The basic objective of running any business organization is to earn profits. Profits determine the financial position, liquidity and solvency of the company. They serve as a yardstick for judging the competence and efficiency of the management. profit planning is therefore a fundamental part of the management function and is a vital part of the total budgeting process.
The management determines the profit goals and prepares budgets that will lead them to the realization of these goals. However, profit planning can be done only when management is aware about the various factors which affect profits. Some of the important factors affecting profits are as follows:
- Selling Price– Variation in the selling price causes variation in the amount of profit also. An increase in the selling price increases the profits and vice versa.
- Cost:- The term ‘cost’ means ‘ the amount of expenditure (actual or notional) incurred on or attributable to a specified thing or activity’. A variation in the cost also affects the amount of profit.
- Volume:- The term ‘volume’ refers to the level of activity. This may be expressed in any of the following manner:
- Sales capacity as a percentage of maximum sale;
- Value of sales;
- Quantity of sales;
- Production capacity as a percentage of maximum production;
- Value of production;
- Quantity of production
- Direct labour cost;
- Direct labour hours; and
- Machine hours.
Units for a desired profit = (Fixed Cost + Desired Profit) / Contribution per unit
Sales for a desired profit = (Fixed Cost + Desired Profit) / P-V Ratio