How does a company budget efficiently (2.3)

Question 1

What is a budget ? and what is its purpose ?

Answer 1

A budget is a financial document which forecasts costs and revenues.

Purpose of a budget:

• a budget helps a manager keep control of a business and run it more efficiently
• also a bank will require a budget forecast before giving a loan

Question 2

What are the two types of budget ?

Answer 2

an income or sales budget: which sets out expected sales revenue

an expenditure budget: which sets targets for cost

Question 3

what are the different approaches to setting up a budget ? and what are the problems with each approach ?

Answer 3

1) an existing business will use historical data (last years budget to predict this years), potential problems are:
- sudden rise in costs
- sudden changes to business environment can occur making prediction inaccurate (2008 recession)

2) Other businesses might use zero budget approach - where each department is given a zero budget and the manager has to bid for a sum of money each year. benefits + potential problems are:
- stop department spending money they don’t need to
- managers spend lots of time trying to bid for their budget rather than work going on in the department

Question 4

How would a new business set up a budget ? and what are the potential problems ?

Answer 4

A new business would set up a budget by:

• obtaining data on the budgets linked to other existing similar businesses - which are already established.
• using market research - to predict potential sales for new business. potential problems are:
• your market research may be unreliable
• predicting revenue will be harder than predicting costs

Question 5

what is a favorable and adverse variance ?

Answer 5

Favourable variance:
- Is where the actual figures are lower than the business budgeted for.
Adverse variance:
- is where the actual figures are higher than the business budgeted for.

Question 6

What is a sales forecast ? what are the difficulties of estimation ?

Answer 6

Forecast involve estimating future sales revenue, costs and profits.
Difficulties of estimation:
- changes in economical factors such as increased inflation rates, recession.
- If your business has no historical data will have to use other similar business data

Question 7

define working capital ?

Answer 7

working capital is the money needed to keep going in the time gap between paying out cash for all the input costs incurred during production and the time when sales revenue comes in from customers.

Question 8

how should companies monitor working capital ?Problems with working capital problems ?

Answer 8

business can monitor cash flow by comparing their actual cash flow against their forecast cash flow, problems with working capital problems:

• there are sudden changes of the business environment
• danger of ‘over trading’ - where a business has tried to expand too quickly and cannot pay its bills.

Question 9

What are the ways of managing working capital ?

Answer 9

businesses will have contingency finance planning, this plan may include the following:

• bank overdraft - this will provide a fast injection of cash into the business
• bank loan - will give the business long term benefits of improving its working capital needs
• managing suppliers credit better - eg: negotiate extended payment terms longer than 30 days
• managing customer credit better - eg: give incentive such as a discount for customers to pay quickly
• reducing stock levels - introduce JIT so stock levels fall. this can drastically reduce working capital needs.

Question 10

Define cash flow ?

Answer 10

the total amount of money being transferred into and out of a business, you need it to be positive to survive.

Question 11

Define profit ? and what is its importance ?

Answer 11

profit is revenue minus costs and is key importance in the long term, as without profit the company will have to close.

Question 12

A positive cash flow allows …

Answer 12

• the company to stay in business by being able to pay creditors
• also provides funds for takeover and expansion

Question 13

how can cash flow be improved ?

Answer 13

• timing of payment, eg: getting stock a month early selling straight away but don’t have to pay for several months
• long term investment in new assets, eg: new facilities, new product range.
• New cash injection into the business, eg: loans, extra capital invested by owner.

Question 14

Why do business fail ?

Answer 14

• poor market research both primary and secondary
• poor management of cash flow
• over estimating sales
• poor stock control
• recession
• changing in buying habits
• changes in technology