praise
. Third party
views (from press comment)
. JIT record
. Delinquency in
supply
. Adherence to
plan
Technology
. Number (and
percentage) of new products being sold which were not in existence five
(and three) years ago
. Percentage sales
from new products
. Speed of getting
new products/services to the market
EXAMPLES OF
INDUSTRY-SPECIFIC INDICATORS
Car hire
. Market share
. Number of rental
days sold in the period
. Number of rental
transactions closed/opened (closing ratio)
. Percentage
vehicles at the 'correct' location
. Percentage
utilisation per day
. Percentage
chargeable utilisation
. Average length
of car hire
. Complaints
. Unsolicited
praise
. Repeat business:
who, why, when, where
. Customers lost
(to whom) and gained (from whom)
. Getting it right
first time
. Breakdowns
. Faults found on
internal checks
. Billing errors
. League tables
comparing branches with each other
Courier
. Misroutings
. Mis-sorts
. Breakages
. Losses
. Pilferage
. Claims
. Reasons for
failures
. Late
consignments
. Number of
consignments
. Revenue per
consignment and per kilo
. Consignment
weights
. Excess capacity
GLOSSARY OF
TERMS
CASH MANAGEMENT
Cash flow
forecast
The cash generated
and spent in a given period is called the cash flow. Cash flow
forecasts, linked to the bank balance show the movement (receipts and
payments) week by week or month by month for a period in the future. For
a small business it is usual to set out the forecast weekly for a period
of three months say, after which the figures would typically be shown
monthly for the next nine months. In businesses where cash is critical
it is not unusual to monitor cash flows daily.
WORKING CAPITAL
Stocks (or
inventories)
Goods held
comprising:
. Goods or other
assets purchased for resale
. Raw materials
and components purchased for incorporation into products for sale
. Products and
services in intermediate stages of completion (work-in-progress) only
goods that can be and are expected to be sold are included, i.e.,
obsolete and defective stocks are excluded.
Stock holding
period
The period during
which stock is held in relation to sales. Normally the aim of a business
is to reduce this period to the minimum consistent with sales and
continuing production.
Working
capital
is the capital available for conducting the day-to-day operations of the
business. Working capital has to be managed properly for the operations
to be managed properly. Working capital is defined as the excess of
current assets over current liabilities (i.e. cash, plus amounts owed by
debtors, plus stocks, less amounts owing to creditors). It consists of
short-term items all of which have a direct and immediate impact on
cash. Proper cash management therefore entails effective management of
working capital. The details below describe the main items of working
capital and the main indicators used in its management.
Businessmen
hardly need to be reminded that balance sheets and profit and loss
accounts are all very well, but that cash is the lifeblood of business.
A business that can not pay its way is bankrupt. Cash has to be planned
for to ensure adequate funds are always readily available (either on
hand or from the bank or other outside parties) and to provide for any
seasonal factors (such as a build up of stocks), or heavy special
one-off payments (such as tax or VAT or expenditure for fixed assets).
The cash flow forecast is the document that providers of finance, such
as banks, place most emphasis on.
Stock turn
The number of
times stock is 'turned over' or utilised during a given period,
generally a year, but adapted to individual requirements for internal
control purposes. Where individual product margins are small (as in
sales of canned foods for instance) the aim would be to turn over the
stock very frequently. Where the stock cannot be turned over so
frequently (e.g., luxury clothes or automobiles) the objective will be
to achieve substantial margins for each individual item sold.
Stock days
It is also usual
to show this in terms of months.
Amounts owed by
third parties (also called debtors, outstandings, and receivables)
Money owed to the
business by its customers or others These should be split up according
to when payment is/has been due so as to identify those within the due
period and the overdue (30, 60, 90, etc., days overdue).
Debtor days
These are
calculated as follows:
The usual period
taken is a year, thus a year's sales would be taken and 365 days could
be used. It is also usual to show this ratio in terms of months or
weeks.
Borrowings and
repayment terms
These should be
identified by: amount borrowed, terms, when due to be repaid.
The
significance of this ratio is that it indicates the effectiveness of
credit control procedures in general. The figure of days outstanding
should be compared with trends over time within the business, with the
standard terms of business, and with ratios achieved by competitors. The
organisation cannot benefit from money tied up unnecessarily in
receivables.
´ days in the
period Debtors (at the due date) Sales (inc. VAT) in the period The
significance of this split is that it shows the company where to focus
the credit control, i.e., on the overdue element, particularly the long
overdues (e.g. 90 days or more). The significance of this statistic is
that (in comparison with trends over time within the business or with
other businesses) it can indicate whether excessive levels of stock are
being held, tying up cash unnecessarily.´ days in the period
(i.e. 365) Stock at the due date (i.e. period end)
Total cost of
sales for the period (say a year)
BUDGETS AND
PLANNING
Budget
A financial or
qualitative statement of policy expressed in financial and non-financial
terms and prepared and approved by management prior to a defined period
of time (usually the business's financial year). It is normally
financially oriented and will show income, expenditure, sales, and
profitability. Budgets are usually phased over the months (or quarters)
of the year in question, and it will be particularly important to do
this where the business is seasonal. While the budget has to be approved
by top management it is important that it should be prepared by the more
junior managers who will have the responsibility for carrying it out.
Business plan
A plan which
typically covers in both the long and short term:
. Customers
. Market analysis
. Resources (e.g.,
staff, finance)
. Service and
distribution
. Selling and
supplying
. Future strategy
. Product
development
. Manufacture
. Stock holding
and control
. Management and
staff
. Finance
Business
planning
The systematic
review of business strategy and the development of a long-term plan to
enable the business to achieve its objectives It goes without saying
that without a plan a business merely drifts, without knowing where it
is going. A plan gives direction to a business.
The short-term
plan (the budget)
. enables the
business to organise its resources for the period in question
. enables it to
gauge the impact of unforeseen events during the period, and provides a
framework for dealing with them
. sets
performance standards for subordinate managers and therefore can be a
powerful means of motivating them
Above all, a
budget provides a safeguard against the businessman's biggest dread,
unpleasant surprises.
A business plan
enables providers of finance to a business to evaluate it. They will
usually not lend money unless there is a viable plan.
BALANCE SHEET
Fixed assets
Any asset,
tangible or intangible, acquired for retention by a business for the
purpose of providing a service to the business, and not held for resale
in the normal course of trading.
Long-term
liabilities and loan capital
Long-term
liabilities:
amounts payable to
external creditors (how the business is financed and how the proceeds
from asset sales would be shared if the business were sold).
Loan capital:
debentures, bonds and other long-term loans to a business; overdrafts,
being theoretically repayable on demand, are not usually shown in this
category.
Long-term
liabilities are items payable more than one year after the balance-sheet
date. Short-term liabilities are included under working capital.
Equity
The issued
ordinary share capital plus reserves; these latter represent the
investment in the business by the ordinary shareholders (the owners).
Retained
earnings
Included in
equity, retained earnings are the amounts set aside (usually apportioned
out of profit) for continued investment in the business.
Working capital
Working capital
consists of short-term assets and liabilities, namely:
. current
assets: cash or any assets likely to be converted into cash or
consumed in the normal course of business within the normal operating
cycle (usually one year), i.e., cash, stocks, good debtors
(receivables);
. current
liabilities: amounts owed that are expected to be repaid within one
year, i.e., bank overdrafts (in the UK), dividends, tax, amounts owing
to trade creditors.
See earlier
section on working capital.
This key
document sets out the financial position of the business at a particular
date in the past showing what the business owns, what it owes, and the
owner's equity in it. Large organisations produce their balance sheets
as frequently as once a month, but smaller businesses will find it
necessary to produce them much less often, say only once a quarter. What
is important to realise is that a balance sheet is a photograph of the
business at a particular point in time. In order to understand
how the business has moved, and to benchmark it against other, similar
businesses, it will be necessary to view a series of balance sheets, and
the profit and loss accounts linking them.
The main
components of a balance sheet are set out below.
PROFIT AND LOSS
ACCOUNT
Sales revenue
or turnover
Shown net of VAT
Cost of sales
Usually includes
only those costs that would be allocated to stocks, i.e., costs incurred
in manufacture - materials, direct wages, power, etc. In a service
business the cost of sales would cover the payment to third parties for
items included in the service provided by the business.
Operating
expenses
Expenses, other
than cost of goods sold, incurred in the normal operation of the
business (typically administration, distribution, and selling expenses)
Gross margin
The difference
between sales revenue and cost of sales
Contribution
Sales value less
the variable cost of sales; it may be expressed as total contribution or
as a percentage of sales. Contribution is a central term in marginal
costing where the contribution per unit is expressed as the difference
between the selling price and its marginal cost.
Profit
Gross profit:
excess
of sales revenue over cost of sales
Net profit:
profit
after all expenses (which can be before or after tax and/or interest,
provided this is made clear).
FINANCIAL
RATIOS
Business
managers need to be aware of the more important ratios used by outsiders
(such as banks) to evaluate the financial strength and the profitability
of businesses.
The profit and
loss account is the second key document essential for the management of
a business. It sets out how the business has performed over a period of
time (a month and/or a quarter, and/or a year), the beginning and end of
the period being marked by balance sheets. It can be seen as the
movement from one balance sheet to another in operating terms. In
particular the profit and loss account will show how well the business
is doing and whether it is paying its way. A business that consistently
fails to make a profit cannot survive. An operating statement is a
shortened form of profit and loss account which excludes the non-trading
items such as interest payable, rents receivable (where there are
non-trading items), etc.
The key
items in a profit and loss account are as follows:
Gearing
The ratio of
fixed-interest capital and long-term borrowing to equity capital. It is
calculated as follows:
Current ratio
This is the ratio
of current assets to current liabilities. Current assets are stocks,
amounts owing and due to be received within a year, and cash. Current
liabilities are amounts owed and due to be repaid within a year.
Liquidity ratio
(also known as the acid test ratio)
This shows the
ratio of liquid assets to current liabilities. Liquid assets are debtors
(amounts owed) plus cash; current liabilities are debts the business has
to repay within a year.
Profitability
ratios
The most commonly
used profitability ratios are profit on net assets (or return on capital
employed - ROCE), and Return on Investment (ROI) showing the return on
the total investment in the business. These show how well the business
has used its investment in capital and has turned it into profit. Two
ratios combine to give the main ROCE ratio.
. Profit/sales:
indicating margins achieved and expressed as a percentage of sales
. Sales/net
assets: indicating efficiency in the use of assets and expressed as
the rate of turnover of net assets in relation to sales
Each of these has
a group of subsidiary ratios, the purpose of which is to indicate
. the order in
which improvements in performance should be sought
. the maintenance
or improvement of performance (by observing trends)
. the effect of
improvement in each area on the main ratio, profit/net assets
The
significance of this ratio is that it relates short-term obligations to
funds likely to be available to meet them. The 'rule of thumb' is that
the ratio should be about 1:1 though some sector averages tend to be
lower. Ratios below 1:1 however, may indicate financial stress. A ratio
much in excess of 1:1 may indicate inadequate credit
control or
under-utilised cash. The significance of this ratio is that it indicates
the cushion available to short-term creditors against a possible
shortfall in the realised value of current assets. The 'rule of thumb'
often quoted is that the ratio should be about 2:1, though the averages
in some industry sectors tend to be lower. A ratio in excess of 2:1 may
indicate excess stocks, inadequate credit control, or under-utilised
cash. The significance of this ratio is that outsiders are usually
unwilling to lend to a business with an unfavourable balance between the
owners' investment and borrowing from outside. Businesses in this
situation which are able to attract outside lending will find
themselves paying a heavy price for such loans. A ratio of up to 1:2
between fixed-rate capital and equity capital, is usually regarded as
satisfactory. This ratio also shows the scope for further borrowing
should it be necessary. Fixed dividend capital + long-term loans Equity
funds
COSTS AND
COSTING
There is a whole
series of internal indicators used by businesses as appropriate, to
guide them in their financial management.
Breakeven point
The level of
activity at which contribution (i.e. sales revenue less variable costs)
covers all fixed costs so that there is neither profit or loss. It may
be calculated by the use of a breakeven chart or by the use of formulas.
Breakeven chart
A chart which
indicates the approximate profit and loss at different levels of sales
volumes within a limited range. The breakeven point is critical to the
understanding of the business, for example:
. Where profits
begin to be made in a period
. Where there is
scope for marginal pricing
. The cost/volume
relationship
Costs
. Fixed costs:
Costs that do not vary with the level of business but remain constant
over a period of time and that, within certain operational limits, tend
to be unaffected by fluctuations in the level of activity. Examples are:
rent, business rates, insurance.
. Variable
costs: Costs that vary with the level of business.
. Direct costs:
Costs that can be economically identified with a specific product or
saleable service, e.g., employees, material, etc.
. Indirect
costs: Costs that can not be related directly to a specific product
or service, e.g., managers covering several areas, power, floor space in
general use, general stores, etc.
. Overhead
costs: General expenses that can not be related to products and
services, typically head office costs.
. Marginal
costs: The amount, at any given volume of business, by which
aggregate costs are changed if the volume of business is increased or
decreased by one unit; in other words the extra cost of one further unit
or the cost that would be avoided if the unit was not produced or
provided. In this context, a unit is either a single article or a
standard measure such as a litre or kilogram, but may in certain
circumstances be an operation, process, or even part of an organisation.
An understanding of the nature of the costs running through the
business is essential to proper business management (such as the
definition of the breakeven point) and to cost management.
METHODOLOGIES
Benchmarking
The assessment of
how well a business is doing against competitors and similar firms and
the analysis of what must be done to improve performance to be as good
as, and do better than, the industry leaders. Benchmarking covers
non-financial as well as financial figures. It goes without saying that
for benchmarking to be carried out properly, the business has to prepare
figures (financial as well as non-financial) that can be compared with
other businesses.
Factoring
The sale of debts
(normally only 'clean' debts, however) to a third party (the factor) at
a discount in return for prompt cash. The factor in effect takes over
the running of the sales ledger.
Invoice
discounting
As with factoring,
debts are sold to the factor but here the business continues to operate
its own sales ledger and deals with customers when collecting
outstanding debts.
Just-in-time (JIT)
A technique for
the organisation of work flows, to allow rapid, high quality, flexible
production while minimizing manufacturing waste and stock levels. This
is usually done in conjunction with suppliers who supply the products
exactly when (and only when) they are needed. The management of
supermarkets is an excellent example of the use of this technique.
Just-in-time
production
A system which is
driven by demand for finished products whereby each component on a
production line is produced only when needed for the next stage.
Just-in-time
purchasing
Matching the
receipt of material closely with usage so that raw material inventories
are reduced to near zero levels.
SWOT analysis
A critical
assessment of the business's strengths, weaknesses, opportunities, and
threats (SWOT), in relation to the internal and environmental factors
affecting the business, in order to establish its condition prior to the
preparation of a strategic review or a long-term plan.
Total quality
management (TQM)
The continuous
improvement in quality, productivity, and effectiveness obtained by
establishing management responsibility for processes as well as output.
Key suppliers
and customers
The 80/20 rule is
useful here, i.e., the 20% or so of the customers/suppliers that account
for 80% or so of the business/management time/activity/problems. It is
remarkable how constant this rule is and how widespread its application,
for example: the 20% of employees who take up 80% of the management's
time, the 20% of the fleet vehicles that cause 80% of the problems, etc.
Turnover per
employee
It is very common
to view the trends and relate this ratio to competitors and to industry
averages. |