Managerial Accounting - Profit Planning
A business must earn enough to pay for all costs and still keep itself in an adequate state of liquidity. Besides, it must make additional investment to grow and prosper. A sound and developing organization is favored by financial institutions in the capital market.
Profit is an essential cost of any business activity. It must be planned and managed just like other costs of doing business
Peter Drucker has rightly said, "Profit is a condition of survival. It is the cost of the future, the cost of staying in business”.
How profit is planned?
Profit planning is setting a profit target for the coming period. It is like a summarized version of estimated income statement. It starts with a forecast of expected sales and desired percentage for gross profit keeping in view the market conditions.
Profit planning requires preparation of a master budget and various analyses for risk and what-if scenarios. Tools for profit planning include the CVP analysis and budgeting.
In a nutshell, profit planning is a set of steps taken to achieve a desired level of profit. To accomplished this, a number of budgets are prepared. which taken together make a business plan.
How profit is managed?
Managing is ensuring that eventual profits are at least equal to the estimated level. In order to do so, steps are taken to compare actual results with estimates on daily or weekly or monthly basis. All deviations are examined and reported to the top management to seek instructions for a corrective action, if necessary. The management remains focused on the objectives set down at the planning stage and expects their achievements by all parts of the organization. A sound system of rewards and penalties ensures full compliance as far as possible. This has been explained in details in a hub entitled “Managerial Accounting – Variance Analysis.
Managing profit is a continuous process where by:
- Operations are monitored and evaluated to see if they as per plans.
- Need for additional resources is determined which may be assets or personnel to ensure un-interuppted operations.
- Likewise, requisite finances are worked out and a financial plan chalked out which states debt requirements, if any, and internally available funds.
Master budget is a comprehensive profit plan that integrates all operations of an organization. It comprises many seprate budget or schedules which are interdependent.
TYPES OF BUDGETS
Main types of budgets are list below:
- Activity Based Budget vis-a-vis Traditional Budget.
- Flexible Budget
- Rolling Budget
- Zero Based Budget
These are discussed as under:
Profit Plan serves as a bench mark or target or objectives in quantitative terms. By constently comparing actual performance with the bench mark, the management can readily detect which phases or units or process or departments are in out-of-line conditions. Usually, small variations are ignored but systematic variations, howsoevr small, are investigated and a corrective action taken promptly, reducing the chances for a continuous loss. The profit plan also serves as a road map for employees who are responsible for sales or costs. This would enable the management to evaluate their performance and reward them accordingly.