3.9 Flashcards
what is a budget?
Budget – a quantitative financial plan that estimates the revenue and expenditure over a specified future period of time. Budgets help setting targets and are in line with the organization’s objectives. They also enable efficient resource allocation in the specified period.
Budgets are forward-looking financial plans prepared normally on a monthly, quarterly or yearly basis.
what is a budget holder?
a person involved in the formulation and achievement of the budget. The budget holder is responsible for ensuring that the specified budget allocations are met.
introduce cost and profit centres?
As a business grows, managing its finances becomes more difficult.
Different areas of the firm become more and more difficult to account for as a whole.
Therefore, different sections of the business are divided into either cost centres or profit centres.
A manager will have the responsibility for the costs and revenues incurred by each department (or centre).
what are cost centres?
Cost centres are a part of the business where costs are incurred and recorded. The costs are clearly attributed to the activity of each department (i.e. salaries, energy usage, advertising or insurance).
The aim is to make these different sections of a business aware and accountable of their costs which help managers to have a better control on the firms costs.
Some examples of how a business divides their cost centres are….?
By department – for example, Finance, Marketing, Production and HR will each have a specific cost centre.
By product – businesses that produce several products could ensure that each product has its own cost centre. For example, Apple produces phones, computers, iPads, etc. each of these products could have its own cost centres since their costs are measured in their production.
By geographical location – organizations like Burger King, Mc Donald’s, Coca-Cola, Starbucks etc. operate in different parts of the world and each of their locations can be treated as cost centres.
what are profit centres?
Profit centres are departments or units that incur in both, costs and revenues (hence profits). Each profit centre is responsible for contributing to the overall profits of the business.
Profit centres help the business to identify the areas that generate the most or the less revenue enabling the business to compare performance between different sections of the company.
Same as with cost centres, profit centres can be divided by department, by product or by geographical location.
The role of Cost and Profit Centres (advantages)???
Aiding decision making – Having specific cost and profit centres information, can help (aid) the managers to make decisions on continuing or discontinue producing a particular product.
Better accountability – it helps identify the poor performance of a department and hence identify the manager in charge and held him/her accountable for the inefficiency. On a positive note, accountability can also promote better team spirit and productivity between different areas of the organization if the outcome is positive.
Tracking problem areas – Using cost and profit centres allows the firm to identify loss-making sections or products of the business. It enables specific problem areas in a firm to be detected and hence solved.
Increasing motivation – the performance of a cost or profit centre can be used to encourage and reward teams. Incentives such as promotions or bonuses will help with target achievements and help the morale of the costs and profits centres at the same time.
Benchmarking – comparing performances between the various cost and profit centres in the firm can help identify the areas that are less efficient. This aims to help the organization on improving the overall efficiency of the firm.
Problems of Cost and Profit Centres (disadvantages)????
Indirect cost allocation – indirect costs such as advertising, rent or insurance are a subjective task and can be allocated “unfairly” creating distortions on the overall business performance.
External factors – factors such as “competition” or higher raw material prices can affect specific cost and profit centres differently. The influence of the external factor can be higher in the cost centre and lower in the profit centre; creating discrepancies in the overall performance of the firm.
Centre conflicts – managers will be interested on cutting cost and increase revenue, in their own departments. These will create unnecessary internal competition creating tension and conflicts between the various sections on an organization that might lead to lack so sharing important information.
Staff stress – managing cost and profit centres can be very stressful for staff specially if they don’t have the right skills. This could lead to motivational and productivity issues.
To construct a Budget we will use the following terms (some covered in earlier chapters???
Total Revenues – all the revenues (money received by the business) need to be added. For example, sales revenue and interest earned. Also remember that: TR = PxQ
Total Costs - all the costs incurred by the business are added. This could include, wages, rent, cost of raw materials and advertising. Remember that: TC = FC + VC
Excess Revenues over (under) costs - this is the difference between the Total Revenue and the Total cost (notice that we don’t; use the term “profit” [Pr = TR – TC] here; since this is a Budget)
Budgeted figure - estimated amount of money to be revived or spent as set out in the Budget . In other words, what you plan to spend or receive.
Actual figure – the actual money that has been spend or received as a result of the business activity.
Variance – the difference between the budgeted figure and the actual figure
what is veriance?
A variance is calculated at the end of a budget period once the actual outcome is calculated.
Variance analysis is a budgetary control process of assessing the difference between the budgeted amount and the actual amount . It could be done for costs and sales revenue budgets. Variances can either be favourable or adverse.
VAR=actual outcome - bugest outcome
what is a favorable variance?
A favourable variance occurs when the difference between the budgeted and the actual figure is beneficial (positive ) for the company. For example, if the budgeted value for marketing was £250,000 and the actual cost was £220,000; the firm has a favourable variance of £30,000. This would be the opposite when we take Revenue into account.
what is an advser or unfavorable variance?
An adverse (or unfavourable) variance occurs when the difference between the budgeted and the actual figure is financially costly (negative) for the company. In other words, when the actual costs are higher than expected. If in our previous example the actual cost was £270,000 the firm has an adverse variance of £20,000. Same as before, it will be the opposite if a revenue is considered.
Advantages of using variance in strategic planning?
Variance analysis targets to compare the actual performance and the budgeted performance. Hence, it helps accessing the overall organizational performance.
Variance analysis helps detecting the causes of budget deviation and therefore impose corrective measures.
Variance analysis provides and objective way to evaluate budget holders responsible for different departments.
What is decision making?
Decision making – is a process that involves selecting a course of action from various possible alternatives. The aim is to provide a solution to an existing problem.
Businesses are always facing “decision-making” opportunities to determine their future direction and fulfil their vision. Therefore, they need to allocate their resources efficiently.
In simple words, the business needs to know their actual position and the opportunities available to achieve their objectives.
Some of the benefits of using budgets and variance in decision-making are….?
Planning and guidance
Coordination
Resource allocation
Detecting “deviations” or mistakes
Motivation
SMART goals + compasion
