2.2.4 Budgets Flashcards
what is a budget
- forecasts future earnings and future spending for a (typical 12 month) period
what are the 3 types of budget
1 income budgets
2 expenditure budgets
3 profit budgets
what is an income budget
shows how much revenue a business is going to make
what is an expenditure budget
predict the businesses total costs
- often broken down between departments
- departments may then break this budget down further to specific areas or projects
what is a profit budget
calculate the expected profit for the year using the income and expenditure budgets
what are the reasons for using a budget?
- planning and monitoring (problems can be preempted)
- control
- coordination and communication create a framework for decision-making and communication
- they can be motivating as they provide employees with targets, which improves efficiency
drawbacks of budgeting
- budgeting can cause rivalry and resentment between departments if they have to compete for money
- budgets can be restrictive, could be problematic if the business needs to be dynamic
- budgeting is time-consuming to construct
- new businesses may find it difficult to get reliable data to make an accurate budget
budgets must be __________ . unrealistic budgets may demotivate staff.
achieveable
budgets are influenced by a businesses __________
objectives
budget holders check performance against the budget using ________ _______
variance analysis
what is variance analysis
- the difference between budgeted figures and the actual figures is calculates
what is a favourable variance
when the business is performing better than expected
e.g. profit or sales revenue is above expected or costs are below expected
what is adverse variance
when the firm is performing worse than expected
e.g. selling less than the business predicts or spending more than the budget set outs
variances can add up, this is called ________ ________
cumulative variance
both favourable and adverse variances need to be looked at within the business, why ?
- favourable variances suggest that the budget wasn’t stretching enough or something needs to be highlighted
- adverse variance needs to be fixed
what external factors cause variance
- competitors behaviour , may affect demand
- changes in the economy,
- cost of raw materials
what internal factors cause variance
- improving efficency
- chnaging selling price
- overestimating sales revenue
- underestimating costs
X internal causes of variance suggest there is communication problems within the business
what is the impact of a small variance
- a small favourable variance can motivate staff
- a small adverse variance can motivate staff to catch up and resolve the problem
what is the impact of a large variance
- a large favourable variance can demotivate staff as they disregard the importance of the budget
- a large adverse variance makes people feel the budget is impossible and that they have failed
how should businesses react to a variance?
- they could change the business actions
OR - change the budget to suit the businesses actions
HOWEVER changing the budget too much can defeat their purpose as they don’t HAVE to meet the targets
how can a business deal with adverse variances
- change the marketing mix, prices ? different promotion ? change the product ? new market ?
- streamlining production, improves efficiency
- motivate employees to better efficiency
- cost cut by negotiating better deals
- market research
how can a business deal with favourable variance
- set more ambitious targets next time
- try and spread efficient business activities across departments
- more sales than expected, a business may need to increase production
businesses can be both historical or zero-based, explain both terms
historical budgeting- budgets are based on historical data
zero-based budgeting- when no budget is allocated and all spending needs to be justified and approved
evaluate historical budgets
+ simple to operate and easy to understand
+ variance can be seen quickly
+ gives employees freedom which may be more motivating
- employees will spend up to the budget on purpose to maintain the budget for the next year
- the budget may become out of date and irrelevant
- encourages linear behaviour from the business
