Budgeting

Question 1

explain what is meant by a budget

Answer 1

it is a financial plan relating to the use of resources to achieve specific objectives over a given time/a financial plan of income and expenditure

Question 2

what are the 6 steps on how a budget is prepared?

Answer 2

establish the aims and objectives of the business

set the production, marketing and financial budgets which are the main functional budgets

each budget should be further broken down into more categories

procedures for monitoring the budgets should be set up including regular checking and communication between managers and budget holders

any variance from expected budgets should be identified and analysed - why did it occur?

the experience and knowledge gained should be used when setting budgets in future

Question 3

what are three types of budget and explain each one

Answer 3

production budget -
this is an expenditure-only budget

the objectives of the business have established the output levels required so the production budget attempts to put these output levels into practice

this involves costs of materials/components/direct labour costs, amongst others

marketing budget -
both revenues and costs are included

revenues are from predicted sales

costs are from operating the business’s marketing strategy

financial budget -
based upon the cash flow forecast

will income cover expenditure or will there be a need to examine methods of raising funds to finance other budgets?

Question 4

what are 4 purposes of a budget?

Answer 4

control expenditure

identify the variance between actual and budgeted figures

provide a means of monitoring different departments

process can facilitate the efficient allocation of resources

Question 5

what is variance analysis?

Answer 5

it involves calculating the difference between actual figures and budgeted figures (sales variance)

Question 6

what are two ways variance is described?

Answer 6

favourable
adverse

Question 7

describe favourable variance

Answer 7

happens when the actual revenues are higher than expected
expenditure is less than expected
the figures are better than the figures that were budgeted for so result in a higher profit

Question 8

describe adverse variance

Answer 8

occurs when the actual revenue is lower than expected
expenditure is higher than expected
figures are worse than figures that were budgeted for so result in a lower profit

Question 9

what is the formula for expenditure variance?

Answer 9

budgeted figures - actual figures

Question 10

what 13 reasons may expenditure variances occur?

Answer 10

materials might be purchased at special discount prices for some time

a new lower-priced supplier might be found

a price war might break out among suppliers

cheaper, inferior materials might be purchased

materials might be wasted due to careless work

materials might be wasted if they are of poor quality perhaps due to a decision to buy cheaper materials

poor stock control or pilferage could cause materials to be lost

a shortage of skilled labour

government legislation such as raising the minimum wage

greater or reduced reliability of machinery used by workers

improvements or reductions in the quality of raw materials and components

changes in productivity of workers may be due to level of training provided

loss of morale and motivation in the workforce perhaps due to fears of job losses

Question 11

what three things should be done if an adverse expenditure variance occurs?

Answer 11

shop around for less expensive suppliers or negotiate bulk purchase discounts

improve quality control systems in purchasing department or better maintenance of machinery and improved training of the workforce

automate the production process so that less skilled lower-paid workers can be used or improve productivity perhaps by motivation

Question 12

what 9 reasons may cause sales variance?

Answer 12

unplanned sales in new markets at different prices to usual

new competitors in the market causing prices to be lower or rivals leaving the market allowing price to increase

discounts for bulk buying customers

special offers or trial prices

changes in the state of economy so causing a rise or fall in consumer demand

competitors’ actions eg a new advertising campaign

sudden changes in consumer tastes perhaps caused by health scares

government policy such as changes in taxes/interest rates

changes in the quality of the product

Question 13

what 2 things can be done if the overall sales variance is adverse?

Answer 13

make a greater effort in promoting the product by advertising maybe

price cuts can sometimes increase overall sales revenue depending on the elasticity and the success of this depends on the reactions of competitors (they may copy) and on consumers’ perceptions (they may feel the product is of poor quality so not buy)

Question 14

what are 4 benefits and drawbacks of using budgets?

Answer 14

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monitoring performance -
managers can identify departments incurring high costs or those doing well and act accordingly

identifying factors affecting performance -
prompt variance analysis allows managers to identify whether variances are due to internal or external factors and once causes have been traced they can be corrected

improved plans in future -
by identifying variances and their causes managers may be able to produce more accurate budgets in the future, aiding planning and perhaps improving the performance of the business

improved accountability -
this can be linked to performance-related pay eg budget holders may receive a bonus at the end of the budget period if they can show favourable variances which may improve motivation

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motivation -
if workers are not consulted about the budget/budget is unrealistic then it can be hard to motivate them

manipulation -
a manager may be able to arrange an easily achievable budget and this will make their department look successful but may not help the business achieve its objectives

rigidity -
budgets can constrain business activity eg a budget that prevents the acquisition of new vehicles for a business may result in inefficiency as ageing vehicles require more maintenance and repair leading to higher costs and customer dissatisfaction

short-termism -
some managers might be too focused on the current budget and they might take actions that undermine the future performance of the business just to hit current targets

Question 15

how is budgeting an important management tool?

Answer 15

they help with financial control and in coordinating business activity and they also assist in motivating staff

Question 16

how can a poorly constructed budget affect a business?

Answer 16

it wastes time, demotivates staff and may restrict business activity so that management cannot react to changes in the marketplace

Question 17

how do shareholders and investors use budgets?

Answer 17

see what level of sales a business is predicted to have which will impact the level of dividend received by shareholders

a potential investor may not invest in a business that has adverse variances on its sales revenue in the past

Question 18

how do employees use budgets?

Answer 18

see if the business is forecast to make enough sales and profit to ensure employees have job security

if sales are predicted to increase, employees may be interested to see if they need to work overtime and so receive higher rates of pay and bonuses

if employees receive part of the profits, they may look at the budget to see what level of profit-share they may receive

Question 19

how does the bank use budgets?

Answer 19

to grant a loan or mortgage since a bank needs to see evidence of forecast sales and expenditure

Question 20

how does the suppliers use budgets?

Answer 20

if the business has adverse sales/expenditure variance this may concern suppliers who have supplied raw materials on credit to the business because if the business doesn’t generate enough profit they will be unable to pay their debt to their suppliers