Chapter 30- budgets and variance

Question 1

What is a budget?

Answer 1

• it is a plan for the future that takes into account the resources that are available to the business
• it will apply monetary values to different aspects of business activity, such as revenue, output and costs

Question 2

How can managers then monitor the performance of the business?

Answer 2

• with respect to the budgeted figures

Question 3

What do the main areas for budgeting involve?

Answer 3

Costs and revenues of a business

Question 4

What does the act of budgeting encourage?

Answer 4

The production of inflows and outflows and helps the organisation to confront problems and act on them
- it will also show which areas of the business are likely to be successful and those that need extra attention or which may need to be changed or dropped

Question 5

Reasons for undertaking budgeting in the firm

Answer 5

• measuring the money entering and leaving the business in all areas using this information to indicate the level of efficiency and effectiveness of the businesses activities
• giving information on the productivity levels of staff and providing one possible means of appraising and rewarding workers
• providing information for current and prospective shareholders and investors
• ensuring that the cash flow is adequate to meet the day-to-day needs of the business
• providing the basis of control and meeting objectives

Question 6

Budgeting for cash flow

Answer 6

• the need to pay workers either at the end of each week or month makes it essential for the business to ensure adequate cash flow

Question 7

Overdraft facility

Answer 7

• an agreement with a bank to be able to overdraw on an account up to a stated limit
• this overdraft facility will usually have an agreed rate of interest (in relation to the Bank of England base rate) charged upon it

Question 8

Need for liquidity

Answer 8

• what the demand for cash is likely to be at any time to allow the business to meet the demands for payments
• once figures have been calculated manager/owner can start to think about how that cash could be generated

Question 9

Improving liquidity

Answer 9

• cash flow can be improved significantly by delaying payments to suppliers and demanding payment from customers

Question 10

Dealing with the bank or other lenders

Answer 10

• bank will require other information such as accounts and projected sales figures

Question 11

Making changes

Answer 11

• sometimes the cash flow forecast may highlight the fact that changes need to be made

Question 12

Budgeting in other areas

Answer 12

• budgeting is used in all areas of an effective business to ensure that spending is controlled and to provide forecasts of likely costs and returns
• budgeting by department makes it possible to split the business into smaller units and pass responsibility to departmental heads for their own performance
• this delegation of responsibility will be useful in a number of ways
• responsibility for budgeting may be a motivator showing that senior management trust the judgement of their more junior managers

Question 13

Delegation

Answer 13

The passing on of responsibility, usually to someone at a lower level in the organisation

Question 14

Zero budgeting

Answer 14

• involves setting all budgets at 0 requiring managers to justify any requirement for funds
• advantage of this system is that it prevents a situation where the same money is given each year without any consideration of actual need
• main problem with zero budgeting is the amount of tim edit takes for budget holders and financial co ordinator to manage the system

Question 15

Flexible budgets

Answer 15

• allow a business to make allowances for changes in the level of sales volume so that adverse variances are avoided

Question 16

Variance analysis

Answer 16

• the variance is the amount by which the actual financial results for an item differ from the amount in the budget
• variance can be adverse or favourable
• for revenue if actual sales exceed the budgeted figures the variance will be favourable whereas for cost if actual costs exceed the budgeted figure the variance will be negative
• a positive variance improves profit
• negative variance reduces actual profit

Question 17

Why is variance analysis useful?

Answer 17

• it allows managers to see where there are problems in meeting budgets and where departments are doing particularly well
• managers need to bear in mind that the variances may have occurred because the budget was unrealistic to start off with

Question 18

Historic information

Answer 18

• information that exists from past years