3.9 (HL) - Budgets Flashcards
Define 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.
Define 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.
What is the purpose of a cost and profit centre
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).
Define 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).
What is the aim of a cost centre
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.
What are three ways business divide their cost centres
- By product
- Geographical location
- by department
How does a business divide their cost center by department
Finance, Marketing, Production and HR will each have a specific cost centre.
How does a business divide their cost centres 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.
How does a business divide there cost centres into 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.
Define profit centre
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.
What is the purpose of a profit centre
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.
How can profit centres by divided
Same as with cost centres, profit centres can be divided by department, by product or by geographical location.
What are 5 roles of a cost and profit centre
- Aiding decision making
- Better accountability
- Tracking problem areas
- Increasing motivation
- Benchmarking
What are the advantages of 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
What are the advantages of 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.
What are the advantages of tracking problem areas
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.
What are the advantages of 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.
What is the advantage of 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.
What are the 4 problems with cost and profit centres
- Indirect cost allocation
- External factors
- centre conflicts
- Staff stress
What is the problem with indirect cost allocation on cost and profit centres
indirect costs such as advertising, rent or insurance are a subjective task and can be allocated “unfairly” creating distortions on the overall business performance.
What is the problem with external factors upon cost and profit centres
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.
What is the problem with centre confit of cost and profit centres
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.
What is the problem with staff stress of cost and profit centres
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.
Define total revenue
all the revenues (money received by the business) need to be added. For example, sales revenue and interest earned
State the total revenue equation
TR=PxQ
Define total costs
all the costs incurred by the business are added. This could include, wages, rent, cost of raw materials and advertising.
State formula for total costs
TC=FC+VC
Define excess revenues over 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)
Define budget figures
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.
Define actual figure
the actual money that has been spend or received as a result of the business activity.
Define variance
The difference between budget figure and actual figure
What are the four headings in a budget sheet
- all figures in (amount of money)
- budgeted figures
- actual figures
- variance
What 2 subheadings fall under the title of all figures (amount of money)
- revenue
- total revenue
- costs
- total costs
Define variance
A variance is calculated at the end of a budget period once the actual outcome is calculated.
What is the purpose of a variance analysis
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.
Define a favourable variance
A favourable variance occurs when the difference between the budgeted and the actual figure is beneficial (positive ) for the company.
Define a adverse 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.
