Budgets Flashcards
What are budgets, what aren’t they and what do they do?
- A financial plan for the short term, typically one year
- Not a forecast
- Converts long term plans into an actionable blueprint for the future
What are forecasts?
- Predictions of the future state of the environment
- Useful to the planner/budget setter
What are the limiting factors concerning budgets?
- Aspects of a business that stop it from achieving objectives
- Limited ability to sell its products
- Shortage of funds, labour, materials or plants
What do budgets achieve?
- Promote forward thinking and the possible identification of short term problems
- Help coordinate various sections of the business
- Motivate managers to achieve better performance
- Provide a basis for a system of control
- Provide a system of authorisation for managers to spend up to a limit
What is the utility of the cash budget?
- The cash budget is a key budget - all aspects of a business are eventually reflected in cash
- Reflects the whole business more than any other single budget
- All businesses large or small will almost certainly prepare a cash budget as a minimum
What are the steps to cash budget preparation?
- Determine operating activities plans
- Determine investment activities plans
- Determine financing activities plans
What are the steps to determining operating activities plans in the budget setting process?
- Start with the sales budget and opening cash balance
- Determine expected levels of accounts receivable
- Determine required inventory levels
- Calculate purchases
- Determine expected level of accounts payable
- Determine expected level of other expenses
What are the steps to determining investing activities plans in the budget setting process?
Determine expected amount of capital purchases and sales e.g. PPE
What are the steps to determining financing activities plans in the budget setting process?
Determine borrowings, repayments in borrowings and movements in owners equity e.g. dividends paid & share capital issued
What is the format of a budget?
- Reciepts
- Accounts receivable etc.
- Total receipts
- Payments
- Accounts payable
- Salaries & wages
- Overheads
- Capital purchases
- Total payments
- Cash surplus
- Opening balance
- Cash balance
How is depreciation calculated for the cash budget?
Does not involve cash expense so is not included in cash budget
How are overheads in arrears calculated in the cash budget?
Successive months expenses added and paid in term
In the cash budget, what is the cash surplus?
Total cash received - total cash payment
In the cash budget, what is the cash balance?
Opening balance + Cash surplus
How is cash paid to suppliers calculated in the cash budget and what is it dependent on?
- Purchases (cash to suppliers) = Ending inventory - opening inventory + COGS
- Changes in inventory will appear in ending inventory for the month of the change first
- Depends on credit terms
- If say one month, then purchases form previous month would be purchases for current month
How should performance be compared to the budget?
- Draw a comparison between actual costs incurred and budgeted costs for the actual level (volume) of production achieved
- We need to compare actual costs incurred (for the actual volume of production) and those we would have incurred in a budget if we had planned to achieve the level of production actually achieved
By what mechanism can actual performance and budgeted performance be compared?
Flexing the budget
What is flexing the budget?
- Revising the budget to reflect costs that would have been expected for the actual activity
- The flexed budget makes a more accurate comparison between budget and actual performance
- i.e. scale the original budget figures up or down based on actual output
What are the steps to flexing a budget?
- Identify which items are fixed and which are variable relative to the level of output
- Revise variable costs to actual level of production
- ( (Original budget cost/quantity of inputs) / (original budget output) ) x (actual output)
- Fixed costs in flexed budget do not vary from original budget even if
actual costs were different - Prepare the revised (flexed) budget, then compare with actual figures
What are the kinds of variances?
- Adverse variance
* Favourable variance
What is an adverse variance?
A difference between planned and actual performance, where the difference will cause the actual profit to be lower than the budget one
What is a favourable variance?
A difference between planned and actual performance, where the difference will cause the actual profit to be higher than the budget one
Examples of variances?
- Sales volume (quantity) variance
- Sales price variance
- Materials variance
- Total direct materials variance
- Direct materials usage variance
- Direct materials price variance
- Labour variances
- Total direct labour variance
- Direct labour efficiency variance
- Direct labour rate variance
- Fixed overhead spending (expenditure) variance
What are the factors to consider when investigating variances?
- Can be both time consuming and expensive
- Needs to establish a policy on which variances to investigate and which to ignore
- Significant adverse variances represent a potential very costly fault and should be investigated
- Significant favourable variances represent things not going to plan and may mean targets are too low
- Insignificant variances should be kept under review in case they are not the result of chance factors
What is the budgetary reconciliation?
Budgeted profit + all favourable variances - all adverse variances = actual profit
What are the limitations of budgetary control?
- Budgets are time consuming and costly to put together
- Not all expenses can be directly linked to productive activity
- Training expenses
- Advertising expenses
- Standards can rapidly become obsolete due to technological and price change factors
- Delineating management responsibility may prove difficult in practice
- Budgets can constrain responsiveness and flexibility
- Some factors can be outside of management control e.g. economic
What are the behavioural aspects of budgetary control?
- Reseach indicates that
- Existence of budgets tends to improve performance
- Demanding but achievable targets seem to motivate more than easy targets
- Unrealistic targets adversely affect performance
- Allowing managers to set their own targets improves motivation, commitment and performance
