Theme 2 - Budgets - 2.2.4 Flashcards
What is a budget ?
A budget is an estimate of income or expenditure for a set period of time
Whats an example of an income budget, expenditure budget and variance ?
Seth runs a small jewellery business. He estimates that he will make 20,000 this year - this is his business income budget
He also estimates that his cots will be 5000 - that is his business expenditure budget
Seth can now trade and measure his actual income and expenditure against his budget - any changes are called a variance - so for e.g. you had more/less expenditure than the estimated budget - this would be a variance
What are the four purposes of budgets ?
- planning
- forecasting
- communication
- motivation
What is the purpose of budgets - planning ?
A business owner can use a budget to help them plan for any expenses in the year e.g. tax
A business budget is vital for the small businesses to help them identify where a when they may run into problems with finances - for e.g. they could see if they could keep up their profits from sales in line with their expenditure for rent for e.g.
The business budget would usually run on a monthly basis with regular reviews to help planning
What’s the purpose of budgets - forecasting ?
Sales or revenue forecasts are typically based on a combination of the business sales history and how effective they expect their future trading to be
using the businesses sales and expenditure forecasts they can be prepared for the next 12 months
This will enable the business owners to analyse their margins and other key ratios such as their ROI
What is the purpose of budgets - communication ?
Setting a budget in a business is an ideal opportunity for the owners to communicate their objectives of the business in a financial plan
Setting a budget will help people explain why they should do this or that in a business as they will know how much they can spend per month etc
What is the purpose of budgets - motivation ?
Budgets can be used to motivate staff to be more careful with finance
If staff are involved in the setting of budgets they are more likely to be more cautious when spending company’s money on items like stationary
If the budgets are tied to perks and benefits of the business the employees are much more likely to keep their costs in line with the budgeted amounts
What are the 2 types of budgets ?
Historical budget
Zero based budget
What is a historical budget ?
This is a budget set for the business using current finically figure and based on historical performance of the business
The previous years income and expenditure are used as a base on which to build the budget figure for the next year
Realistic in that it is based on last years results
Drawbacks is that it doesn’t take into account for shocks, uncertainty etc
What is a zero based budget ?
This is a budget set for a business by using figure based on POTENTIAL performance
This method takes away all historical assumptions and starts with a clean slate
Managers must justify levels of expenditure based on the number of customers they are likely to serve next year
What is variance ?
It is when you analyse the budget figures against what actually happens - there might be a variance
What is favourable variance ?
It is if for e.g. the manager has underspent in his department - this would be regarded as a success as any costs cut ( so like underspending - u have money left over ) will have an impact on profit - mo money left over mo profit
What is adverse variance ?
The manager overspent and it would depend on the reasons, perhaps they needed more staff than was budgeted for and had to hire during the year
What are the difficulties of budgeting ?
It is time consuming to prepare, monitor and control
Unrealistic budgets can be demotivating
What are the limitations of budgeting ?
Budgets can cause inter-department rivalry as some departments get more money than others
Can make managers become budget driven rather than customer driven - being budget driven could be a problem as the managers could cut corners to look better ( for e.g. changing test scores to make their department look better so they get a better budget next time ) - this results in worse quality
In some industries it’s difficult to plan ahead because of large unplanned changes e.g. in farming the weather can have a huge impact on crops
