Cash Flow v's Profit

Why cash flow is not profit….

Profit is the surplus after total costs have been deducted from total revenue, whereas cash is money at bank or in hand, readily available for use.

Profits are calculated in the ‘income statement’ whereas cash is shown in the cash flow forecast.

Cash is only recorded when money changes hands, that is, it will only be recorded in the statement once the business has 'actually' received money, rather than what it is 'promised' to receive.

For instance, if a business makes sales which are 10% on cash and 90% on credit, then the cash flow statement will only record the money received for the "10%" of sales and it will record the rest of the "90%" when it has 'actually' received this money.

On the other hand when we calculate profit, we will include the cash as well as credit sales, which means all of the sales made. Now this shows that the business is profitable but it will actually be short on cash.

Some other cases where profitable business can run out of cash are :
a: purchase of an fixed asset (through cash)
b: over-trading

Cash flow is vital in the short run and profit is vital in the long run.

Therefore, cash is important in the short run as it is needed to pay creditors and workers. Without sufficient cash, creditors (in extreme cases) can take you to the court and declare you bankrupt or insolvent in case of companies.

See this video.http://news.bbc.co.uk/1/hi/business/7874984.stm

Workers who will not be paid on time will be demotivated, resulting in poor productivity, high absenteeism and high labour turnover.

Profits are essential for the long term survival of the business, otherwise no institution would be interested to invest in a business which yields them low return on their capital investment.

BUSS2 Finance Homework for Wednesday 22.01.14

Warwick Clothing Ltd

Alan Holding owns 40% of the shares of Warwick Clothing Ltd and manages the business.  The company supplies specially designed clothing to other businesses.  Its most popular items include jackets and coats carrying the names and logos of businesses, company uniforms and customised sportswear.  Alan is keen to see his business grow.

Despite operating in a competitive market in which overall demand has been falling, Warwick Clothing Ltd has enjoyed rising sales.  This has been due to winning large orders from major business customers such as Tesco.  

However, profitability has been a concern for the company’s shareholders.  The company has also suffered from declining levels of customer service shown by the rising number of customer complaints.

Some of the company’s key financial data are shown in Figures 1 and 2 below.

Figure 1: Financial Date for 2009-2010

                          

	£000s
Sales revenue	46,200
Fixed costs	12,220
Labour costs	15,500
Material costs	13,425
Fuel and other costs	3,900

Figure 2: Financial and Operations Data

	2008-2009	2007-2008
Sales revenue (£000s)	£45,250	£42,125
Net profit margin	4.1%	4.9%
Capacity utilisation of factory	88%	81%
Unit cost	£14.88	£14.01
Satisfaction with customer service	74%	87%

Because of low levels of profitability, Alan has implemented a piece-rate system of pay which has proved unpopular with some workers, although there is some evidence that unit costs have started to fall since 2009.  In addition, he has cut expenditure on training.  These decisions may have contributed to the company’s level of labour turnover rising from 10% to 25% over the past year.  

The company has also had problems with cash flow and has exceeded its overdraft limit several times.  Alan has taken action to delay outflows of cash wherever possible.

The company’s factory has been operating near to full capacity in recent months.  Alan was delighted to win a very large order to supply an airline with uniforms if 90 days’ trade credit was offered and high standards of quality were achieved.  

The order was initially for six months with the possibility of a further three-year contract.  To meet the initial order, Alan decided to sub-contract the work to a supplier in Vietnam who has low costs and was recommended to him by one of his customers.  Alan believes that this will be the best way to supply the airline’s order.

1 [a] Calculate Warwick Clothing Ltd’s net profit margin for the 2009 – 2010 financial year (6)

1 [b] Discuss which poses the greater threat to Warwick Clothing Ltd’s future success: problems with cash flow or low levels of profitability. (15)

BUSS2 Classroom Resource Finance Calculations

Greggs

Greggs plc is the UK’s leading retailer that specialises in sandwiches, savouries and other bakery related products, with a particular focus upon takeaway food and catering.

With over 1,200 shops in the UK, the business trades using two retail brands - Greggs and Bakers Oven.

The marketing mix of the bakery product range focuses on providing customers with "great taste", with an emphasis on product freshness, quality and outstanding value for money.

At the end of 2008 Greggs had capital employed of £148m. In 2008, Greggs made a net profit of £48m on sales of £628m which were 7% up on 2007. However, net profit declined by 7% in 2008 due to substantial increases in the cost of food raw materials.

Greggs decided not to pass these cost increases onto consumers since the demand for takeaway food is very sensitive to changes in price.

The Greggs business has a divisional structure with central bakeries around the country each supplying the shops in their surrounding areas.

The business employs around 19,000 people in a range of jobs, including shop staff, drivers, bakery staff, savoury production, finance, personnel, purchasing and IT.

Complex retail IT systems help Greggs management monitor store and product performance, manage cash flows from the tills and deal directly with ingredient and other key suppliers.

One of the founding principles of Greggs is that the business put people first. Greggs are passionate in their belief that if the business treats its people correctly, they will treat customers with similar consideration.

 As well as giving staff an enjoyable place to work with good career prospects, Greggs also look to fairly reward all its employees. A number of pay schemes and fringe benefits are on offer including:

 Competitive rates of pay

 Profit share

 Staff discount

 Free group life assurance

 Pension scheme

 Extra holiday entitlement for long service

In terms of competition, Greggs competes with everyone who sells bakery products and takeaway food – from the major supermarkets to independent bakers and fast food outlets.

Although the market is well served, Greggs believes that there is significant potential for expansion in the UK, with the potential to grow to over 2,000 stores on the UK Mainland, both by expansion within existing trading areas where the business is under-represented and by moving into new regions.

The markets in which Greggs operates are large, fragmented and growing. Even though it is the market leader, Gregg's national market share is only around 2.5%.

Using the data in the case study, calculate:

(i)         Greggs sales in 2007

(ii)      The return on capital employed in 2008

(iii)     The net profit margin in 2008

BUSS2 Classroom Activity w/c 16.01.12

And so this is Christmas……….

Reena Patel is the store manager of the Stratford branch of a leading mobile phone company. She has received the following email from Head Office:

            November 1^st 2011: Budgets for December 2011, Stratford store

                                                                            £s

            Sales revenue:                                     420,000          

            Variable costs of phones:                     210,000

            Labour costs:                                          28,000

            Other overheads:                                     6,000

            Contribution to advertising budget         42,000

            (10% of sales)

            Contribution to head office (10%)          42,000

        Profit for December:                   92,000

            All stores are reminded that no staff are allowed holiday time until
            after Christmas.

As she does every month, Reena checks the budget against her records of last December’s sales and costs. She then phones her Regional Sales Manager and asks: “Nick, did you have any input into the latest budgets? They’re crazy! They expect my sleepy store to do 40% more sales than last December, but with only 12% more labour costs! How can I motivate myself to achieve these, let alone my staff!” It quickly emerges that Nick knows no more than Reena about where the budget numbers came from.

Later in the day Nick phones Head Office, but he makes no headway in finding who set the budgets and why. He gives up quite easily, and gets on with other things. At 7.15, after closing up the shop, Reena phones again, but Nick makes it clear that she is cutting into his evening. “No, I couldn’t find it out, Reena, but it’s your job to hit those numbers.”

The following day does not run smoothly, as Reena is in a foul mood. She has to apologise several times to staff and customers, but cannot seem to stop herself. One junior member of the sales team is shouted at for reminding Reena that he’s flying to Nigeria in early December, to go to his sister’s wedding. Whirling around her head is the same point: ‘How can I boost sales by 40%; and if I don’t, I’ll lose the bonus I’ve worked hard for all year”.

Questions (25 marks; 30 minutes)

1. Last year’s December sales were £300,000. Outline two reasons why the mobile phone company’s Head Office might have decided that this year’s sales should rise by 40%. (4)

2. Explain two ways in which the business might have benefited from discussing this budget with Reena, instead of setting it from the Head Office.(4)

3. When December is over, it proves to be that sales are 10% below budget, and that labour costs are 5% above. All the other costs are as you would expect.

            a) Set out the Budget, Actual and Variance figures for December.(6)

            b) State two positive features of these figures.(2)

4. Discuss the ways in which this company’s process of budget setting could be improved in 2012.(9)