Finance and financial planning: cash-flow forecasting, budgeting and variance, the income statement, and profitability ratios (gross profit margin and net profit margin).

What this dot point is asking

WJEC Unit 2 covers how a firm plans and controls money: cash-flow forecasting, budgeting and variances, the income statement, and the profitability ratios. This is heavy on the quantitative skills, so you must compute and interpret. The single most important idea is the difference between cash and profit, because confusing them is the classic exam error.

The answer

Cash-flow forecasting

The forecast lets a firm see in advance when cash will be tight and act early - arranging an overdraft, delaying a payment or chasing customers. Because a profitable business can still fail if it runs out of cash to pay wages or suppliers, managing cash flow is vital, especially for new and growing firms.

Budgeting and variance

A budget is a financial plan: a target for revenue, costs or profit over a period. Comparing the actual outcome with the budgeted figure produces a variance:

• A favourable variance is better than budget (revenue higher, or costs lower than planned).
• An adverse variance is worse than budget (revenue lower, or costs higher).

Variance analysis helps managers control performance: it flags where the firm is off-plan so action can be taken, and it supports motivation and accountability if budgets are realistic.

The income statement

Profitability ratios

Two ratios from the income statement measure profitability:

• Gross profit margin = (gross profit / revenue) x 100. It shows the percentage of sales left after the direct cost of sales; a higher margin means each sale is more profitable before overheads.
• Net profit margin = (net profit / revenue) x 100. It shows the percentage of sales left after all expenses; it reflects overall efficiency, including overheads.

Comparing margins over time or against competitors shows whether profitability is improving and where costs are eroding it (a falling net margin with a steady gross margin points to rising overheads).

Examples in context

Example 1. A profitable firm with a cash-flow gap. A growing Welsh manufacturer wins a large order but must buy materials and pay wages now, while the customer pays 60 days later. On paper the order is profitable, but the cash-flow forecast shows a shortfall in the intervening months. Because the firm forecast this, it arranges a short-term overdraft in advance and avoids running out of cash. The example shows why cash flow, not just profit, decides whether a firm survives.

Example 2. Using variances to control costs. A café chain budgets monthly staff costs and finds an adverse variance: actual wages are well above budget because of overtime. Spotting the variance early, the manager adjusts rotas and the overspend stops. The example illustrates budgeting and variance analysis as a control tool that turns a financial plan into action.

Try this

Q1. Define the term cash-flow forecast. [2 marks]

• Cue. A prediction of the cash flowing into and out of a business over a future period, showing opening balance, inflows, outflows, net cash flow and closing balance.

Q2. A firm has revenue of £300,000 and net profit of £45,000. Calculate its net profit margin. [2 marks]

• Cue. Net profit margin = (45,000 / 300,000) x 100 = 15%.