Term Paper: Budget Building a Profit Plan Entrepreneurship 101

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Budget

BUILDING a PROFIT PLAN

Entrepreneurship 101: What is the primary goal of a person entering into or is already engaged in a business? In a heartbeat, the answer is simply "to earn profit." It is tradition. However, "to earn profit" is actually not as simple as it is said. In the present business environment, organizational and environmental factors should be considered. Such factors greatly influence an organization's strategy. To consider otherwise, the ambition of profitability will go into a plummet. Not being able to adapt to current situations and probably means that the organization is stagnating and not facing the ever changing business environment.

Management should establish standards in order to measure any progress towards achieving profitability and implement effective controls to minimize costs and maximize profit without the risk of compromising the market such as an increase in retail price for goods sold or services rendered. Another is to set specific objectives that would serve as a medium for evaluation of output or performance of personnel and of the business entity itself. Objectives vary depending on intended results which may be effectively achieved through strategic profit planning.

Translating the organization's goals and objectives into the specific activities and resources is called planning. The dynamic plan that dictates how the organization's goals and objectives will be fulfilled reflects strategy. Strategic profit plans are developed to give detailed information about the time-honored mission of achieving the desired profit margin.

How does a person earn profit? Through doing business a person can earn profit, but for how long? A better question would go, how would a person continue to earn profit? A well-thought profit plan is the answer.

I. Objectives of a budget

Strategic planning requires that the latest information regarding the economy, environment, technological developments and available resources be incorporated into the setting of goals and objectives. The process of formalizing plans and translating company goals and objectives into a documented, quantitative format is called budgeting. The end result of this process is a budget, which expresses a commitment. It is a commitment to planned activities, resource acquisition and use of resources based on predictions, protocols and a collective promise to accomplish the agreed-on results. A budget is a plan for the future or period of time where the budget will be effective. Budgets are commonly used in large companies which usually have formal and sophisticated systems of operation. The process becomes significantly complex in entities having a higher level of funds and resources.

The main objective of budgeting may be generalized into two important functions that it serves: planning and control. The entire budgeting process involves planning. Planning provides the basis for control which involves comparison of actual results from established standards. Control allows management to make necessary corrective actions under unfavorable cases.

A budget requires a substantial amount of time an effort form the person who prepares it. In preparing a budget, managers must remember that organizational departments interact with each other, and the budget for one department may form the basis of or have an effect on the budgets of other departments. Therefore, budgets for all departments must be consistent with the established profit plan of the entity.

II the Profit Wheel

Profit does not just come. Its realization cannot be left to chance. Businessmen cannot just stay in their office, wait for customers, then hope and pray that enough sales be generated to yield the desired profit. Profit can be planned. A certain amount of profit may be set s the goal for a period, and strategies may be thought of to attain the goal set. It seems easy to accomplish, theoretically speaking.

Budgeting and profit planning are often interchanged because they are viewed as synonymous. However, profit planning is a broader term than budgeting. Profit planning is a well thought out operational plan which involves setting of goals and objectives as well as the methods or programs by which such goals are to be achieved. Profit planning encompasses sales planning programs, programs for control of all manufacturing and non-manufacturing costs, programs affecting working capital and plant investment, and a review of all factors affecting the return on investment.

A profit plan establishes the key indicators of financial performance and milestones used to measure and control the progress toward the profit goal. Certain procedures are used in the practice of profit planning. One is a bottom-up budgeting process that begins with the operating profit target. Management specifies a desired profit and then draws up plans to achieve such return. The profit objective comes first before the entire planning process. Another is when management draws up plans and then sets the target profit as a result from the plans drawn. In this case, the profit objective results from the entire plan itself. Lastly, management uses an acceptable and reasonable profit standard that is set based on the company's own business experience.

A profit wheel is a tool or guide for profit planning. Factors involved in the determination of profit are the volume or number of units, selling price, variable cost and fixed cost. Any change in these factors will involve a change in profit.

1. Estimate the level of sales

The profit plan establishes the required revenue and profit target and level of expense necessary to support the budget and attain the profit plan goal. Planning for a desired profit would be considered alongside the determination of sales of revenue since profit is directly related to revenue. A merchandising or manufacturing concerned business would determine profit per final goods sold while a service concerned business would determine profit per service rendered. At this point, managers must take into consideration the company's past experiences in setting a target profit and other standards. The organizational structure, organizational and environmental constraints must also be considered since they play a major role in income realization.

The process begins with the estimate level of sales or services based on expected demand and profit to be earned per output. The profit plan establishes the profit multipliers and billing rates to be used.

In estimating the level of sales, the first step is to prepare the sales budget in units and in pesos. The projected sales will be the basis of the desired profit managers are planning to achieve. The sales in volume will be the basis in preparing a production budget which will be part of costs. Revenue may be expressed as:

Revenue = Sales volume in units X Sales volume in peso (sales price)]

Using trend analysis, managers will now adjust, whether increase or decrease, sales in order to achieve the profit target based on the previous budgets. Also using the trend analysis, the sales budget will also determine how much cash the company is expecting to flow into the company based on existing credit and collection policies.

2. Forecasting operating expenses

Costs may be classified in a lot of ways depending on the management's need for cost information.

According to function, costs are classified as direct or indirect costs.

Direct cost, or production / manufacturing costs, are related to acquiring and making the products or rendering services that directly generate the revenues of a business entity. It is composed of three elements namely, direct materials, direct labor and overhead. Indirect cost or expenses are those related to other business functions such as administrative or selling.

These costs or expenses are further classified into variable and fixed costs.

Cost that varies in total in direct proportion to changes in the level of activity is a variable cost. Variable cost is extremely important in the total profit picture of the company. Every time a product is produced and sold or a service has been rendered, a relative amount of that variable cost is incurred. A cost that remains constant in total within a relevant range of activity is a fixed cost. Such costs are incurred to provide a company or firm with production capacity regardless of the level of activity. In building a profit plan, it is best to identify specific cost items into variable and fixed costs in order to give due consideration on the effect on profit and costs and determine areas where necessary controls must be applied. To accomplish this, managers would need to apply their experience in the business particularly the in the industry that they operate.

When the sales level and target profit is established, the next step is to make projected or budgeted cost plans. The cost plans would cover all direct and indirect cost, whether variable or fixed.

A production budget shows the number of units a company wants to produce and the cost that it expects to incur for such production. It is composed of a materials budget, direct labor budget and an overhead budget. Production is established based on the desired profit and as well as the desired volume of units sold or service rendered needed to achieve the profit target. The production budget will then serve as basis for budgeted cash outlays the… [END OF PREVIEW]

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Budget Building a Profit Plan Entrepreneurship 101.  (2007, May 13).  Retrieved June 16, 2019, from https://www.essaytown.com/subjects/paper/budget-building-profit-plan-entrepreneurship/7302

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"Budget Building a Profit Plan Entrepreneurship 101."  Essaytown.com.  May 13, 2007.  Accessed June 16, 2019.
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