Definition of Profit Planning

Profit planning aims to set a profit objective for a budgeting period. Also, it seeks to establish the main policy decisions regarding how to achieve the objectives. The profit objective will normally be related to the return required on the investment in the business.

In profit planning, alternatives are evaluated to select the most likely option that will yield the required profit objective. Managers can plan their budgets on this basis.

Purpose of Profit Planning

There are several purposes of profit planning, namely:

  • To set profit objectives for the budget period
  • To specify the policy decisions and course of action to be followed during the budget period
  • To give planning directives for the preparation of detailed operating plans

The profit objectives reflect the expected return on capital employed. This depends on:

  • The commercial environment during the budget period
  • Projected sales of the company
  • Past profits
  • Maintenance of liquidity

Profit Planning Guidelines

The main factors to specify in profit planning guidelines are:

Return Required on Capital Employed

After the capital employed has been determined, it is then necessary to specify the required rate of return. Criteria to consider include:

  • What return can the company derive from other forms of investment?
  • What degree of risk is involved in the company’s activities?
  • Do considerations other than profit influence the owners, such as environmental or ethical concerns?
  • How do competitors in the same industry sector perform?
  • What is the company’s immediate past record?
  • What are the expected trading conditions for the period of the profit plan?

The end result of this process is a statement of the profit objective and how it is to be achieved. This statement is the starting point for budgeting.

Profit Planning Techniques

The following chart clearly demonstrates the techniques of profit planning.
Profit Planning Techniques Overview

Frequently Asked Questions

What is profit planning?

Profit planning is the process of setting a profit objective for a budgeting period and establishing the main policy decisions on how to achieve that objective.

Why do companies need to engage in profit planning?

There are several reasons why a company might need to engage in profit planning. The most common are to set profit objectives for the budget period, specify policy decisions and course of action to be followed during the period, give planning directives for the preparation of detailed operating plans, and assessing whether there is enough money available for investment.

What are profit planning guidelines?

Profit planning guidelines are sets of rules or recommendations that indicate how planners should determine the profit objective and how it should be achieved.

What factors must a company consider when evaluating its past records?

When evaluating past records, a company must look at such things as the commercial environment during the budget period, projected sales of the company, past profits, maintenance of liquidity, and changes needed in volume, price and cost.

What factors must a company consider when evaluating its past records?

In profit planning, managers evaluate alternatives to select the most likely option that will yield their required profit objective. It is also a way for management to set out the main policy decisions regarding how to achieve its objectives during a budgeting period or other period of time.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

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