2.2.4 Budgets:

Question 1

Budgets:

Answer 1

A budget is a spending limit put on the business’ expenditures (spending of funds). It acts as an financial business plan for the revenue and costs of business to

Question 2

Why to make budgets:

Answer 2

-motivate managers- control over budgets-allow flexibility & better quality decision making based on financial goals- maslows hierarchy of needs meets self esteem needs- budgets also ensure delegation between staff without loss of control .
-monitor performance- budgets used to benchmark to its aims and objective- outlines directions.

Question 3

Two types of budgets:

Answer 3

Historical Budgets
Zero Based budgets

Question 4

Historical budgeting:

Answer 4

-historical budgets use pervious yrs performance to create budget eg if they underspent last yr, lower budget this yr.
-Realistic in results however circumstances change over time eg new products, lost customers.

Question 5

Zero based budgets:

Answer 5

• zero based budget is when costs and revenues set at zero and is built from the bottom up where managers negotiate the budget from scratch.
  -is more complicated and time consuming but set to meet goals.

Question 6

Process of constructing budgets:

Answer 6

1-analyse the market - market size, growth, share etc
2-refer to sales budget - use of sales forecast, new products, price changes.
3- refer to cost budgets- shown in sales forecast, changes in supply price etc.

Question 7

Difficulties in constructing budgets:

Answer 7

• sales forecast may be difficult to use if in a dynamic market w rapid changes or high levels of comp or in start up business with little experience.
  -costs make budgeting more difficult as business can face unexpected changes in cost eg by external environment changes like tax/exchange rates.

Question 8

Variances:

Answer 8

The difference between budgets and actual results of business to establish variances.

Question 9

Two types of variances:

Answer 9

-Positive/Favourable
-Unfavourable/Adverse.

Question 10

Favourable variances:

Answer 10

-Favourable variances is when business figures are under the budget - cost lower/revenue/profit higher than expected. This may be due to stronger demand, cautious cost assumptions, higher productivity/efficiency.

Question 11

Adverse variance:

Answer 11

Adverse variance is when business overspend their budget. May be due to unexpected events increasing costs over budget/competition & market making selling prices lower than budget. However adverse variance also mean higher production costs than budget as sales are higher than budget.

Question 12

Use of variance analysis:

Answer 12

-items with large adverse variance show business problem child (boston matrix) and areas to focus ;extension strategy.
-encourage managers to investigate causes of variance.

Question 13

Limitations of budgets:

Answer 13

• budgets dont account for changes in circumstances like increased cost of production due to taxes, changes outside managers control cannot be predicted
  -Historical budgets must be regularly reviewed &updated to ensure accuracy, however R&D for budget updates- time consuming & expensive
  -historical budget encourage a use it ot lose it mentality-managers spend up to limit to make sure that there next year’s budget does not fall- doesnt account for the long term effect.
  -If budget unrealistic- demotivate workers as they will not be able to achieve it despite working hard.
  -Budgets lead to inflexibility in decision making- limit opportunities and risks when in dynamic markets.