2.2.4 - Budgets Flashcards
Define a Budget?
A budget is an estimate of income or expenditure for a set period of time.
What is the purpose of budgeting?
- Planning
- Forecasting
- Communication
- Motivation
Why is planning important when setting a budget?
- 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
Why is forecasting important when setting a budget?
• 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
Why is communication important when setting a budget?
- 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
Why is motivation important when setting a budget?
- 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
What are the two types of budgets?
Historical Budget
Zero Based Budget
Define and explain a Historical Budget?
• 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
Define and explain a Zero Based Budget?
- 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
What is Variance Analysis?
• Analyse the budget figures against what actually
happens – there might be a variance
What are the two types of variance analysis?
Favourable Adverse
Adverse Variance
Define Favourable Variance?
The manager has underspent in his department, this would be regarded as a success as any costs cut will have an impact on profit.
Define Adverse Variance?
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 year.
Name the difficulties of budgeting?
- 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
Name limitations of budgeting?
• Budgets can cause interdepartmental 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
