SMALL BUSINESS FINANCE CHAPTER 5 Profit Planning

1. Small Business Finance
Ch 5: Profit Planning

2. Process that outlines the planned sales revenues and
expenses and the net income or loss for a time period.
Contents of a profit plan are
• The firm’s objectives set by the owner
• How to achieve these objectives.
• A feedback on tracking the objectives(feedback).
Profit Planning
Profit planning is the set of actions taken to achieve a targeted
profit level. These actions involve the development of an
interlocking set of budgets that roll up into a master budget.

3. Issued to be resolved before profit
planning
Following two issues must be resolved before
developing the profit plan.
1. Who is to give responsibilities to formulate
plan?
2. What should be the content of the plan
required?
Profit Planning
A General Framework

4. For large organization
1. special staff is hired for planning
2. a group of people formed form organization
of specific department
For small organization limitation
1. Limited resources to hire experts
2. For group formation all the key employee are
engaged in planning activity either they are expert
or not
A General Framework
Planning Authorities

5. • The plan is initiated by establishing the firm’s statement
of objectives.
• The time periods could be quarterly if the profit plan is
applicable for the forth-coming year or annual for long
term profit plan.
A general framework for profit plan
1. Statement of operating profit objectives
I. short term quarterly basis objectives
II. long yearly basis objectives
III. Parameter define for planning process
Profit Planning
Profit Planning

6. A general framework for profit plan
2nd phase - Basic Guidelines.
I. Assumption related to profit plan
II. profitable assets detail
III. limitation on acceptable risk levels
3rd phase Operation plan for each department.
I. Identify of alternatives
II. Revenue and cost estimate for the various alternatives
III. Selection of specific option and corresponding statement of objective
IV. Plan of action for achieving objective
4th Phase Financial Plan For The Company.
i. Anticipate earning contribution for each department summarized
ii. Projected capital investment for each departments
iii. Cash budget statement
iv. pro forma profit and loss statement
v. Performa balance sheet
5th MIS (Management Information System).
I. Establish procedure
II. Timing for analyzing the progress being made toward the stated company
objective

7. There are two key elements in predicting the company’s
profitability:
sales and the related costs and expenses.
Forecasting Sales
Sale Forecasting Approaches
There are two basic approaches to forecasting sales
1. the judgment based method
2. use of quantitative analysis.
Profit Planning
Developing The Plan
the process of estimating future revenue by predicting the amount of
product or services a sales unit in specified period of time .(next week,
month, quarter, or year.)

8. Judgment Based Method
Judgment based method relies upon management, firm owners
and on consensus opinion .
In using the judgment or subjective approach, the historical
sales data, combined with the assumptions about the external
and internal assumption, serve as the foundation.
Profit Planning
Forecasting Sales Method
Internal Assumptions
Past sales patterns
Changes in the size and
composition of the sales staff
Advertising budget
Pricing Policies
Availability of supplies
External Assumptions
General Economy
Industry Trends
Competitive conditions
Government Actions

9. Forecasting sales
Quantitative Method
he quantitative forecast method uses past data
to forecast future data especially with
numerical data and continuous pattern. This
method is generally used for short term
predictions. It is based on mathematical models
and objective in nature.
Profit Planning
Forecasting Sales Method

10. Exponential Smoothing
Exponential smoothing is a time series forecasting method for
univariate data that can be extended to support data with a
systematic trend or seasonal component.
widely preferred class of statistical techniques and procedures
for discrete time series data, exponential smoothing is used to
forecast the immediate future. This method supports time
series data with seasonal components, or say, systematic trends
where it used past observations to make anticipations.
Exponential smoothing methods is a method for
continually revising an estimate or forecast by accounting
for fluctuations in the data.

11. The Simple Exponential Smoothing method used for time series have no
trend (stationary) and the mean (or level) of the time series Yt is slowly
changing over time.
Formally, the simple exponential smoothing model is
Exponential Smoothing

12. Box-Jenkins Method
The Box-Jenkins Model is a forecasting methodology
using regression studies on time series data. The
methodology is predicated on the assumption that past
occurrences influence future ones. The Box-Jenkins Model
is best suited for forecasting within time frames of 18
months or less.
consists of the following 3 steps:
Identification. Use the data and all related information to help select a sub-
class of model that may best summarize the data.
Estimation. Use the data to train the parameters of the model (i.e. the
coefficients).
Diagnostic Checking. Evaluate the fitted model in the context of the
available data and check for areas where the model may be improved.

13. Econometric
Econometric forecasting models are systems of relationships
between variables such as GNP, inflation, exchange rates etcetera.
Their equations are then estimated from available data, mainly
aggregate time series
The econometric methods are comprised of two basic methods, these are:
Regression Method: The regression analysis is the most common method used to
forecast the demand for a product. This method combines the economic theory
with statistical tools of estimation.
Simultaneous Equations Model: Under simultaneous equation
model, demand forecasting involves the estimation of several
simultaneous equations. These equations are often the behavioral
equations, market-clearing equations, and mathematical identities.

14. An expenses forecast estimates your ongoing
operational costs over a period of time.
There are two major types of cost which are to be forecasted.
o Fixed costs are fixed so forecasting fixed cost is easier due to their fix
nature. they tend to remain constant within relevant Range of
production
o Variable costs move directly with the firm activity level. Variable
expenses change in constantly proportion with dollar rate
o Semi-variable cost. contain both fixed and variable element enhance
if activity level reach to zero there would still be a fixed amount of
expenses incurred .
Forecasting Expenses

15. Break Even Analysis refers to the point in which total
cost and total revenue are equal.
A break even point analysis is used to determine the
number of units or dollars of revenue needed to cover
total costs (fixed and variable costs).
The firm just at “breaks even.”
Break Even Analysis

16. Profit Planning
Break Even Analysis

17. Break Even in units
Revenues = Cost
Unit Sale Price X Quaintly Of Unit Sold = Fixed Cost + (Units Variable Cost X
Quantity Of Unit Sold)
BEP units = Total Fixed Costs
Unit Sale Price – Unit Variable Cost
BEP units = Total Fixed costs
CM per unit
Profit Planning
Break Even Analysis

18. Break Even in sale in dollar
Dollar sale at breakeven point = fixed cost +total variable cost
BEP revenues = Total Fixed costs
Profit Planning
Break Even Analysis

19. • To calculate the minimum amount of sales required
in order to be able to break even.
• To see how changes in output, selling price or costs
will affect profit levels.
• To calculate the level of output required to reach a
certain level of profit.
• To allow various scenarios (what-if) to be tested out.
• To aid forecasting and planning.
Uses of break even analysis

20. • It’s accuracy depends upon the accuracy of the data
used.
• Forecasting the future is difficult, especially long
term.
• It assumes there is a simple relationship between
variable costs and sales.
• Sales income does not necessarily rise in a constant
relationship to sales volume.
Limitations of break even analysis

21. The percentage change in operating profit
resulting from 1 percent change in sales.
o It refers to the ability of firm to generate an
increase in net income when sales revenue
increases.
Operating Leverage

22. DOL = Contribution Margin
Operating Income
DOL = Increase in operating profit/ Operating profit
Increase in sale / Sales
Profit Planning
Operating Leverage