Revise Lecture 19

Profit Planning Benefits of planning 1.Anticipation of problems and opportunities 2.Coordination of actions 3.Assistance in control 4.Providing standards of performance 5.Time saving

Benefits of planning Anticipation of problems and opportunities Planning involves people at different levels in the organization and forces them to think ahead. This encourages managers on varying levels to anticipate possible problems and to attempy to identify potential opportunities.

Benefits of planning Coordination of actions Because they are involved in planning discussions with others in management positions, managers begin to coordinate courses of action. Frequently, early coordination facilitates the achievement of company goals by increasing communication and reducing potential conflicts.

Benefits of planning Assistance in control Plans may be used as tools to help managers control their areas of operation. A detailed plan gives department and divisions specific goals to pursue and means to achieve the goal. As the firm conducts its operation, managers can watch for variations from the plan that indicate a need for tighter supervision and control.

Benefits of planning Providing Standards of performance A comparison of the plan with actual performance during the planning period can be used to provide a standard of achievement. Did the company reach the goals outlined in the plan? If not, why not? Did certain areas perform exceptionally well? Answers to such questions help the firm evaluate its own performance during a recent operating period

Profit Planning Budget A budget is the result of financial planning. Stated simple, a budget is a formal plan expressed in dollar /Rs. The process of financial planning is frequently called budgeting; it makes use of pro forma financial statements. SFP, Income statement, fund-flow statements and other formal statements may be incorporated in the firm’s budgets.

Profit Planning Break-Even and Profit-Volume Analysis A fundamental profit-planning tool involves the determination of the likely profits at different levels of production. To develop the necessary calculations, the financial managers builds on the basic tool of break-even analysis and expands it through profit-volume analysis.

Profit Planning Break-even analysis is used to determine the level of operations at which a firm neither makes a profit nor loss money. At this level, the firm operates at a zero profit level, or break-even point. Break-even analysis makes use of fixed costs, variable costs and revenues and may be used graphically or mathematically/

Profit Planning Graphic approach to Break-Even Analysis The costs that are included in the analysis are: 1. Fixed costs remain the same at all levels of production. An example would be the rent paid on a building. 2. variable costs change directly with the number of units produced. At 0 units of production, the firm incurs no variable costs.

Profit Planning As production rises, the variable costs rise proportionately. Two aspects of variable costs are important and should be noted: A) Variable costs plotted as total costs. If the variable costs are plotted from 0 point on the graph, they reflect only the variable costs of production

Profit Planning B) Variable costs as constant costs. It is traditional to plot unit variable costs using a straight line. This implies that unit variable costs are constant costs, that is they are the same at all levels of production.

Draw p137

Future Earnings Per Share In financial planning, it is important that the firm consider the effect of different course of action on the value of the stock. If the firm takes actions that cause a decline in the market price of the common stock, management may be criticized by angry shareholders. A valuable tool for analyzing the future market price of the stock is the calculation of future earnings per share.

Future Earnings Per Share Why future earnings per share are critical? In profit planning, two measures of corporate profits are especially important: 1.Return on Investment (ROI) 1.Earnings per Share (EPS)

Future Earnings Per Share Return on Investment (ROI) This is an operating indicator of profits and a key measure of the success of the firm’s management. If this ratio is high, the firm is generating sufficient sales on its assets base and is making sufficient profit margins on its sales. The use of ROI allows a financial manager to make comparisons of the different firms or of the same firm in different time periods.

Future Earnings Per Share Earnings per share (EPS) This is market indicator of profits and the most important profit measure for stockholders and other individuals outside the firm. If the earnings continue to increase on a per- share basis, the firm is judged to be increasingly successful. On the other hand, a drop in earnings per share is viewed as a symptom of problems.

Future Earnings Per Share Other factors related to future EPS 1.Risk from high levels of debt 2.Growth 3.Difficulties in Implementing proposals 4.Risk from uncertain ventures or unstable returns