Setting budgets Flashcards
What is a budget?
Budgets forecast future earnings and spending, usually over 12 months.
What are the three types of budgets?
Income budgets - how much will enter the business as sales revenue, use sales figures and market research.
-Expenditure budgets - how much a businesses total costs will be for a year, VC increase with output so that will have to be predicted too.
- profit budget used income budget - expenditure budget to calculate the profit for the year.
What are budgets good tools for?
Communication - they help all stakeholders see what needs to be achieved for the firm to reach profit targets.
How do budgets effect all aspects of a business?
The cost budget is often broken down into department expenditure budgets - each department is allocated a specific amount, many businesses will have budget holders in departments to manage budgets. Expenditure budgets in each department will be broken down into specific activities in the business within the department to help the managers with their work.
How do businesses set their budgets?
Business will firstly do sales forecasting for the year to find income budgets, they will also research how their costs are likely to fluctuate over the year and add up their expenses from the year based on their predicted output.
Budgets will be impacted by a businesses objectives - they may want to increase sales so will increase their marketing budget and income and cost budgets to match that.
Annual budgets will be negotiated by budget holders who emphasise how much they think they will need to get the businesses desired outcome.
How achievable should it be for a business to meet their budgets?
It should be a bit of a stretch but achievable, it may be demotivating to set an unrealistic budget as many will feel failure is imminent.
What do budget holders do to check how well they are sticking to budgets?
They check performance against the budget using variance analysis.
What are the advantages of setting budgets?
Motivating - goal to achieve.
Control income and expenditure
Helps managers to review their activities and make adaptations if needed
Helps businesses to focus on priorities and allocating their capital to the best sources
Can be a communication tool to show how capital is spent
Helps departments to coordinate spending
Can persuade investors the business will be successful if they keep exceeding their budgets
Drawbacks of budgeting
Can cause conflict and rivalry if departments have to fight for money.
Can be restrictive and not allow firms to respond and adapt to change
May stop businesses from pursuing good opportunities they weren’t expecting.
Time intensive
Can’t easily predict inflation
Hard for new businesses to budget
What are the two methods of budgeting each year?
Historical and zero based - zero based is starting from scratch as it is not based on past experience so suits newer businesses. After a year, a business must decide whether to do historical or zero based budgeting for the year.
What are historical budgets?
Historical budgeting is a budgeting method that uses past financial data as a basis for creating future budgets. This method involves looking at the historical financial records of a company, analyzing past revenues, expenses, and other financial metrics, and using this data to create a budget for the upcoming year.
Strengths of historical budgeting?
Easy to implement: Historical budgeting is a straightforward method that does not require extensive planning or forecasting. It is easy to understand and can be implemented quickly.
Accurate: Historical budgeting uses actual financial data, making it more accurate than other budgeting methods.
Useful for benchmarking: Historical budgeting provides a benchmark for future performance, making it easier to track progress and identify areas for improvement.
Simple to adjust: Historical budgets can be adjusted easily if actual results differ from projected ones.
Weaknesses of historical budgeting?
Limited flexibility: Historical budgeting is based on past data, which may not reflect changes in the market or industry that could impact future financial performance.
Focus on short-term goals: Historical budgeting is often geared towards short-term goals, which may not align with the long-term strategic objectives of the comany.`
What is zero based budgeting? How are they formulated? Pros/cons
When budget holders start with £0 and have to get approval to add to the budget at every step. The budgets are based on potential performance, and budget holders have to plan all expenditures, ask for the money to spend on them and be prepared to justify spending in places.
It takes a lot longer to do and requires decent skill and understanding of what is likely to cost what.
However it is a lot more accurate than historical budgeting assuming all is done correctly.
What is fixed budgeting? What are the benefits?
Have to stick to budgets regardless of circumstances. Although it can provide certainty and better cash flow, also means business has less chance of wasting capital.
