Working curriculum of the course

There are certain features when developing business plans for the various organizations, as, for example, for the one-dot and multipoint organization. If business already exists, the plan joins reporting data for previous year to which indicators of planned year are compared. The business plan for the organizations with the large investment project demanding external financing, is the most difficult type of the business plan. The first place is occupied here by the indicators characterizing the investment project. Then the usual sections of the business plan coordinated to the investment project are stated.

Feature of the diversified organizations is the directed implementation of several kinds of activity. It should be reflected in business plans of such organizations. More often in the diversified organizations separate kinds of activity are carried out in special divisions – branches (business units). In such cases the organization acts as multipoint, and the business plan is made respectively.

Questions for self-examination

1. Definition of the purposes of the business plan

2. Business plan functions

3. Business plan structure

Literature

1. Ershov V. F. Business design: Application guide / Century F.Ershov. - SPb.: St. Petersburg, 2005. - 288 pages.

2. Small business program. Management in small business. Business plan. - M: "DECK" IKK, 1993. - 59 pages.

3. Small business program. Management in small business: How to make financial decisions. - M: "DECK" IKK, 1993. - 70 pages.

4. Small business program. Management in small business: Budget drawing up. - M: "DECK" IKK, 1993. - 79 pages.

5. Ushakov I.I. Business plan / I.I.Ushakov. - SPb.: St. Petersburg, 2008. - 224 pages - (Practice of management)

6. Financial analysis and planning [Electronic resource]: A training course. - Electron. applied прогр. (520 Mb). - M: Kordis & Media, 2005. - 1 эл. wholesale. disk (CD ROM):

 

 

Subject 3 Analysis of break-even of firm

The lecture purpose – to study a design procedure of a point of break-even, analytical and graphic methods

Lecture questions

1. Definition and need of planning

2. Factors of an increasing role of business planning

3. Planning limits.

4. Calculation of a point of break-even

        Content of lecture

The business plan as firm any of another plans, has an external orientation, turns into some kind of goods which sale should bring the maximum prize. Therefore, unlike the traditional plan of economic and social development of the enterprise the business plan considers not only the internal purposes of the enterprise organization, but also the external purposes of persons which can be useful to new business. Besides, in the business plan the main attention is concentrated to marketing and financial and economic aspects of business while the scientific and technical, technological and social parties are presented less in details.

The business plan is one of key elements of strategic planning. As well as the strategic plan of the organization, covers rather long period, usually 3-5 years, sometimes are more. However between the business plan and the strategic plan there is a number of distinctions:

1) unlike the strategic plan the business plan includes not all complex of common goals of firm, but only one of them – that which is connected with creation and development of a certain new business. The business plan of the organization is focused only on development while the strategic plan can include other types of strategy of the organization;

2) strategic plans are usually plans with the growing horizon of time. The business plan has accurately outlined temporary framework;

3) in the business plan functional components (plans of production, marketing, etc.) have much more powerful value, than in the strategic plan, are full, equilibrium parts of structure of the business plan.

The investment project is expedient for considering in the second sense. The organization business plan sometimes acts in relation to the investment project as the document representing plans of development and realization of the corresponding part of the investment project.

For short-term, small on scale or the local business projects which are not demanding considerable expenses and short on terms of realization, the business plan can replace the investment project. In it all stages and the works which are carried out in a predynvestitsionny phase of business planning are combined. There can be also the business plan of the organization including planned results of the investment project, for example, if the investment project is realized at the operating enterprise. In this case the investment project can be included in the business plan of the enterprise which regulates an order of use of available funds of the enterprise and extra financial resources within the investment project.

Thus, the investment project and the business plan can be close on structure. The structure of the business plan is similar to the investment project, especially in that its part where justification of an investment plan is carried out.

The business plan begins with the title page on which usually specify:

1) project name;

2) place of preparation of the plan;

3) authors of the project, name and enterprise address, phones;

4) names and addresses of founders;

5) purpose of the business plan and its users. The memorandum of confidentiality usually is located on the title page.

Also title page can contain the requirement about return to the author of the business plan.

After the title page the table of contents – the formulation of sections of the plan with the indication of pages and allocation of the most important points according to features of the specific project follows.

The business plan can contain the summary in which the short description of the purpose and basic provisions of the business plan (0,5-2 pages) is given. The summary can be issued in sequence which is specified below.

1. Enterprise.

2. Address.

3. Phone, fax.

4. Director.

5. An essence of the offered project and a realization place.

6. Result of implementation of the project.

7. Necessary financial resources.

8. Project payback period.

9. Expected mid-annual profit.

10. Expected form and conditions of a fate of the investor.

11. Possible guarantees on return of investments.

In introduction the problem of drawing up of the business plan and a circle of people to which it is addressed are specified.

The summary (the business concept) – a summary of basic provisions of the expected plan.

The concept is made after writing of all sections of the business plan as contains the basic from all its sections.

Besides allocation of a main goal (purposes) of the business plan, it is specified, for whom it is intended.

Thus, the summary contains the following data:

1) ideas, purposes and project essence;

2) features of the offered goods (services, works) and their advantages in comparison with similar production of competitors;

3) strategy and tactics of achievement of goals;

4) qualification of the personnel and especially top managers;

5) demand forecast, sales volumes of the goods (services, works) and sums of revenue of the next period (month, quarter, year etc.);

6) planned product cost and requirement of financing;

7) expected net profit, level of profitability and a payback period of expenses;

8) major factors of success.

It is known that the purpose of activity of firm (enterprise) in modern economy is receiving profit. Provided that the firm can stably exist and provide to itself a basis for growth. The stable profit of firm is shown in the form of the dividend on the enclosed capital, promotes involvement of new investors and, therefore, increase in own capital of firm. Therefore there is clear an interest to problems of profitability of activity of firm. Very important aspect of the matter is the concept of break-even of activity of firm, as first step to receiving accounting, and in a consequence and economic profit. In this chapter we will contemplate a problem of break-even of activity of firm from the point of view of the economic theory further to study questions of definition of a point of break-even of firm, the analysis of break-even activity of firm and break-even planning in the short-term and long-term periods.

From the point of view of the economic theory break-even is a normal state of firm in the modern competitive market being in a condition of long-term balance. Thus we accept in consideration economic profit, that is, profit definition at which expenses of firm join a market average rate of the income on invested, and also the normal income of the enterprise. At such assumptions determination of break-even sounds as follows:

The point of break-even is such sales volume of production of firm at which the proceeds from sales completely defray all expenses on production, including market average percent on own capital of firm and the normal enterprise income.

Really, if the firm has accounting profit, that is the balance of the income of sales and monetary costs of production of sold production is positive, it can not reach break-even points in sense of economic profit. For example, the profit of firm can be less, than market average percent on own capital of firm. Therefore, there are more favorable ways of use of the capital which allow to get higher profit. Thus, the concept of a point of break-even is at the same time and a certain criterion of efficiency of activity of firm. The firm which is not reaching points of break-even, operates inefficiently from the point of view of the developed market conditions. However, this fact in itself doesn't serve as the unequivocal reason for the termination of existence of firm. To answer this question it is necessary to investigate structure of expenses of firm in details.

In order that the firm functioned optimum it is necessary maximizing profit of firm. Process of maximizing profit is equivalent to process of search of a point of break-even in economic sense. In the analysis of process of maximizing profit we will use the following fundamental concepts:

1. The limiting income - size on which the cumulative income of firm will change at increase in output at one unit;

2. Limiting expenses - size on which cumulative expenses of firm will change at increase in output at unit;

3. Average full expenses - a share of full expenses (that is constant expenses + variable expenses + transient expenses), falling on unit of let-out production.

From a course of microeconomics it is known that, since some moment (from some volume of release) the curve of variable expenses will be increasing, and a curve of the limiting income - decreasing. For maximizing profit by the basic the ratio between the limiting income and limiting expenses is at increase in release at one unit. It is obvious that in a case when limiting expenses less limiting income, the increase in release will cause increase in the income of firm; in a case when limiting expenses more limiting income, will lead output reduction to increase in the limiting income of firm. Now we can formulate criteria of a point in which the maximum profit is reached:

The maximum profit of firm is reached at such volume of production at which the limiting income is equal to limiting expenses.

  For definition of that, the profit or a loss is reached in an optimum point, it is necessary for us to consider a ratio between the price for production of firm and average full expenses. It is more convenient to make all this graphically:

I case. In this case equality of the limiting income and limiting expenses is reached in that point, in which price of realization of this quantity of production above average full expenses. Therefore, in this case the enterprise maximizes the economic profit. It is easy to determine by this schedule, what size of economic profit. On graphics full costs of firm for the production, the full income of firm of production realization are shaded. Therefore, the area shaded only - economic profit of firm.

II case. At such structure of expenses and a price situation in the market the firm doesn't receive economic profit for its full expenses in accuracy are equal to the cumulative income in a point of optimum volume of production.

Average variable expenses will be necessary for consideration of the following two possible situations - that is the share of variable expenses falling on unit of let-out production for us.

III case. In this situation the cumulative income, received from realization of production of firm in a point of optimum volume of output, is insufficient for a covering of cumulative expenses. However, at such ratio of the price for production and costs for its production variable costs for its production become covered. Thus, the firm functions with an economic loss, but it can exist in a short-term interval of time. In such situation nevertheless it is favorable to continue production as the firm bears constant expenses regardless of output volume. Let's notice that existence of economic losses doesn't mean existence of accounting losses. Really, economic losses can arise, for example, because of payment of the lowered percent on the capital invested in production.

     IV case. In this case the cumulative income doesn't suffice even for compensation of variable expenses. Therefore at this structure of the prices and expenses the most optimum is the decision on production discontinued.

In the following paragraphs we will study the analysis and planning of accounting break-even of the enterprise, that is to study I, II and partially the III cases considered above.

The first problem connected with a point of break-even, is a problem of determination of critical volume of production at which break-even is reached. In this paragraph we will consider at first three approaches to definition of a point of break-even: equations, marginal income and graphic representation. Further we will discuss a method of the analysis of sensitivity of look-ahead calculation of a critical point to changes of the accepted assumptions (CVP - the analysis). At the end of the paragraph we in brief will concern possible sources of information for break-even forecasts.

Let's pass to consideration of methods of calculation of a point of break-even.

I Method of the equation

In the most general view the scheme of any report on financial results looks as follows:

Revenue - Variable expenses - Constant expenses = Net profit

or

IN – ПИ – GIVE TO DRINK = STATE OF EMERGENCY

 The same equation can be copied in algebraic record. Let's designate profit for the studied period through П, through R - the price of sale of unit the made firm of production, x - volume of made and sold production for the specified period, and - level of the fixed expenses, in - variable expenses on made (and sold) production. In such designations the equation "profit-income-expenses" looks as follows:

П= R*kh - (and + в*х) (1)

or

П= (R - in) *х - and  

       The last form of the equation emphasizes that all factors share on realization depending on volume and independent of it. In particular, as it was already told, all expenses of firm can be divided into constants and variables.

Use of the equation (1) allows to define easily a break-even point by simple algebraic transformations.

The release volume at which the break-even point is reached, is defined from a condition:

П= 0,

and it is equal

х0 = (П + and) / (R - in) = and / (R - in) (2)

As an example we will consider calculation of a point of break-even for Experimental Electronics Inc firm. The following data will be necessary for calculation for us:

 

The price of one electronic block which is let out by firm of $5000

Variable expenses (a salary the worker, cost of accessories etc.) counting on one product of $4000

Constant expenses of $20000

The maximum volume of output at which break-even of activity of firm is reached:

х0 = $20000 / ($5000 - $4000) = 20 (products).

The period, for which it should be made (and is realized) хо products, is defined by for what term we defined size of constant expenses.

Using the equation (2) we also we can define, what volume of release is necessary for reaching to receive a certain size of profit. So, in order that Experimental Electronics Inc firm. got profit at a rate of $10000, it is necessary to make:

x = ($10000 + $20000) / ($5000 - $4000) = 30 (products).

II Marginal income

The method of the marginal income is updating of the previous. We will understand the income which is received by firm from production of one product as the marginal (limiting) income. The marginal income is equal in our example:

$5000 - $4000 = $1000 for unit.

Thus, in a break-even point the financial report can be presented in the following look (using terms of the marginal income):

Indicators Price for unit, $ Units Sum, $

Revenue 5000 20 100000

Variable expenses 4000 20 80000

Marginal income 20000

Constant expenses 20000

Net profit 0

III Graphic method

Two considered before a method in essence are methods static. Really, we consider the realization fixed the price, variable expenses, constant expenses and profit. Further on the basis of these data we count volume of production at which the set profit is reached. If to refuse the fixed size of profit, we will receive dependence between volume of release and profit which it is easy to express graphically.

Let's notice that on graphics the line of revenue and the line of variable expenses start with one point and a difference between them and there is no other than the marginal income. Using the schedule, we can easily define profit or loss size for this or that volume of release.

Let's notice that at zero release the loss is equal in accuracy to constant expenses.

We received rather convenient tool of the graphic analysis of dependence between release, revenue, expenses and profit. This method can be used and at other (nonlinear) characteristics of dependences between volume of production and financial performance. However, it should be noted and the shortcoming inherent in the considered method. As well as any graphic method, it yields not so exact results.

Let's pass now to discussion of those assumptions which underlie application of the above described methods to real economic data. All three methods belong to the so-called CVP analysis, that is the analysis of ratios of profit, expenses and sales volume.

First of all, it should be noted that actually the picture presented by us at the description of methods of the CVP analysis, is true only in a limited range of volumes of release. Limitation results, first of all, from this that at rather large volume of output many preconditions underlying the CVP analysis, for example, invariable character and size of constant expenses, etc. cease to be true.

In order that it was possible to represent more precisely probably relevance area for the CVP analysis, we will list the assumptions used for creation of the above described models:

1. The behavior of the general expenses and revenue is rigidly defined and linearly within relevance area. This assumption is true only for those cases when change of output of firm is insignificant in comparison with market capacity of this production. Otherwise linearity of dependence between volume of release and revenue is broken.

2. All expenses can be divided into variables and constants. About various approaches to classification of expenses it will be in more detail told in the following paragraph.

3. Constant expenses remain independent of volume within relevance area.

Very important assumption which is essentially facilitating the analysis, but also strongly limiting relevance area. Really, at such assumption the volume of output is limited by available fixed assets. Neither to increase their volume, nor receive fixed assets in rent we can't. The assumption that constant expenses change in steps is more realistic. However such assumption strongly complicates the CVP analysis as the schedule of the general expenses becomes explosive function.

4. Variable expenses remain independent of release volume within relevance area. Actually the size of variable expenses is some function from volume of production as there is an effect of falling of limiting productivity of factors of production. Therefore in the conditions of the assumption 3 (independence of constant expenses of volume of production) variable expenses increase with growth of volume of production. As more exact approach it is possible to offer the similar step schedule.

5. The price of realization of release doesn't change. This most vulnerable assumption as the price of realization of production depends not only on actions of the enterprise, but also from demand structure in the market, actions of competitors, a situation in the market of the goods substitutes etc. Costs of firm of goods advance of the market, the organization of own distribution network, etc. can make essential impact on change of the price of realization. Here we enter area of the analysis of results of change of two or more factors influencing the CVP analysis. However, such analysis is very difficult, and in each case the individual approach is necessary.

6. The prices for materials and the services used in production, don't change. A situation similar with item 5. Very disputable assumption, however, it strongly facilitates the analysis.