2.2.4 - Budgets

Question 1

What is a budget

Answer 1

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

Question 2

What are the purposes of a budget

Answer 2

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

Question 3

How is planning a purpose of a budget

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

How is forecasting a purpose for budgeting

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

p

Answer 5

p

Question 5

How is communication a purpose for budgeting

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

How is motivation a purpose for budgeting

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

What are the types of budget

Answer 7

• Historical based budget
• Zero based budget

Question 8

What is a historical budget

Answer 8

• 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 9

What is a zero based budget

Answer 9

• 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 10

What is favourable variance

Answer 10

• 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 11

What is adverse variance

Answer 11

• 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

Question 12

What are the difficulties 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

What are the 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