2.2.4 - Budgets

Question 1

What is a budget?

Answer 1

A budget is a financial plan that forecasts future earnings and expenditures, usually for a 12-month period. It helps businesses plan and control their financial activities.

Question 2

What are the three types of budgets a business uses?

Answer 2

1. Income Budget
2. Expenditure Budget
3. Profit Budget

Question 3

What is an income budget?

Answer 3

Forecasts revenue based on sales predictions.

Question 4

What is an expenditure budget?

Answer 4

Estimates total costs, including both fixed and variable costs.

Question 5

What is a profit budget?

Answer 5

Calculates expected profit or loss by subtracting the expenditure budget from the income budget.

Question 6

How do budgets affect a business?

Answer 6

Budgets impact all areas of a business by allocating resources, setting targets, and guiding spending decisions. They help coordinate efforts across departments.

Question 7

What is a budget holder?

Answer 7

A budget holder is the person responsible for managing and spending money within a specific budget, such as the head of a department.

Question 8

What factors influence the budget setting process?

Answer 8

Businesses research sales forecasts, production costs, inflation, and other factors. Budgets align with business objectives and are often negotiated to ensure feasibility.

Question 9

What is variance analysis?

Answer 9

Variance analysis involves comparing actual financial performance with budgeted figures to identify differences (variances) and understand their causes.

Question 10

What is a favorable variance?

Answer 10

Favorable Variance: When actual performance exceeds expectations (e.g., higher revenue, lower costs).

Question 11

What is an adverse variance>

Answer 11

Adverse Variance: When actual performance is worse than expected (e.g., lower revenue, higher costs).

Question 12

How is variance calculated?

Answer 12

Variance = Actual figure - Budgeted figure. The result helps determine if the variance is favorable or adverse.

Question 13

What are the external causes of variances?

Answer 13

External: Market competition, economic conditions, changes in raw material costs.

Question 14

What are the internal causes of variances?

Answer 14

Internal: Efficiency improvements, under/overestimated costs, pricing changes, and internal communication issues.

Question 15

What are the advantages of budgeting?

Answer 15

1. Motivation through clear targets.
2. Helps control income and expenditure.
3. Focuses on priorities and goals.
4. Coordinates spending across departments.

Question 16

What are the disadvantages of budgeting?

Answer 16

1. Can cause resentment between departments.
2. Time-consuming and may distract from the core business.
3. Hard to predict inflation accurately.
4. New businesses may lack data, leading to inaccurate budgets.

Question 17

What is zero-based budgeting?

Answer 17

In zero-based budgeting, every budget starts at zero, and budget holders must justify all their spending plans for the year. It’s more accurate but time-consuming compared to historical budgeting.

Question 18

What is historical budgeting?

Answer 18

Historical budgeting involves adjusting last year’s budget by a percentage increase or decrease based on expected changes. It’s simple but assumes that conditions remain constant, which is not always the case.

Question 19

What is fixed budgeting?

Answer 19

Fixed Budgeting: The budget is set at the beginning of the period and cannot be adjusted, providing stability but lacking flexibility.

Question 20

What is flexible budgeting?

Answer 20

Flexible Budgeting: Allows for adjustments based on changes in the business environment or market conditions.

Question 21

Why do businesses react to variances?

Answer 21

Businesses must investigate variances to understand why they occurred and take corrective actions to either adjust their operations or the budget itself.

Question 22

What decisions might a business make based on adverse variances?

Answer 22

1. Change the marketing strategy or product pricing.
2. Streamline production to reduce costs.
3. Motivate staff to improve performance.
4. Negotiate with suppliers for better deals.
5. Conduct further market research to improve forecasts.

Question 23

What decisions might a business make based on favorable variances?

Answer 23

1. Set more ambitious targets for the next budget.
2. Replicate successful strategies across the business.
3. Increase production or hire more staff to meet higher demand.

Question 24

What is cumulative variance?

Answer 24

Cumulative variance is the total variance, combining all favorable and adverse variances.

For example, if revenue is $3,000 above budget and costs are $2,000 under budget, the cumulative variance is $5,000 favorable.