Budgeting

Question 1

Budgeting

Answer 1

the process of predicting/ estimating the nancial consequences of future events

Question 2

Budgeting reports look almost exactly the same as the reports we have already prepared, but are different in two key ways:

Answer 2

1
Budgets report future events rather than historical events; they focus on what might happen rather than what has already happened.
2
As a consequence, budgets use estimates or predictions rather than actual, veri able data.

Question 3

2 purposes of budgeting

Answer 3

Assist planning

Aids decision making

Question 4

How does budgeting assist planning

Answer 4

Budgeting assists planning by predicting what is likely to occur in the future. This allows the owner to prepare in advance so that possible problems may be managed, and possible opportunities may be taken.

Question 5

How does budgeting aid decision making

Answer 5

Budgeting aids decision-making by providing a standard (a benchmark or yardstick) against which actual performance can be measured. This allows the owner to identify areas in which performance is unsatisfactory, so that remedial action can be taken.

Question 6

Budgeting process

Answer 6

Budgeted reports
Actual reports
Variance reports
Decisions

Question 7

Why is budgeting harder for new businesses

Answer 7

The information presented in the budgeted reports should be based on the historical data, but allowances must be made for changes and the effect of new business decisions. (Obviously, a brand new business will not have any historical data on which to rely – this makes budgeting harder for new businesses, but no less important).

Question 8

Cash budget

Answer 8

an accounting report which predicts future cash receipts and payments, determines the expected cash surplus or de cit, and thus estimates the bank balance at the end of the budget period

Question 9

Purpose of cash budget

Answer 9

In order to survive into the future, a small business must have suf cient cash to meet its obligations. These obligations will include paying expenses (such as wages, rent or advertising); meeting loan repayments; and providing cash drawings for the owner. In order to do this, it must generate suf cient cash, chie y through its cash takings or fees.
The Cash Budget attempts to estimate all future cash receipts and payments, and thus predict the rm’s cash balance at the end of the budgeted period.

Question 10

What does a cash budget measureIn order to survive into the future,

Answer 10

Expected cash receipts
Expected cash payments
Expected cash surplus (deficit)
Expected closing bank balance

Question 11

How does the cash budget assist planning

Answer 11

The Cash Budget aids planning by allowing the owner to prepare in advance for an expected cash surplus or cash de cit. That is, the owner will be forewarned if the business is not generating enough cash, or if excess funds will be available, and will then be able to take steps to prepare for (or perhaps even prevent) that outcome.

Question 12

Where the cash budget warns of a cash de cit, the owner may be able to respond by:

Answer 12

• increasing advertising; changing prices; or offering other services in order to increase
Cash Fees
• making a cash capital contribution
• reducing cash payments for expenses (see below)
• deferring the purchase of non-current assets, or using credit facilities or a loan for
their purchase
• deferring loan repayments (on existing loans)
• taking less cash drawings
• organising (or extending) an overdraft facility.
Although cutting expenses is an obvious (and frequently appropriate) response to
a predicted cash de cit, the owner must be particularly mindful of which expenses are cut, as the bene ts the expenses provide may be vital in the earning of cash takings. For example, reducing advertising may mean less exposure; or cutting wages might mean a poorer (or less timely) service; and each may mean less business, and lower cash takings. In cases like these, cutting expenses may actually make the cash situation worse rather than better.

Question 13

Should the cash budget predict an overall cash surplus, the owner might plan to use the extra cash to:

Answer 13

Should the cash budget predict an overall cash surplus, the owner might plan to use the extra cash to • purchase more or newer non-current assets
• increase loan repayments
• increase cash drawings
• expand operating activities by increasing advertising, employing more staff etc.
Alternatively, a business that starts a period with a bank overdraft may choose to do nothing, and let the expected cash surplus bring their bank balance back into surplus.

Question 14

Using the cash budget to aid decision making

Answer 14

In addition to its role in planning, the Cash Budget aids decision-making about the effectiveness of the rm’s cash management. The Cash Budget sets a standard (a target or benchmark) which can be used to assess actual cash receipts and payments. By comparing actual cash ows against the budgeted gures, the owner can identify problems areas (where performance was below expectation), and then act to correct the situation.
For example, Figure 9.2 set a target for Cash Fees of $16 000: should actual Cash Fees not meet this expectation, corrective action (in the form of more/better advertising, or a review of prices) can be taken. Similarly, should payments for Photographic Supplies exceed the budgeted gure of $7 000, the owner may wish to review handling procedures, or even change suppliers (for a cheaper price).

Question 15

Cash budget consecutive periods

Answer 15

In general, more frequent budgets will be more accurate, and therefore more useful as benchmarks for comparison. In addition, they will allow for the earlier detection of problems, so that corrective action can be taken in a more timely fashion (and can perhaps stop a small problem from becoming large).
However, Figure 9.2 relates only to one month taken in isolation. To show the effect of monthly variations it would be wise for a business to prepare budgets for consecutive months. That is, separate budgets for October, November and December 2016 could be prepared and presented side-by-side to show trends in receipts and payments from month to month. Such a budget may appear as is shown in Figure 9.3.

Question 16

Budgeted income statement

Answer 16

an accounting report which predicts revenues earned and expenses incurred, and thus the
expected Net Pro t, for the budget period. the Budgeted Income Statement closely resembles the actual Income Statement, but uses budgeted rather than actual historical data.

Question 17

How does the budgeted income statement assist planning

Answer 17

The Budgeted Income Statement aids planning by reporting expected revenues and expenses and thus indicating the rm’s future requirements relating to issues like staf ng (which may require hiring or ring), the acquisition of supplies or materials, or the need for advertising campaigns. Where a Net Loss is predicted, the owner can respond by:
changing prices, advertising or the services offered to increase Cash Fees seeking cheaper suppliers
examining rosters to ensure staf ng levels are appropriate.

Question 18

How does the budgeted income statement aid decision making

Answer 18

As a decision-making tool, the Budgeted Income Statement provides a standard against which actual trading performance can be measured, allowing problems to be identi ed and corrective action taken. This benchmark can also act as a target or goal to motivate staff and management. Speci cally, the owner could assess:
revenue earning performance (and the effectiveness of advertising) expense control
staff performance.

Question 19

One of the key reasons for preparing a cash budget and how this can be achieved

Answer 19

One of the key reasons for preparing a Cash Budget is that it provides a standard or benchmark for the assessment of actual performance. By comparing actual and budgeted gures, differences – and problems in particular – can be identi ed, allowing the owner to make decisions to improve the rm’s performance. This comparison is facilitated by the preparation of a variance report.

Question 20

Variance report

Answer 20

an accounting report
that compares actual and budgeted gures, highlighting variances
so that problems can be identi ed and corrective action taken

Question 21

Cash budget variance report

Answer 21

an accounting report which compares actual and budgeted cash ows, highlighting variances
so that problems can be identi ed and corrective action taken. In appearance, it is very similar to a Cash Budget, but is has additional columns for actual gures, and the calculation of the variance. It is prepared once the actual gures are available, but before the next budget.

Question 22

Variance, favourable, unfavourable

Answer 22

A variance is simply the difference between the budgeted gure and actual gure. Whether it is favourable or unfavourable depends – in the Cash Budget Variance Report
– on its effect on cash:
• •
a variance is favourable (F) if it means cash will be higher than expected in the budget
a variance is unfavourable (U) if it means cash will be lower than expected in the budget.

Question 23

Income statement variance report

Answer 23

an accounting report that compares actual and budgeted revenues and expenses, and highlights variances so that problems can be identi ed and corrective action taken

Question 24

How the variance reports assist planning and aid decision making

Answer 24

Assuming the variances are not caused by poor estimates, then both the Cash Budget Variance Report and the Income Statement Variance Report are valuable aids to decision-making. The unfavourable variances should be investigated, and their cause(s) identi ed. This will allow the owner to take corrective action.
In this example, a different approach to advertising seems necessary if the business is to generate greater Cash Fees, and an investigation may reveal a need for better techniques for purchasing and/or handling Photographic Supplies. However, the decision to pay cash for the camera equipment seems affordable (provided the business has enough cash to purchase the company car later in the year).
Even if the variances are simply the result of poor budgeting, this does not mean the variance reports are useless. Both variance reports can be used to assist planning for the next reporting period by providing a basis for the preparation of the next budget, so that it is more accurate and thus more useful as a benchmark and decision-making tool.