Financial Planning
Unit 2: Managing Business Activities
Financial Planning
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Sales volume is how many units are sold; sales revenue is what they were sold for. Revenue is price multiplied by volume, so the two can move in opposite directions.
Sales volume counts things. Sales revenue counts money. The specification lists them together and it lists them as two calculations, because a firm that reports "sales are up" has told you nothing until you know which one it meant.
Sales revenue = selling price × sales volume. Melaka Bottling sells bottled fruit drink by the case at $6. At 20,000 cases a month its revenue is $120,000.
Because revenue is a product of two numbers, a change in one can be undone by a change in the other. Sell 24,000 cases at $5.40 and the volume is up by a fifth while the revenue is $129,600 — up by only $9,600. Sell 24,000 at $4.80 and the volume is up a fifth while the revenue has FALLEN to $115,200.
So the two questions a firm asks are different questions: how many can we sell, and what will we take for them. Everything in this chapter is one or the other.
Real Example: A juice bottler that wins a supermarket listing reports a jump in volume and a fall in revenue per case at the same time, because the listing was won on price. Both statements are about the same quarter.
Exam Matters: Appendix 6 defines Calculate as requiring a calculation based on given data, with workings shown. Show the multiplication, not only the product: $6 × 20,000 is the working and $120,000 is the answer.
A fixed cost does not change when output changes; a variable cost does. The split is a statement about a period of time, not about the kind of cost.
A fixed cost does not change when output changes. Melaka Bottling pays $36,000 a month in rent, insurance and salaried staff whether it bottles 0 cases or 25,000.
A variable cost changes directly with output. Every case needs $3.60 of concentrate, bottles, caps and power. Make one more case and $3.60 more is spent; make none and none is spent.
The word that does the work in both definitions is OUTPUT. A cost is not fixed because it is large or because it arrives monthly — it is fixed because output does not move it.
And the split holds only for a stated period. Over a month the rent is fixed. Over three years the plant could move to a smaller building, and then the rent is a choice like any other. This is why chapter 3 lists "costs split cleanly in two" as an assumption rather than a fact.
Real Example: A bottling line's electricity bill has a standing charge that arrives whether the line runs and a unit charge that only arrives when it does. One bill, and the two halves sit on different lines of the cost table.
Exam Matters: Appendix 6 defines Explain as requiring a brief explanation of cause or effect supported by details or an example. A cost named fixed needs the reason it does not move with output, not a list of costs that usually are.
Total cost is fixed plus variable at that output. Average cost is total cost divided by output, and it falls as output rises because the fixed cost is spread wider.
Total cost = fixed costs + total variable costs. At 20,000 cases the plant's variable costs are $3.60 × 20,000 = $72,000, so total cost is $36,000 + $72,000 = $108,000.
Average cost = total cost ÷ output. At 20,000 cases that is $108,000 ÷ 20,000 = $5.40 a case.
Average cost falls as output rises, and the reason is entirely in the fixed half. The variable cost per case is $3.60 at every output. The $36,000 is what gets divided: $3.60 a case at 10,000 cases, $1.80 at 20,000, $1.44 at 25,000.
One row of the chapter's table is worth marking now. At 15,000 cases average cost is $6 — exactly the selling price. A firm whose average cost equals its price is taking in precisely what it spends, and chapter 3 calls that output the break-even point.
Real Example: A plant running one shift instead of two has a higher cost per case than the same plant at full use. The equipment and the building cost the same either way; there are simply fewer cases to divide them between.
Exam Matters: Appendix 6 defines Calculate as requiring workings. An average cost answer with no total cost line above it cannot be followed, because the marker cannot see which output was divided into which total.
Volume is raised by giving more buyers a reason to buy: a lower price, a wider distribution, a change to the product, or promotion that reaches people who had not considered it.
Raising volume means selling more cases. Four routes, and they are not equally available to every firm.
Two of the four cost money up front and none of them is free. A wider distribution needs a discount to the wholesaler; a reformulation needs development; promotion is spent before any extra case is sold. So each route has to be judged against the extra revenue it brings, which is the comparison chapter 3 gives the tools for.
Real Example: A drinks bottler that adds a small single-serve pack alongside its multipack reaches buyers who were never going to carry a multipack home. The product changed; the price per litre went up rather than down.
Exam Matters: Appendix 6 defines Explain as requiring cause or effect supported by details or an example. "Advertise more" is not a cause; "advertise in the region the new depot serves, so the buyers who can now be supplied know the product exists" is.
Revenue can be raised by a higher price or by more volume, and a price cut does both at once in opposite directions. Whether revenue rises depends on how much volume answers.
Revenue is price × volume, so there are two levers and they pull against each other. Raise the price and each case earns more while fewer are sold. Cut it and more are sold while each earns less.
Take the plant's cut from $6 to $5.40, which lifts volume from 20,000 to 24,000 cases. Revenue goes from $120,000 to $129,600 — up $9,600. The cut worked on revenue.
Now the other half. Those extra 4,000 cases carried $3.60 of variable cost each, so total cost went from $108,000 to $122,400. Profit is revenue less total cost: $129,600 − $122,400 = $7,200, against $12,000 before. Revenue up $9,600, profit down $4,800.
This is why the specification names volumes and revenues as two things, and why neither is the same as a third thing the firm actually wants. A route that improves revenue is worth having; it is not automatically worth taking.
Real Example: A bottler that runs a promotional price for a quarter reports its best revenue quarter and a worse operating result than the quarter before it. Both figures are correct and they are measuring different things.
Exam Matters: Appendix 6 defines Analyse as requiring a brief chain of reasoning, and interpretation where it is applied to given data. The chain here has three links: lower price, higher volume, and the variable cost the higher volume brings with it.
A sales forecast is an estimate of future sales volume, and it is the first figure in the section: break-even, cash flow and every budget are built on top of it.
A sales forecast is an estimate of how much will be sold in a future period. It is a volume, usually by month, and it is the figure everything else in this section starts from.
Follow it through the plant. The forecast says 20,000 cases a month. That figure decides how much concentrate to order and how many shifts to roster; it is the output the break-even calculation is compared against; it is the receipts line of the cash-flow forecast; and it is the revenue line of the budget.
So the forecast is not a prediction the firm makes and files. It is a planning figure, and a wrong one is wrong four times over: too much concentrate, a margin of safety that was never there, a cash-flow forecast that promised receipts the firm will not get, and a budget every department is measured against.
That is also the honest answer to "how accurate does it need to be". Accurate enough that the decisions it drives would not have been different — which is a lower bar for a shift roster than for a decision to buy a second line.
Real Example: A bottler orders concentrate three months ahead because the supplier ships by sea. The order is placed against a forecast, so the forecast is a commitment of cash long before any of it is sold.
Exam Matters: Appendix 6 defines Define as requiring the meaning of a term or phrase. Two marks for a sales forecast is the estimate and the period it covers, which are two things and not one said twice.
A consumer trend is a lasting change in what buyers want, and it moves a forecast because the past sales the forecast started from were made under the old preference.
The first of the specification's three factors. A consumer trend is a change in what buyers want that persists — not a good week, and not a seasonal swing that comes back the following year.
The plant's market is moving from sweetened drinks to lower-sugar ones. Half its range is sweetened, so the forecast for those lines is too high: last month's sales were made by buyers some of whom have now changed what they reach for. The adjustment is 2,000 cases off the base.
Direction is not the whole of it. A trend can also be an opportunity that a forecast built on the past cannot see: the low-sugar half of the same range is being carried by the same trend upwards, and a forecast that adjusts one line and not the other is wrong twice.
The hard part is telling a trend from a wobble, and the test is whether the reason for it is still true next year. A change in what people think a drink is for outlasts a hot month.
Real Example: A bottler whose sweetened range had grown for a decade sees it flatten while its unsweetened line grows. Nothing about either product changed; what buyers wanted from the category did.
Exam Matters: Appendix 6 defines Analyse as requiring a brief chain of reasoning without evaluation. The chain is trend, then the product line it touches, then the direction the forecast moves — three links and no judgement at the end.
Incomes, interest rates and exchange rates change how much buyers can spend and what the product costs them, so they move a forecast the firm has done nothing to cause.
The second factor. Economic variables are conditions outside the firm that change what buyers can spend or what the product costs them. Three matter for a forecast.
Notice that all three arrive as a change in VOLUME on the forecast even when they start as a change in a price or a cost. That is the discipline of this chapter: a forecast is a number of cases, so every factor has to be turned into cases before it can be used.
And the firm does not choose any of them. A forecast that ignores economic variables is not optimistic, it is incomplete.
Real Example: A bottler importing concentrate and selling locally is exposed twice: a weaker local currency raises what it pays and leaves its buyers no better off. Neither effect is anything it did.
Exam Matters: Appendix 6 defines Explain as requiring cause or effect supported by details. The detail that earns the second half is the route: rates to disposable income to this product's volume, not rates to "demand falls".
A rival's price, product or distribution changes what the same buyers are offered, so a forecast built on the firm's own plans can be wrong without the firm changing anything.
The third factor, and the one a firm most often leaves out of its own forecast, because a forecast is usually built from the firm's plans and a competitor is not in them.
A rival is opening a plant in the plant's own region. It will compete for the same shelf space, and the adjustment is 3,000 cases off the base — the largest of the three.
A competitor can move a forecast four ways: a lower price, a new product, wider distribution, or promotion that reaches the same buyers first. The effect on the forecast is the same in kind each time — some of the volume the firm assumed was going to be sold by someone else.
The three factors together are why the revised figure is not simply the base one adjusted downwards. One of them adds and two subtract: 20,000 − 2,000 + 1,200 − 3,000 = 16,200 cases.
Real Example: A regional bottler's volume falls the quarter a national brand starts delivering to the same wholesalers. Its own price, product and promotion were unchanged all quarter.
Exam Matters: Appendix 6 defines Analyse as including interpretation where it is applied to given data. Applied to a forecast table, that means saying which line moved and by how much, not that the forecast "may be inaccurate".
A forecast is hard because there may be no history to reason from, the three factors move together, the forecaster is not neutral, and better information costs money.
The specification asks for the difficulties in their own right, and they are not a list of ways the number can be wrong. They are reasons why it cannot be made much better.
The third one is worth slowing down for, because it is the only one that is about a person. A forecast prepared to support a decision already taken is pulled towards the figure that supports it, and nobody in the process has to be dishonest for that to happen.
These four are also the limitations of everything built on the forecast. Chapter 4's receipts line and chapter 5's revenue budget are both this number, so both inherit all four.
Real Example: A bottler launching an unfamiliar flavour has no past sales for it at all, so the forecast is built from a comparable product in another market and a judgement about how close the two are.
Exam Matters: Appendix 6 defines Discuss as requiring chains of reasoning in context with a brief assessment showing awareness of competing factors. An eight-mark Discuss on forecasting needs two of these difficulties developed, not four named.
Contribution is selling price minus variable cost per unit. It is what one more unit leaves behind towards the fixed costs once its own costs are covered.
Contribution = selling price − variable cost per unit. For the plant: $6 − $3.60 = $2.40 a case.
The name says what it is for. Each case pays its own variable cost out of its own price, and what is left over CONTRIBUTES to the fixed costs. Sell one case and the plant is $2.40 nearer to covering the $36,000.
So contribution is not profit. Until the whole $36,000 has been covered there is no profit at all, however many cases have contributed. It is the rate at which the fixed cost is being paid off.
Because it is a per-case figure, only two things change it: the price and the variable cost per case. A change in the fixed costs leaves the contribution exactly where it was — which is why the three change cases later in this chapter behave differently from one another.
Real Example: A bottler asked to quote for a one-off export order checks the contribution per case before the price: as long as the price covers the variable cost with something left over, the order helps pay costs the plant already owes.
Exam Matters: Appendix 6 defines Calculate as requiring workings shown. Contribution is a subtraction and the subtraction is the working: a bare $2.40 cannot be followed, because the marker cannot see which two figures produced it.
The break-even point is the output at which total fixed costs plus total variable costs equal total revenue, so the firm makes neither a profit nor a loss.
The specification states it as an equality: total fixed costs + total variable costs = total revenue. The output at which that is true is the break-even point.
Check it on the plant at 15,000 cases. Revenue is $6 × 15,000 = $90,000. Costs are $36,000 + $3.60 × 15,000 = $36,000 + $54,000 = $90,000. The two are the same number, so the plant makes neither a profit nor a loss.
This is also the row flagged in chapter 1. Average cost at 15,000 cases is $90,000 ÷ 15,000 = $6, which is the selling price. A firm breaking even is one whose average cost has fallen to its price.
Neither a profit nor a loss is not the same as nothing happening. The $36,000 of fixed costs has been paid in full, and so has every $3.60 of variable cost. Break-even is the point at which the firm has covered everything it owes and no more.
Real Example: A bottling plant commissioning a second line asks how many cases the line has to sell before it stops costing money. The answer is an output, not a date, and it is the same question as this one.
Exam Matters: Appendix 6 defines Define as requiring the meaning of a term. Break-even point defined without the words output or units has not said what kind of quantity it is.
The break-even point is fixed costs divided by contribution per unit, because contribution is the amount each unit pays towards the fixed costs.
Checking an output to see whether it breaks even is slow. The specification asks for the shortcut, and the shortcut is the contribution: break-even point = fixed costs ÷ contribution per unit.
For the plant: $36,000 ÷ $2.40 = 15,000 cases. The same answer as the equality, in one step.
The division works because of what contribution is. Each case pays $2.40 towards the fixed costs, so the question "how many cases to cover $36,000" is a division and nothing more. If the formula is remembered without that sentence, it is remembered upside down as often as not.
And now the three cases the specification's interpretation bullet is really about. Change ONE figure at a time and the break-even point moves: price rises by $0.60 a case and it goes to 12,000; fixed costs rise by $6,000 a month and it goes to 17,500; variable cost rises by $0.40 a case and it goes to 18,000. A rise in fixed costs moves it by a different amount from a rise in variable cost, because the first changes the numerator and the second changes the divisor.
Real Example: A bottler told its concentrate will cost more next year recalculates before it renegotiates: a rise in the variable cost per case raises the break-even point more than the same money added to the rent would.
Exam Matters: Appendix 6 defines Calculate as requiring a calculation based on given data with workings. A break-even answer needs the contribution line first: $6 − $3.60 = $2.40, then $36,000 ÷ $2.40.
The margin of safety is current or forecast output minus the break-even point: how far sales can fall, in units, before the firm stops covering its costs.
Margin of safety = actual or forecast output − break-even point. For the plant at 20,000 cases: 20,000 − 15,000 = 5,000 cases.
It is measured in cases, like the break-even point itself, and it answers one question: how much can go wrong before this stops working. 5,000 cases is 25% of the plant's output, so sales could fall by a quarter and it would still be covering its costs.
The figure is only as good as the output it starts from, which is why chapter 2 matters here. Apply the three forecast factors and output becomes 16,200 cases, so the margin of safety falls from 5,000 to 1,200 — from 25% of output to 7.4%. The break-even point never moved.
That is the useful shape of this idea. A margin of safety can shrink because the break-even point rose OR because the output fell, and the two have different answers: the first is a cost or price problem, the second is a demand problem.
Real Example: A bottler with two thirds of its volume going to one wholesaler reads its margin of safety differently from one selling to thirty: the same number of cases is less reassuring when one customer can remove most of it.
Exam Matters: Appendix 6 defines Calculate as requiring workings. A margin of safety answer shows the break-even point being worked out first, because the margin is a subtraction from it and cannot be checked without it.
The revenue line starts at the origin and the cost line at the fixed costs. They cross at the break-even point, and the gap between them is the profit or the loss.
The specification asks for interpretation of break-even charts. Reading one is a matter of knowing where each line starts and what the space between them means.
The revenue line starts at the origin. Nothing sold is nothing earned, so at zero output revenue is zero. It rises by $6 for every case.
The total cost line starts at the fixed costs. At zero output the plant still owes $36,000, so the line begins at $36,000 on the money axis and rises by $3.60 a case — more gently than the revenue line, which is why they meet.
They cross at the break-even point, 15,000 cases and $90,000. Left of the crossing revenue is below costs and the vertical gap is a loss; right of it the gap is a profit. At 20,000 cases the gap is $120,000 − $108,000 = $12,000, which is the profit read straight off the chart.
The margin of safety is on the output axis, not in the money: the distance from 15,000 to 20,000. Two different questions, read in two different directions.
Real Example: A lender reviewing a bottling plant's proposal looks first at how far the current output sits to the right of the crossing, because that distance is the room the plant has before the loan stops being serviced.
Exam Matters: Appendix 6 defines Analyse as including interpretation when applied to given diagrams or data. Interpreting this chart means naming the output at the crossing and the gap at a stated output — reading values off it, not describing what the lines look like.
Break-even analysis assumes one price, a clean split between fixed and variable costs, and that everything made is sold — and it holds all three still.
The useful limitations are not "it might be wrong". They are the assumptions the straight lines are made of.
The second reaches furthest. Chapter 1 defined fixed and variable for a stated period, and over a long enough period every cost is a choice — so a break-even point worked out for a month cannot judge a three-year decision.
None of this makes the analysis useless. The three change cases are what it is good at. The limitation is in treating one point as a forecast rather than as a comparison.
Real Example: A bottler that discounts heavily for large orders has no single selling price, so its revenue line is not straight and its chart puts the crossing further left than the discounted reality does.
Exam Matters: Appendix 6 defines Evaluate as requiring a full awareness of the validity of competing factors leading to a conclusion that proposes a solution or recommendation. A twenty-mark answer here has to say what the firm should do given the limitation, not only that it exists.
A cash-flow forecast lists receipts and payments month by month. Net cash flow is receipts minus payments, and the closing balance is the opening balance plus that.
A cash-flow forecast is a table of money in and money out, month by month. Five lines, and they are always in the same order.
Opening balance is the cash the firm starts the month with. Receipts is money actually arriving. Payments is money actually leaving. Net cash flow is receipts − payments. Closing balance is opening balance + net cash flow — and it becomes the next month's opening balance, which is the line that makes the table a forecast rather than three separate months.
The word doing the work is ACTUALLY. The plant gives its customers 30 days to pay, so month 1's receipts are not month 1's sales — they are the 12,000 cases sold the month before, at $6, which is $72,000. Meanwhile month 1's payments are for month 1's output: $36,000 fixed plus $3.60 × 20,000 = $108,000.
Net cash flow for month 1 is therefore $72,000 − $108,000 = −$36,000, and a $30,000 opening balance closes at −$6,000. Nothing about the plant's trading went wrong in that month.
Real Example: A bottler paying its concentrate supplier on delivery and collecting from wholesalers a month later carries the gap itself. The size of that gap is a line on the forecast, not an opinion about the customers.
Exam Matters: Appendix 6 defines Construct as requiring an accurately labelled diagram, and says the type may be stated or chosen. Constructing a cash-flow forecast means the five labelled lines in order, with the closing balance carried into the next column.
The line to read is the closing balance across the months: where it goes negative, and how deep, is the question the forecast was built to answer.
A constructed forecast is read along ONE line. The closing balance for the plant's three months runs −$6,000, then −$8,400, then $13,200.
Two things are worth saying about that sequence. It goes negative in month 1 and it is negative again in month 2, and the worst point is −$8,400. A negative closing balance means the plant needs cash it does not have — an overdraft, a delayed payment, or an owner putting money in.
And it recovers on its own by month 3, without the plant doing anything differently. $129,600 arrives — the month-2 sales being paid for — against $108,000 of payments, so the closing balance comes back to $13,200.
That shape is the whole argument for building the table. A shortfall that is visible three months ahead and known to be temporary is a conversation with a bank. The same shortfall discovered in the month it happens is an emergency, and it is the same $8,400.
Real Example: A bottler's worst cash month is often the one after its best trading month, because the materials for the extra output were paid for before any of the extra sales were collected.
Exam Matters: Appendix 6 defines Analyse as requiring a brief chain of reasoning and, applied to given data, interpretation. Interpreting this table means naming the month, the figure and the consequence — not that cash flow "could be a problem".
Change one figure and every closing balance after it changes, because each month's closing balance is the next month's opening balance.
A forecast is most useful when it is asked a question. Change ONE variable, leave everything else alone, and read the closing balance line again.
Take the change from chapter 3: concentrate costs $0.40 more a case, so variable cost goes from $3.60 to $4. Payments rise in every month, by $0.40 times that month's output. Month 1's payments go from $108,000 to $116,000.
Now the closing balance line: −$14,000, then −$26,000, then −$12,400. All three are negative, the worst is −$26,000, and month 3 no longer recovers. The same $0.40 raised the break-even point from 15,000 to 18,000 cases in chapter 3.
One changed figure, read on two surfaces, answering two different questions: how much must we sell to cover our costs, and will we have the cash to get there. A firm needs both answers and neither one implies the other.
Real Example: A bottler told its concentrate price will rise runs the new figure through both the break-even calculation and the cash-flow forecast before it replies, because the two answers can point to different decisions.
Exam Matters: Appendix 6 defines Calculate as requiring a calculation from given data with workings. A change case needs the changed line shown as well as the answer, because the marker has to see which variable moved.
A forecast is used to arrange finance early, time the spending a firm controls and price its credit terms. Its limit is that every receipt on it is itself a forecast.
The specification pairs the uses with the limitations, and that is the point: the same table is valuable and unreliable for the same reason.
What it is for.
What it cannot do.
The first limitation connects this chapter to chapter 2: every figure on the receipts line is a sales forecast, so all four difficulties are in this table too — and compounded, because a forecast wrong about the amount is usually wrong about the timing.
Real Example: A lender asked for an overdraft three months before it is needed is being shown a plan. The same lender asked in the week the balance turns negative is being asked to rescue something.
Exam Matters: Appendix 6 defines Assess as requiring a balanced and wide-ranging assessment showing awareness of competing factors, leading to a supported judgement. A ten-mark Assess of a forecast needs a use and a limitation, and then a view on which matters more for this firm.
A budget is an agreed plan in figures for a future period. It is used to plan, to control spending as it happens, to motivate whoever agreed it, and to allocate a fixed total.
A budget is a financial plan for a future period, agreed in advance. The plant's Month 2 budget says revenue $120,000, variable costs $72,000, fixed costs $36,000.
It does four jobs, and they are genuinely different jobs.
Control is the one that makes a budget worth the work. A set of annual accounts tells a firm what happened after it can do anything about it; a monthly budget compared with the actual figures tells it in time to act, which is what chapter 5's variance analysis is for.
And the fourth job is the one students leave out. When the total is fixed, giving one department more means giving another less, so a budget forces a choice that would otherwise be avoided.
Real Example: A bottling plant's maintenance and marketing managers both want the same unallocated sum. The budget is where that is settled, and it is settled once rather than argued about monthly.
Exam Matters: Appendix 6 defines Explain as requiring cause or effect with details or an example. A purpose explained needs the mechanism: control works because the comparison happens monthly, while there is still time to change something.
A historical budget starts from last period's actual figures and adjusts them. It is quick and it carries forward whatever was in last period's spending, justified or not.
The specification names two types of budget. The first starts from what happened: last period's actual figures, adjusted for what is expected to change. The plant's $36,000 fixed-cost budget is last month's figure with an expected rent increase in it.
Why firms use it. It is fast, the figures already exist, and it is easy to explain to whoever has to accept it. For a cost that genuinely does not move much, starting from last month is not lazy — it is correct.
What it carries forward. Everything in last period's spending comes with it, including the part nobody could now justify. A line that was set for a product the plant no longer makes is adjusted by the same percentage as the rest, year after year, because nobody is ever asked what it is for.
So the weakness is not inaccuracy. A historical budget is usually close to right. It is that the method never asks whether the base it starts from deserved to be there, which is exactly the question the second type is built around.
Real Example: A plant's stationery and subscriptions line rises by the same few per cent every year and nobody in the building can say what is on it. That is a historical budget working exactly as designed.
Exam Matters: Appendix 6 defines Assess as requiring a balanced assessment leading to a supported judgement. Assessing a budgeting method means the case for the speed as well as the case against the inherited base, then a view for this firm.
A zero-based budget starts every line at nothing and each one has to be justified from scratch. It tests what a historical budget assumes, and it costs a great deal of time.
The second type. The specification calls it zero based, and the name is literal: every line starts at nothing and every amount asked for has to be justified from the beginning, whatever it was last period.
What it finds. Spending that survived because nobody questioned it. If the plant's marketing manager has to argue for the whole figure rather than for the increase, the parts that cannot be argued for do not get funded. That is the one thing a historical budget can never do.
What it costs. Time, and a lot of it. Every line means a case prepared, a meeting and a decision, across every department, for a budget that may be very close to last year's anyway. A firm that did this monthly would do little else.
Which is why the real choice is not one method or the other. A firm can budget historically as a rule and take one area to zero base each year — the speed where the base is sound, the scrutiny where it is doubtful.
Real Example: A plant that zero bases its maintenance budget once discovers a service contract for equipment that was sold two years earlier. The historical method had been adjusting that line upwards the whole time.
Exam Matters: Appendix 6 defines Evaluate as requiring a perceptive conclusion that proposes a solution or recommendation. The recommendation here is rarely one method for everything, and a conclusion that picks one without saying where it applies has not weighed the cost.
A variance is the difference between a budgeted figure and the actual one: favourable when it helps profit, adverse when it hurts it. None means anything alone.
A variance is the difference between what was budgeted and what happened. It is called favourable when it helps profit and adverse when it hurts profit — which means the same arithmetic reads opposite ways on a revenue line and a cost line.
Revenue above budget is favourable. Cost above budget is adverse. So a variance is never just a number: it is a number and a word, and getting the word wrong inverts the meaning.
The plant's Month 2: revenue was budgeted at $120,000 and came in at $129,600, a variance of $9,600 favourable. Variable costs were budgeted at $72,000 and came in at $86,400 — $14,400 adverse. Fixed costs were $2,400 adverse.
Now add them up the way they affect profit: $9,600 favourable less $14,400 and $2,400 adverse is $7,200 adverse — and the profit variance is exactly that. Budgeted $12,000, actual $4,800.
The best revenue month was the worse profit month. The extra cases were sold at a lower price and they carried their variable costs with them, which is the price cut from chapter 1 arriving on the budget. A favourable variance on one line is not good news until the other lines have been read.
Real Example: A bottler celebrating a record sales month finds the same month's profit below budget. Both reports are right, and the variance table is the only place the two are reconciled.
Exam Matters: Appendix 6 defines Analyse as requiring a brief chain of reasoning and, on given data, interpretation. Interpreting a variance table means linking the lines — this favourable one caused that adverse one — rather than describing each in turn.
A budget is built on a sales forecast, it rewards spending the whole allowance, it demotivates when the target is set too high, and it takes real time to negotiate.
The difficulties of budgeting are a leaf in their own right, and not the same as the drawbacks of one method.
The first closes the loop this section opened. A variance measured against a forecast that was wrong tells the firm about its forecasting, not about its performance.
The second, firms create for themselves. If underspending means a smaller allowance next year, the rational thing to do in month twelve is spend the balance — so a rule meant to control spending has produced some.
None of these is a reason not to budget. They are reasons to read a variance as the start of a question, which is where this section began: every figure in it rests on the one before.
Real Example: A department that comes in under budget two years running finds its allowance cut, and spends to the limit in the third. Nothing in the process was dishonest and the incentive was doing exactly what it was set up to do.
Exam Matters: Appendix 6 defines Discuss as requiring logical chains of reasoning in context with a brief assessment showing awareness of competing arguments. Two difficulties developed with what the firm should do beats four listed.
Sales volume is how many units are sold; sales revenue is what they were sold for. Revenue is price multiplied by volume, so the two can move in opposite directions.
A fixed cost does not change when output changes; a variable cost does. The split is a statement about a period of time, not about the kind of cost.