Using Budgets

Question 1

Cost centre

Answer 1

Is a section of a business which incurs expenses.

Question 2

Profit centre

Answer 2

Is a section of a business which incurs expenses and generates revenue so the profit of it can be calculated and a profit budget set.

Question 3

Delegated budgets

Answer 3

Is given to a specific manager to manage and control. The manager can also be involved in helping to determine the size of the budget.

Question 4

Expenditure budget

Answer 4

Is a plan of the future expenses of a business or cost centre

Question 5

Variance

Answer 5

The difference between a budgeted figure and the actual figure achieved.

Question 6

Variance analysis

Answer 6

Is the comparison by an organisation of its actual performance with its expected budged performance over a certain time period.

Question 7

Favourable variance

Answer 7

This is a change from a budged figure that leads to higher than expected profits.

Question 8

Adverse variance

Answer 8

This is a change from a budgeted figure that leads to lower than expected profits.

Question 9

Possible causes of favourable variances:

Answer 9

• Lower interest rates lead to a higher than expected increase in sales.
• Bad publicity for a competitors products boost sales above target levels.
• Unions agree to a wage settlement below the rate of inflation that was budgeted for.
• Higher £ exchange rate makes imported components cheaper than forecast.

Question 10

Possible causes of adverse variances:

Answer 10

• Competitors offer special price deals that lead to lower sales for our business.
• Staff efficiency falls and this leads to higher wage costs for each unit produced or sold.
• oil price increase raises energy costs.
• Rent increases forced through by property owner are higher than expected.

Question 11

The benefits of using budgets:

Answer 11

1) CONTROLLING FINANCES. Expenditure budgets reduce the risk of a business overspending. Budget system also allows more money to be allocated to ‘problem’ or under performing departments or products. If a firm has one product that is failing to meet its sales targets, then an increase in the promotional spending budget may be needed.

2) IMPROVING EMPLOYEE PERFORMANCE.
Can be used as financial objective for a cost centre or profit centre of a business. Managers can benefit in particular from delegated budgets. This means being involved in helping to set budgets, and given responsibility for managing and controlling them. This increases the status of the managers involved, and provides a powerful motivational element to their work.

Question 12

The potential drawbacks of using budgets:

Answer 12

1) CONFLICTS CAN ARISE IN 2 MAIN WAYS:
- Departments may compete with eachother for a larger slice of the expenditure funds available in the business. A strong manger or a skilled negotiator may gain a large budget for the department they are responsible for - at the expense of other sections which may actually need the resources more urgently.
- short term budget cuts, for example in promotion, to meet strict targets might lead to long-term problems for the business of sales fall as a result. Those setting budgets should not just consider the immediate financial issues facing the business.

2) THE MOTIVATING INPACT OF BUDGETS CAN FAIL TO BE ACHIEVED FOR 2 REASONS:
- Very ambitious targets may be considered virtually impossible to achieve by the budget holder. This might fail to motivate.
- only motivation when people with the responsibility of meeting the targets are able to participate in the setting of them. If budgets are just ‘handed down from higher management’ with no input or discussion from budget holders then they will lose most of their potential for increasing motivation.