1. BUDGETS A2 Business Studies

2. Why budget? What is likely if a business does not plan for the long term or the short term? Demotivated staff...no clear targets set (MBO) nothing to measure appraisals against No future reviews of the business can take place – nothing to measure against – has it improved or not? No benchmark from period to period. No direction or purpose How will a business allocate it’s resources without one?

3. Budgets Budget Holder is responsible for the setting of and the achievement the budget (accountability/responsibility) Variance Analysis – Budget v’s Actual – and analysing the differences! Budgets are NOT forecasts (predictions) They are PLANS that an organisation wishes to fulfil Can be used for any part of the business, but the outcome has to be QUANTIFIABLE - Sales, Labour, Capex, Materials, Administration etc... Are budgets worthwhile? Do you think that managers or cost centres have some responsibility for setting budgets?

4. Budgets Why do departments need to communicate when establishing their budgets? Conflict can occur... eg – The Marketing Dept might want to increase sales How will it do this? Reduce prices? What department could this conflict with? Why? eg – production might have an objective to reduce costs, which would mean reducing output! They need to TALK TO EACH OTHER – to know what each others plans are Resulting in cohesive and agreeable plans and budgets!

5. Budgets What else are budgets used for other than planning the future of a department? APPRAISALS – managers are accountable to how the department has performed How effective have they been in their role? Have they reached or exceeded targets? This will help identify the good managers from the slack ones! DELEGATED BUDGETS Giving someone else the authority to oversee and set the budget – usually a junior manager So, a manager needs to be careful who to delegate to! If a good job isn’t done, they are still accountable as their boss! Which motivational Theorist does this apply to? Making more work for more rewards?

6. Budgets How do you prepare a budget? Organisation objective (last year and forecasts to be considered!) Sales Budget ALWAYS the first on prepared (Most influence on the growth of the business) Subsidiary Budgets Cash BudgetAdmin Budget Materials Budget Distribution Budget MASTER Budget: (P&L/Bal Sheet) Communication...

7. Budgets So, how do you set the budget level? Different ways are... Incremental Budgeting – A small increase... Take last years budget and make adjustments accordingly for the following year An easy option? Not having to justify the whole budget for the future... Just the change (value of %) Good because: less pressure on staff to be more productive Less accountability for managers to justify the variance  BUT – doesn’t allow for unforeseen events – no “safety” has been allowed for What if a supplier increases their prices? What if a competitor reduces their prices?

8. Budgets So, how do you set the budget level? Different ways are... Zero Budgeting You get nothing at the start of the year  So, you have to “make your case” to get any money out You have to justify the WHOLE budget ! Good because: more incentive for managers to plan managers can “protect” their positions and departments Each yearly budget will be “real” and current  BUT – very time consuming competitive for the funding!

9. Budgets So, how do you set the budget level? Different ways are... Flexibile Budgeting Allows for fluctuations in sales/production Why might a favourable variance of $2000 be found in a production budget? Reduces materials costs? BUT – what if output has dropped by a certain amount (due to reduced demand?) You need to allow a degree of “flexibility” to your figures! Good because managers aren’t criticised for drops in production More accurate and realistic on demand changes

10. Budgets Limitations of Budgets? Lack of Flexibility in the main – once set – have to justify any Adverse Variance, even though external factors can be an influence Focus on the short term (12 months) – so, do you reduce labour to cut costs (labour budget)? What if there is a surge in sales! Could lead to unnecessary spending – Favourable budgets! If you don’t spend it, your budget might get reduced next year! Training needs required – can all managers budget? Setting budgets for new products – How much do you need? They often need constant revisions – consider the Rugby World Cup budget!

11. Budgets So, how do we control the budget? VARIANCE ANALYSIS – comparing Actual against Budgeted It is essential to analyse the differences: 1. Comparison of yours and other departments 2. Can identify deviations – why was ACTUAL profit so low compared with what was BUDGETED? 3. Your future budgets can be changed to reflect any deviations – if Sales was lower than planned, you can look at pricing strategies or lowering costs

12. Budgets Complete the following: VariableBudget $Actual $Variance $Adverse/ Favourable? Sales Revenue15,00012,000 Direct Costs5,0004,000 Overheads3,0003,500 Net Profit7,0004,500

13. Budgets Complete the following: Benefits from doing this regularly are? Identification of problems early – you can react Management by “EXCEPTION” – looking at major problems urgently VariableBudget $Actual $Variance $Adverse/ Favourable? Sales Revenue15,00012,0003,000Adverse Direct Costs5,0004,0001,000Fav Overheads3,0003,500500Adverse Net Profit7,0004,5002,500Adverse

14. Budgets You will NEED TO KNOW THE CAUSES OF VARIANCES! ADVERSE VARIANCE ANALYSIS - LEADING TO LOWER THAN EXPECTED PROFITS  Causes? Why might Sales Revenue be lower or higher than expected? Why might Raw Material Costs have been higher or lower then expected? Why are labour costs above or below those budgeted? Why have overhead costs been over or under expected?

15. Budgets CALCULATE and provide REASONS for the variance? What is the affect on profit for each one? VariableBudget $Actual $Variance $Adverse/ Favourable? Sales Revenue25,00020,000 Direct Costs10,00012,000 Overheads5,0006,000 Purchases15,00018,000 Net Profit25,00030,000 Sales Revenue50,00060,000 Purchases18,00012,000

16. Budgets REASONS for the variance? VariableBudget $Actual $Variance $Adverse/ Favourable? Sales Revenue25,00020,0005000A Direct Costs10,00012,0002000A Overheads5,0006,0001000A Purchases15,00018,0003000A Net Profit25,00030,0005000F Sales Revenue50,00060,00010000F Purchases18,00012,0006000F