2.2.4 Budegts

Question 1

Definition: Budgets

Answer 1

• A budget is an estimate of income or expenditure for a set period of time

Question 2

Purpose of budgets

Answer 2

1. Planning
2. Forecasting
3. Communication
4. Motivation

Question 3

Purpose of budgets planning?

Answer 3

• A business owner can use a budget to help them plan for any expenses in the year e.g. tax
• A business budget is vital for the small business to help them identify where and when they may run into problems with finances
• The business budget would usually run on a monthly basis with regular reviews to help planning

Question 4

Purpose of budgeting forecasting?

Answer 4

• Sales or revenue forecasts are typically based on a combination of the business sales history and how effective they expect their future trading to be
• Using the business’s sales and expenditure forecasts, they can prepare projected profits for the next 12 months.
• This will enable the business owners to analyse their margins and other key ratios such as their return on investment

Question 5

Purpose of budgeting communication?

Answer 5

• Setting a budget in a small or large business is an ideal opportunity for the owners to communicate their objectives of the business in a financial plan
• Budgets also require departments or sections to report back on progress on a regular basis to their spending and income can be monitored

Question 6

Purpose of budgeting motivation?

Answer 6

• Budgets can be used to motivate staff to be more careful with the finances
• If staff are involved in the setting of budgets they are more likely to be more cautious when spending company money on items like stationery
• If the budget is tied to perks and benefits of the business the employees are much more likely to keep their costs in line with the budgeted amounts

Question 7

Historical budget

Answer 7

• This is a budget set for the business using current financial figures and based on historical performance of the business
• The previous years income and expenditure are used as a base on which to build the budget figures for the next year
• Realistic in that it is based on last year’s sales
• Drawback is that it does not account for shocks, uncertainty , dynamic markets or actions of competitors

Question 8

Zero based budget

Answer 8

• This is a budget set for a business by using figures based on potential performance
• This method takes away all historical assumptions and starts with a clean slate
• May also be used by a start-up with no historical data
• Managers must justify levels of expenditure based on the number of customers they are likely to serve in the next year

Question 9

Favourable variance

Answer 9

the manager has underspent in his department, this would be regarded as a success as any costs cut will have an impact on profit

Question 10

Adverse variance

Answer 10

the manager has overspent and it would depend on the reasons, perhaps they needed more staff than was budgeted for and had to hire during the yea

Question 11

Variance analysis

Answer 11

• Analyse the budget figures against what actually happens – there might be a variance

Question 12

Difficulties of budgeting

Answer 12

• Budgets are often fixed for a year and as such inflexible, difficult when business is dynamic
• Tendency for managers to spend up to the limit
• Time consuming to prepare, monitor and control
• Unrealistic budgets can be demotivating

Question 13

Limitations of budgeting

Answer 13

• Budgets can cause inter- department rivalry as some departments get more money than others
• Can make managers short-term and short-sighted, they become budget driven rather than customer driven
• Some industries its difficult to plan ahead because of large unplanned changes e.g. in farming the weather can have a huge impact on crops

Question 14

Advantages and disadvantages of zero based budgets?

Answer 14

Advantages of Zero-Based Budgeting:

1. Increased Efficiency: Zero-based budgeting forces managers to justify every expense and prioritize spending based on the needs of the organization. This can help reduce waste and increase efficiency.
2. Better Resource Allocation: Zero-based budgeting can help organizations allocate resources more effectively by focusing on high-priority areas and eliminating unnecessary spending.
3. Improved Strategic Planning: Zero-based budgeting requires managers to think strategically about the organization’s goals and objectives. This can help ensure that budgets align with the organization’s strategic priorities.

Disadvantages of Zero-Based Budgeting:

1.Time-Consuming: Zero-based budgeting can be time-consuming and labor-intensive, especially for large organizations. This can be a significant disadvantage for companies with limited resources or tight deadlines.
2. Difficulty in Implementation: Implementing zero-based budgeting can be challenging, especially for organizations that are used to traditional budgeting processes. This can lead to resistance from employees and delays in implementation.
3. Risk of Cutting Essential Services: Zero-based budgeting can lead to a focus on short-term cost-cutting measures rather than long-term strategic objectives. This can result in the elimination of essential services or investments that are critical to the organization’s success.

Question 15

Advantages of historical budgeting?

Answer 15

1. Historical budgeting is a familiar and easy-to-understand method of budgeting, as it is based on past data and trends. This makes it easier to develop a budget, as historical data is readily available.
2. Historical budgeting helps to provide a baseline for future projections, as past performance can be used to predict future trends and financial outcomes.
3. Historical budgeting allows for the identification of trends and patterns in spending and revenue, which can help organizations make more informed decisions about future investments and expenditures.

Question 16

Disadvantages of historical budgeting?

Answer 16

1. Historical budgeting assumes that past trends and patterns will continue into the future, which may not always be the case. Unexpected events or changes in the market can render past data irrelevant and make historical budgeting inaccurate.
2. Historical budgeting may not account for changes in the organization’s environment or goals, which can make it difficult to accurately predict future needs or expenses.

3.Historical budgeting can lead to a focus on short-term goals, as it is based on past data rather than forward-looking projections. This can lead to missed opportunities for long-term growth or innovation.