Budgets and variances Flashcards
Budget
A budget is a financial plan that outlines expected income and expenses for a specific period of time, usually a year. A budget is created to help individuals, businesses, or organizations manage their finances and make informed decisions about spending and saving.
Variance
Variance refers to the difference between actual results and expected or budgeted results. In budgeting, variance analysis is the process of comparing actual results to the budgeted amounts to determine how much and why actual results differ from the expectations.
How to calculate and interpret budgets
Determine the budget period: This could be a month, quarter, or year, depending on the type of budget being created.
Gather data: Collect historical data and projections for future income and expenses. This information will be used to create the budget.
Determine fixed expenses: These are expenses that remain constant regardless of changes in the level of activity, such as rent, insurance, and loan payments.
Determine variable expenses: These are expenses that change with the level of activity, such as supplies, labor costs, and advertising.
Establish budgeted amounts: Use the data collected to determine budgeted amounts for each category of expenses and income.
Review and adjust the budget: Once the budget is complete, review it to make sure it is realistic and make any necessary adjustments.
How to calculate and interpret variances
Calculate the variances: Subtract the budgeted amounts from the actual results for each category of income and expenses.
Analyse the variances: Examine the reasons for the differences between actual results and budgeted amounts.
Determine the impact of variances: Evaluate the impact of the variances on the overall budget and financial performance.
Take corrective action: Based on the analysis, determine what steps need to be taken to address unfavourable variances and improve future budget performance.
Favourable (budget/variance)
A favourable budget or favourable variance refers to a situation where actual results are better than expected or budgeted.
Adverse (budget/variance)
An adverse budget or adverse variance refers to a situation where actual results are worse than expected or budgeted
The impact of a budget on a business
Planning and control: A budget provides a framework for planning and controlling a company’s financial activities. It helps companies set financial goals and track their progress towards those goals.
Improved decision making: A budget provides information that helps companies make informed decisions about spending and investment. By comparing actual results to budgeted amounts, companies can identify areas where they may need to adjust their spending or make other changes to improve their financial performance.
Increased accountability: A budget holds individuals and departments accountable for their financial results. It provides a clear understanding of what is expected of each person and helps to ensure that resources are used efficiently.
Increased motivation: A budget can motivate employees to achieve their financial goals. When employees understand the budget and their role in achieving the company’s financial objectives, they are more likely to work towards those goals.
Better risk management: A budget helps companies identify and manage financial risks. By forecasting future financial performance, companies can make informed decisions about investing in new projects, expanding into new markets, or acquiring new businesses.
the impact of a variance on a business
Improved decision making: Variance analysis helps companies identify areas where actual results differ from budgeted amounts. This information can be used to make informed decisions about spending and investment.
Increased accountability: Variance analysis holds individuals and departments accountable for their financial results. It provides a clear understanding of what is expected of each person and helps to ensure that resources are used efficiently.
Improved performance: By identifying areas where actual results differ from budgeted amounts, companies can take corrective action to improve their financial performance. For example, if a department is consistently incurring higher-than-expected expenses, the company may need to adjust the budget for that department or explore alternative ways to reduce costs.
Better risk management: Variance analysis can help companies identify and manage financial risks.
evaluate the usefulness of the budgeting process and variance analysis to a business and its stakeholders
Planning and control: The budgeting process provides a framework for planning and controlling a company’s financial activities. It helps companies set financial goals and track their progress towards those goals.
Improved decision making: The budgeting process and variance analysis provide information that helps companies make informed decisions about spending and investment. By comparing actual results to budgeted amounts, companies can identify areas where they may need to adjust their spending or make other changes to improve their financial performance.
Increased accountability: The budgeting process and variance analysis hold individuals and departments accountable for their financial results. It provides a clear understanding of what is expected of each person and helps to ensure that resources are used efficiently.
Better risk management: The budgeting process and variance analysis help companies identify and manage financial risks. By forecasting future financial performance, companies can make informed decisions about investing in new projects, expanding into new markets, or acquiring new businesses.
Improved communication: The budgeting process and variance analysis provide a common language for communication among stakeholders, including management, employees, investors, and creditors. This can help to ensure that everyone is working towards the same financial goals.
Increased stakeholder confidence: By demonstrating a commitment to financial planning and control, companies can increase the confidence of their stakeholders in their ability to manage their financial resources effectively.
