Budgets Flashcards
Definition of budgets
• A budget is an estimate of income or expenditure for a set period of time
Budgets explained
• Seth runs a small online jewellery business. He estimates that he will make £20,000 this year – this is his business income budget
• He also estimates that his costs will be £5,000 – that is his business expenditure budget
Purpose of budgets
• A business will create budgets for expenses, sales or profits for a wide variety of reasons. The ones that your exam board would like you to know are:
1. Planning
2. Forecasting
3. Communication 4. Motivation
Purpose-planning
A business owner can use a budget to help them plan for any expenses in the year e.g. tax
• A business budget is vital for the small business to help them identify where and when they may run into problems with finances
Purpose-forecasting
• Sales or revenue forecasts are typically based on a combination of the business sales history and how effective they expect their future trading to be
• Using the business’s sales and expenditure forecasts, they can prepare projected profits for the next 12 months.
Purpose- communication
• Setting a budget in a small or large business is an ideal opportunity for the owners to communicate their objectives of the business in a financial plan
Purpose- motivation
• Budgets can be used to motivate staff to be more careful with the finances
• If staff are involved in the setting of budgets they are more likely to be more cautious when spending company money on items like stationery
Historical budget
• This is a budget set for the business using current financial figures and based on historical performance of the business
• The previous years income and expenditure are used as a base on which to build the budget figures for the next year
Zero based budget
• This is a budget set for a business by using figures based on potential performance
• This method takes away all historical assumptions and starts with a clean slate
• May also be used by a start-up with no historical data
Variance analysis
• Analyse the budget figures against what actually happens – there might be a variance
• Favourable variance – the manager has underspent in his department, this would be regarded as a success as any costs cut will have an impact on profit
• Adverse variance – the manager has overspent and it would depend on the reasons, perhaps they needed more staff than was budgeted for and had to hire during the year
Difficulties of budgeting
• Budgets are often fixed for a year and as such inflexible, difficult when business is dynamic
• Tendency for managers to spend up to the limit
Limitations of budgeting
• Budgets can cause inter- department rivalry as some departments get more money than others
• Can make managers short-term and short-sighted, they become budget driven rather than customer driven
