PROFIT PLANNING

Profit

ž"Profit is a condition of survival.  It is the cost of the future, the cost of staying in business".  Peter Drucker

žProfit is an essential cost of business activity and must be planned and managed just like other costs.  Successful business performance requires balancing costs and revenues.

WHAT IS PROFIT PLANNING ?

DEFINITION:

Process of developing a profit plan that outlines the planned sales revenues and xpenses and the net income or loss for a time period. Profit planning requires preparation of a master budget and various analyses for risk and what-if scenarios. Tools for profit planning include the cost -e volume - profit (cvp) analysisand budgeting.

HOW IS IT USED?
The profit plan is used in the following ways:
Evaluating operations.
Determining the need for additional resources such as facilities or personnel.
Planning purchasing requirements.
Anticipating any additional financing needs. Advantages of Profit Planning

Advantages of Profit Planning: 

1.      Performance evaluation. 

2.      Awareness of responsibilities. 

3.      Cost consciousness. 

4.      Disciplined approach to problem-solving.

5.      Thinking about the future. 

6.      Financial planning. 

7.      Confidence of lenders and investors.

Factors Affecting Sales

       žAfter categories have been selected and current sales divided among them, the various factors which can affect sales in each category must be considered. These factors could be either internal or external. Internal factors are those that you can influence. External factors are those that affect the market served by your business, but are generally beyond your control.

·         Internal Factors 

·         External Factors

 Internal Factors:

The following are typical internal factors that could influence your sales forecast:

ž  Promotional plans

ž  Expansion plans

ž  Capacity restrictions

ž  New product introductions

ž  Product cancellations

ž  Sales force changes

ž  Pricing policy

ž  Profit expectations

ž  Market expansion to new customers or territories

External Factors:

ž  Among the external factors that must be considered are the following:

ž  Business trends

ž  Government policies

ž  Inflation

ž  Changes in population characteristics

ž  Economic fortunes of customers

ž  Changes in buying habits

ž  Competitive pressures

Sales forecasting approaches:

•       Judgment Based Method

•       Quantitative Models

v  Time Series Analysis

•       Other Methods Of Forecasting Sales

v  Multiple Linear Regression

v  Exponential Smooting

v  Box Jenkins Metod

v  Econometrics

Time series analysis:

ž  A time series is a set of observations generated sequentially in time

ž  Continuous vs. discrete time series

ž  The observations from a discrete time series, made at some fixed interval h, at times t₁, t₂,…, t_N may be denoted by x(t₁), x(t₂),…, x(t_N)  

Introduction (cont.):

ž  Discrete time series may arise in two ways:

¡  1- By sampling a continuous time series

¡  2- By accumulating a variable over a period of time

ž  Characteristics of time series

¡  Time periods are of equal length

¡  No missing values

Components of a time series:

InAreas of application: ž  Forecasting ž  Determination of a transfer function of a system ž  Design of simple feed-forward and feedback control schemes Forecasting: ž  Applications ¢  Economic and business planning ¢  Inventory and production control ¢  Control and optimization of industrial processes ž  Lead time of the forecasts is the period over which forecasts are needed ž  Degree of sophistication ¢  Simple ideas ¢  Moving averages ¢  Simple regression techniques ¡  Complex statistical concepts ¢  Box-Jenkins methodology Approaches to forecasting:  Self-projecting approach ž  Cause-and-effect approach ARIMA models: ž  Autoregressive Integrated Moving-average ž  Can represent a wide range of time series ž  A “stochastic” modeling approach that can be used to calculate the probability of a future value lying between two specified limits ARIMA models (Cont.): ž  In the 1960’s Box and Jenkins recognized the importance of these models in the area of economic forecasting ž  “Time series analysis - forecasting and control” ¡  George E. P. Box              Gwilym M. Jenkins ¡  1st edition was in 1976 ž  Often called The Box-Jenkins approach Forecasting expenses: ž  What is an expenses forecast? ž  The expenses forecast is an estimate of your ongoing operating expenses (overheads, outgoings, fixed costs) for the year. It answers the question of how much it will cost to run your business. The selling price of your products or services must include an amount to recover these expenses. Definition of 'Break-Even Analysis: ž  An analysis to determine the point at which revenue received equals the costs associated with receiving the revenue. Break-even analysis calculates what is known as a margin of safety, the amount that revenues exceed the break-even point. This is the amount that revenues can fall while still staying above the break-even point. Uses of Break-even analysis: ž  Break-even analysis is a useful tool to study the relationship between fixed costs,variable costs and returns. A break-even point defines when an investment will generate a positive return and can be determined graphically or with simple mathematics. ž   Break-even analysis computes the volume of production at a given price necessary to cover all costs. Break-even price analysis computes the price necessary at a given level of production to cover all costs." "The main advantage of break-even analysis is that it explains the relationship between cost, production volume and returns. It can be extended to show how changes in fixed cost-variable cost relationships, in commodity prices, or in revenues, will affect profit levels and break-even points. Break-even analysis is useful when used with partial budgeting or capital budgeting techniques. The major benefit to using break-even analysis is that it indicates the lowest amount of business activity necessary to prevent losses."