2.2.4 Budgets

Question 1

what is a budget

Answer 1

• forecasts future earnings and future spending for a (typical 12 month) period

Question 2

what are the 3 types of budget

Answer 2

1 income budgets
2 expenditure budgets
3 profit budgets

Question 3

what is an income budget

Answer 3

shows how much revenue a business is going to make

Question 4

what is an expenditure budget

Answer 4

predict the businesses total costs
- often broken down between departments
- departments may then break this budget down further to specific areas or projects

Question 5

what is a profit budget

Answer 5

calculate the expected profit for the year using the income and expenditure budgets

Question 6

what are the reasons for using a budget?

Answer 6

• 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

Question 7

drawbacks of budgeting

Answer 7

• 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

Question 8

budgets must be __________ . unrealistic budgets may demotivate staff.

Answer 8

achieveable

Question 9

budgets are influenced by a businesses __________

Answer 9

objectives

Question 10

budget holders check performance against the budget using ________ _______

Answer 10

variance analysis

Question 11

what is variance analysis

Answer 11

• the difference between budgeted figures and the actual figures is calculates

Question 12

what is a favourable variance

Answer 12

when the business is performing better than expected
e.g. profit or sales revenue is above expected or costs are below expected

Question 13

what is adverse variance

Answer 13

when the firm is performing worse than expected
e.g. selling less than the business predicts or spending more than the budget set outs

Question 14

variances can add up, this is called ________ ________

Answer 14

cumulative variance

Question 15

both favourable and adverse variances need to be looked at within the business, why ?

Answer 15

• favourable variances suggest that the budget wasn’t stretching enough or something needs to be highlighted
• adverse variance needs to be fixed

Question 16

what external factors cause variance

Answer 16

• competitors behaviour , may affect demand
• changes in the economy,
• cost of raw materials

Question 17

what internal factors cause variance

Answer 17

• improving efficency
• chnaging selling price
• overestimating sales revenue
• underestimating costs
  X internal causes of variance suggest there is communication problems within the business

Question 18

what is the impact of a small variance

Answer 18

• a small favourable variance can motivate staff
• a small adverse variance can motivate staff to catch up and resolve the problem

Question 19

what is the impact of a large variance

Answer 19

• 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

Question 20

how should businesses react to a variance?

Answer 20

• 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

Question 21

how can a business deal with adverse variances

Answer 21

• 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

Question 22

how can a business deal with favourable variance

Answer 22

• 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

Question 23

businesses can be both historical or zero-based, explain both terms

Answer 23

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

Question 24

evaluate historical budgets

Answer 24

+ 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

Question 25

evaluate zero-based budgets

Answer 25

+ more accurate than historical budgeting
+ suitable for cutting costs
- time consuming
- clear communication is required to make this work