Budgets Flashcards
What is a budget?
A budget is an estimate of income or expenditure for a set period of time.
What is a variance?
Any change in actual income and expenditure against a budget.
What is an expenditure budget?
An estimate of how much will be spent on costs.
What is an income budget?
An estimate of home much money a business will make for the year/ time period.
List the different purposes of budgets.
Planning
Forecasting
Communication
Motivation
Explain planning as a purpose of a budget.
A business owner can use a budget to help them plan for any expenses in the year – for example tax
A business budget is vital for the small business to help them identify where they may run into problems with finances
The business budget would usually run on a monthly basis with regular reviews to help planning
Explain forecasting as a purpose of a budget.
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.
This will enable the business owners to analyse their margins and other key ratios such as their return on investment
Explain communication as a purpose of a budget.
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
Budgets also require departments or sections to report back on progress on a regular basis to their spending and income can be monitored
Explain motivation as a purpose of a budget.
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
If the budget is tied to perks and benefits of the business the employees are much more likely to keep their costs in line with the budgeted amounts
List the different types of budgets.
Historical
Zero based
What is a 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
Realistic in that it is based on last years sales
Drawback is that it does not account for shocks, uncertainty , dynamic markets or actions of competitors
What is a 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
Managers must justify levels of expenditure based on the number of customers they are likely to serve in the next year
Explain variance analysis.
This is analysing budget figures against what actually happens.
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
What are the 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
Time consuming to prepare, monitor and control
Unrealistic budgets can be demotivating
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
Some industries its difficult to plan ahead because of large unplanned changes
