Profit Planning, Flexible Budgets, and Performance - Coursework Example

INTRODUCTION

There are various reasons why firms, companies or business entities are formed but the major goal is profit maximization. The concept of profit maximization refers to the activities of the firm to reduce cost and increase revenue. However, some of the goals of the business entities include, social responsibility, growth, and carry out business ethics. Social responsibility is concerned with the particular firm providing goods and services to the public that maximizes their utility. Hence, the firms ensure that the requirements and desires of the customers are put into considerations. Growth is where the firm aims at acquiring huge returns to expand and enjoy the economies of scale. All business institutions work towards expanding their activities to get even higher returns. Finally, business ethics is important in any organization since it provides the code of conduct within the organization.

For the business organizations to run effectively and achieve their objectives, there has to be proper profit planning, flexible budgets, and performance. It is crucial that the three strategies are put into considerations to ensure that the companies remain in operation coping with the competition from other firms. Also, the concepts are crucial if implemented since the particular firm will operate efficiently due to proper management. The paper will discuss the concepts of profit planning, flexible budgets, and performance. Under profit planning, the paper will give the definition and the concepts under the profit planning strategy. However, in the discussion of flexible budgets, there will be adequate information on what is budget, what flexible budget entails, the types of budgets, and the constraints to flexible budgeting. The performance will be discussed by defining the concept, and the various ways of measuring the financial performance of a firm.

PROFIT PLANNING

Profit planning is a term that is used in business referring to the necessary steps that an entity should take to increase the level of profit gain. Profit maximization is one of the main objectives of any institution and it comprises of minimizing cost and maximizing revenue. “However profit maximization has some limitations in a firm which include; it ignores the time value of money, it does not put into account future uncertainties, and it ignores other participants in the firm other than the shareholders” . Planning is important in a firm, and it is done via a series of budgets that are prepared and brought through the master budget. A master budget is one of the managements tools used in communicating the plans of the management in an organization; it ensures efficient allocation of resources and coordinates activities in the institution.

Profit planning introduces the concept of responsibility accounting whereby the manager of the institution is supposed to control all factors that can be controlled either directly or indirectly in the organization. When the budget is prepared, and the required or target profit is highlighted in the budget, the manager is supposed to ensure that the required profit is achieved by controlling the costs and revenues in the firm. “In the case where the required profit is not achieved, then the manager is held responsible for the deviation of the target plan that is the deviation from the target profit” .

The manager is therefore supposed to take responsibility of all the cash inflows and outflows of the firm and ensure that there is no mismanagement of any money to get the required profit. There are the steps that are to be followed to achieve the target profit in any organization and it includes, identifying the profit goals, establishing the expected volume of sale, estimating the expenses, and determining the required profit.

Identifying the profit goals

Basing on the resources of the organization, the profit goals should be in alignment with the all of the strategic plans of the organization. The goals should be realistic and achievable to ensure that the set profit goals are easily achievable depending on the firm’s capability.

Establishing the expected volume of sale

The firm should ensure it has determined the sales that have to be made to acquire or get the target profit. Hence, the production process of the goods and the services should be set at a certain level that will enable the staff to work at maximum capacity to achieve the set sales volume. “The sales volume should be set after considering the market trends, resources at disposal, competition from other similar or different firms, and the manpower to produce the expected sales volume” .

Estimating the expenses

It is an important step in ensuring that the planned achievable profit is obtained since unnecessary expenses are a great setback to achieving the target profit. After estimating the sales volume, the expense of producing the sales volume should be established. However, the expenses should be directly adjusted according to the respective economic status of the country.

Determining the profit

The step is beneficial in determining the specific value of sales to see if the profit targeted is achievable. After determining the profit, the organization must ensure that the profit is controlled. Profit control comprises of measurements of the gaps of the difference in the targeted profit and the real profit obtained by the firm. “In cases where there is a deviation in the planned level of profit, then the organization is to take the necessary steps. The determination of the profit is obtained in the following way; Estimated Profit =Projected sales income - Expected Expenses” .

Flexible Budgets

The term flexible budget refers to the calculations of the different capacities of expenditure levels concerning the variable costs depending on the changes that arise in the actual revenue. The result after the calculation is a budget that varies depending on all the different activities that have been experienced in the firm. In the case where the where a firm puts in the actual revenues or other activity measures into the flexible budget after the completion of the accounting period, a budget with the specific inputs is produced. There are the steps that are to be followed in the creation of a flexible budget and they comprise of;

Identification of the fixed expenses and segregating them in budget model

Determination of the extent of change of the variables costs with the changes in activity measures

Creation of the budgeting model in which the fixed costs should be “hard coded” into the model. However, the variable expenditures should be stated as the percentage of the relevant activity measures.

Entering the particular activity measures to the budgeting model after completion of the accounting period

Entering the resulting flexible budget for the just completed accounting period into the firms accounting system for the purpose of comparing with the actual expenses

Types of Flexible Budgets

Basic flexible budget

The basic flexible budget alters expenses which change directly with the levels of revenue in the organization. The budget model contains a percentage that is multiplied by the real achieved revenue to get the expenses that should be at stated revenue level.

Intermediate Flexible budget

Here, some of the expenditures in an institution change with other measures of activity rather than with the revenue. For example, the expenses from the use of the telephone in a firm change with the changes in headcount.

Advanced flexible budget

Here, the expenditures may vary only due to or with particular ranges of the firm’s revenue or other activities. “However, on the outside of the firm’s range, a different quantity of expenditure might apply, and the sophisticated, flexible budget is likely to change for the firm concerning the expenditures if only the measurements that they are relying on exceed the target ranges” .

Advantages of the Flexible Budget

It is possible to use it in an environment with variable costs where the costs are aligned with the firm’s business activities like retail environment.

It can be used as a means of measuring the performance of the business due to the ability of the flexible budgets to restructure itself basing on the levels of the business activities hence making it possible to evaluate the performance of the managers.

It provides an efficient way of budgeting since it can be used to adjust or update a budget where the revenue of the firm or other activities have not been finalized.

Limitation of Flexible Budgeting

“It has a sophisticated way of formulating it since it contains much expenditure that is not fully variable”. Therefore, due to the sophistication or complication in its formulation, it wastes a lot of time in preparing .

PERFORMANCE

Performance refers to the quantifiable indicator that businesses use to evaluate if the desired objectives or targets of the entity are being met. The performance of a business entity should be high since the earnings of the institution depend wholly on the performance of the staff. There should be set ways of determining and measuring the performance of an institution. “There are multiple ways of measuring the performance of a firm in account, some of the ways comprise of measurement of performance as the level of; Return on Assets, Return on Equity, Tobin-Q, Profit Margin, and Earnings Per Share” .

Return on Assets

It is a concept that is used to determine the level of profit in a firm relative to the cumulative assets that the firm obtains. It gives the exact efficiency level of how the management uses the assets of the firm to generate revenue. It is calculated as follows;

ROA=

Return on Equity

Return on equity is amount of net income that is returned in percentage of the shareholder's equity. It measures the level of profitability index by showing the exact amount that is earned through the money invested by the shareholders. It is calculated as follows;

Tobin-Q

It refers to the ratio of the market value that belongs to the company’s assets and the divide by the book value or the replacement value. The formula is as follows;

Profit Margin

Profit margin refers to the maximum amount that the revenue generated by the firm exceeds the costs of the firm. The formula is as follows;

Earnings per share

Earnings per share comprise of the proportion of a firm’s profit that is allocated to every outstanding share of the common stock. It generally indicates the level of the firm’s profit and the formula is as follows;

“Measuring the performance of the company or the business entity helps in drawing conclusions; if the firm is generating required profit if the managers are performing their duties, if the company is experiencing a loss and it helps in implementing new policies and eradicating unfruitful policies in the company” . Therefore, it is justifiable to conclude that measuring the performance of the company is important as it gives the financial position of the company.

Conclusion

Profit planning is a term that is used in business referring to the necessary steps that an entity should take to increase the level of profit. Making profit is one of the main objectives of a company and the necessary steps should be implemented. There are the steps that are to be followed to achieve the target profit in any organization and it includes, identifying the profit goals, establishing the expected volume of sale, estimating the expenses, and determining the required profit. On the other hand, flexible budget refers to the calculations of the different capacities of expenditure levels concerning the variable costs depending on the changes that arise in the actual revenue. There are various types of flexible budgets, and they include basic flexible budget, intermediate flexible budgets, and the advanced flexible budget.

One of the main advantages of flexible budgets is that it is possible to use it in an environment with variable costs where the costs are aligned with the firm’s business activities like retail environment. Performance refers to the quantifiable indicator that businesses use to evaluate if the desired objectives or targets of the entity are being met. The returns of the business should be high as an indicator that there is a positive increase in the performance of the company compared to previous performances. Measuring performance of the company gives the financial power of the organization which then determines if the company is ready for expansion or not.