budgets chapter 32 Flashcards
budgeting
planning future activities by establishing performance targets, especially financial ones
what happens when a business does not have a budget
be without a direction or purpose
be unable to allocate the scarce resources of the business effectively
have demotivated employees with no plans or targets to work towards
be unable to measure its progress by measuring the plans against actual performance
process of budgeting
planning for the future must take into account the financial needs and likely consequences of these plans. the budgeting process: setting and agreeing financial targets for each section of a business. it is usually for each cost centre and profit centre to have budgets set for the next 12 months, broken down on a month by month basis
the measurement of performance
why should business managers know the performance of business
knowing how the different departments and divisions of a business are performing helps managers assess the strengths and weaknesses of the organisation
what can be done after measuring performance
management action can be taken to build upon strengths and correct the weaknesses. assessing actual performance against pre set targets is the best way of measuring the performance, over time, each section of a business.
what needs to be done to review the financial performance of a business
financial targets have to be set. These targets are called the budgets of the business and they should be established for all divisions and sections of a business.
benefits of using budgets: Planning
The budgetary process makes managers consider future plans carefully so that realistic targets can be set. With a clear sales budget
benefits of using budgets: allocating resources
Budgets can be an effective way of making sure that the business does not spend more resources than it has access to. Without a detailed and coordinated set of plans for allocating the business’s money and resources, who would decide ‘who gets what”?
benefits of using budgets: setting targets
Most people work better if they have a realistic target to aim for. This motivation will be greater if the budget holder or profit centre manager has been delegated some accountability for setting and reaching budget levels.
benefits of using budgets: coordination
Discussion about the allocation of resources to different departments and divisions requires coordination between these departments. Once budgets have been set, people will have to work effectively together if targets are to be achieved.
benefits of using budgets: controlling and monitoring a business
Plans cannot be ignored once they have been set and agreed with the budget holder. Checks must be undertaken regularly to control and monitor the performance of the budget holder and their department. Many factors might have changed since the budget was set. Managers cannot assume that the budget target will be achieved without careful control and monitoring.
benefits of using budgets: measuring and assessing performance
Once the budgeted period ends, variance analysis is used to compare actual performance with the original budgets. This is an important way of assessing managers’ performance. It would not be possible to assess how well individual departments had performed without a clear series of targets to compare actual performance with.
budget
the individual responsible for the initial setting and achievement of a budget.
variance analysis
calculation of the differences between budgets and actual figures, and analysis of the reasons for such differences.
potential drawbacks of using budgets: lack of flexibility
If budgets are set with no flexibility built into them, then sudden and unexpected changes in the external environment can make them very unrealistic. Unrealistic budgets will demotivate the budget holder and other employees.
potential drawbacks of using budgets: focus on short term
Budgets tend to be set for the relatively short term. Managers may take a short-term decision to stay within budget that may not be in the best long-term interests of the business.
potential drawbacks of using budgets: unnecessary spending
If managers have underspent their budgets just before the end of the budgeting period, they might make decisions to spend unnecessarily so that the same level of budget can be justified next year.
potential drawbacks of using budgets: training on budgets
Setting and keeping to budgets is not easy and all managers with delegated responsibility for budgets will need extensive training in this role.
potential drawbacks of using budgets:: budgets for new projects
Setting budgets for big new projects is very difficult and often inaccurate. This is particularly true if similar projects - like a super-fast train line - have not been undertaken before.
delegated budgets
budgets for which junior managers have been given some authority for setting and achieving
features of effective budgeting
a forecast is a prediction of what could occur in the future given certain conditions
cost centres and profit centres with a measurable outcome will have budgets set
coordination between departments when establishing budgets avoid departments making conflicting plans
decisions regarding budgets should be made with managers who will be responsible for meetings and people responsible for fulfilling a budget. it motivate departments and leads to establishment of more realistic targets
budgets can be used to find successful and unsuccessful managers by reviewing the performance of each manager
incremental budgeting
uses last year’s budget as a basis, and an adjustments is made for the coming year. cost budgets will be adjusted for forecasted inflation and expected changes in output. it d
ways of budgeting: incremental budgeting
uses last year’s budget as a basis, and an adjustments is made for the coming year. cost budgets will be adjusted for forecasted inflation and expected changes in output. it
features of incremental budgeting
cost budgets will be adjusted for forecasted inflation and expected changes in output. it does not allow for unforeseen events. by using the previous years budget, the entire budget for the coming year does not have to satisfied. there is no fundamental appraisal of each department’s targets or need for resources
ways of budgeting: zero budgeting
sets budgets to zero each year and budget holders have to argue their case for target levels and to receive any finance.
features of zero budgeting
it is time consuming as fundamental review of the work and importance of each budget holding section is needed each year . it does not provide added incentive for managers to defend the work of their own section. changing situations can be reflected in very different budget levels each year
ways of budgeting: flexible budgeting
cost budgets for each expense are allowed to vary if sales or output vary from budgeted levels. budget can change whether there is a favorable variance or a adverse variance
features of flexible budgeting
Flexible budgets are more motivating for budget-holding managers as they will not be criticized for adverse variances, which might occur just because output was lower than budgeted. The flexible targets are more realistic. flexible budgets make it easier to produce valid and accurate variance analyses as they indicate changes in efficiency, not changes in output.
favorable variance
a change from the budget that leads to higher than planned profit
adverse variance
a change from the budget that leads to lower than planned profit
variance
difference between a budget and the actual figure achieved at the end of the budget period
reasons to calculate variances
Variances measure differences from the planned performance of each department over a given period. Measuring performance is a key benefit of budgets.
Finding out the reasons for variances can help set more realistic budgets in the future.
Finding out the reasons for variances can help the business take better decisions.
The performance of each individual cost centre and profit centre may be appraised in an accurate and objective way.
why should favorable variances be analysed
They may reflect a poor and inaccurate budgeting process where cost budgets were set too high. A favorable direct cost variance caused by output being much less than planned for is not a sign of success - why were sales and output lower than planned for?
why should adverse variances be analysed
companies are able to use the information to identify a problem so that it can be fixed or simply to improve overall company performance
possible causes of adverse variances
Revenue is below budget because either fewer units were sold or the selling price had to be lowered due to competition.
Actual raw material costs are higher than planned because either output was higher than budgeted or the cost per unit of materials increased.
possible causes of favorable variances
Revenue is above budget due to higher-than-expected economic growth or a competitor closing down.
Raw material costs are lower because either output was below budget or the unit cost of materials was below budget.
benefits of regular variance analysis
Identifying potential problems early so that remedial action can be taken.
Allowing managers to concentrate their time and efforts on the major problem areas. This is known as management by exception. In this case, it seems that managers should quickly investigate the likely causes of the lower-than-expected sales figures.
