What is a budget? A forward financial plan that covers all the aspects of a businesses costs and revenues.
Why prepare a budget? To exercise financial control within a business. It can provide direction and coordination. To ensure that no department has an overspend. Sets targets that performance can be judged against, which can motivate workers. To delegate spending power to individuals or departments.
Budgetary control The process by which financial control is exercised within an organisation. Budgets for revenue and expenditure are prepared in advance and compared with actual performance to establish any variances. Managers are held responsible for any adverse variances and will need to take action.
Types of budget Zero Budgeting Budgeted costs and revenues are set to zero. Budget is based on new proposals for cost and sales. Time consuming, but starting from scratch can ensure that funds are allocated in the right way. Historical Budgeting Use last years figures and add a little for inflation. It is much quicker and simple but may not focus on problem areas of the business. It does not encourage efficiency.
Budget allocation The level of expenditure will depend on the following factors: the amount available inflation external factors This is a difficult task for certain businesses, as prices fluctuate and sales figures are unpredictable, e.g. restaurants, agriculture and clothing companies.
Exam focus In terms of BUSS2, variances are often the main focus of an examiner’s questions. It is essential that you can calculate variance analysis questions with confidence in preparation for the exam.
Variances These measure the anticipated performance (the budget) against what actually happened. The variance is the difference between the two. Favourable (positive) variance is better than expected: costs lower than expected revenue higher than expected Adverse (negative) variance is worse than expected: costs higher than expected revenue lower than expected You need to use these two terms within the exam.
Worked example: beginner January–March 2013 Budget (£) Actual (£) Variance Favourable or adverse? Sales income5,0004,500500A Cost of materials1,000900100F Wages/salaries1,0001,500500A Marketing costs1,000800200F Other costs1,0001,200200A Total costs4,0004,400600A Profit1,000100900A Sales Income is £500 lower than expected — this is an adverse (A) variance The business limits its spending on marketing, which is £200 lower than expected — this is a favourable (F) variance Overall, the variance is £900 (adverse), as the business budgeted a profit of £1,000 and only made £100
Practice qquestion 1 JanuaryFebruary BudgetActualVarianceBudgetActualVariance Sales income 50,00060,000 Cost of materials 20,00025,00020,00030,000 Wages/salaries 10,000 Overheads 10,00015,00010,00015,000 Total costs 40,00050,00040,00055,000 Profit 10,000 20,0005,000
Answers JanuaryFebruary BudgetActualVarianceBudgetActualVariance Sales income 50,00060,00010,000 F60,000 0 Cost of materials 20,00025,0005,000 A20,00030,00010,000 A Wages/salaries 10,000 0 0 Overheads 10,00015,0005,000 A10,00015,0005,000 A Total costs 40,00050,00010,000 A40,00055,00015,000 A Profit 10,000 020,0005,00015,000 A
Practice question 2 MarchApril BudgetActualVarianceBudgetActualVariance Sales income 30,50029,70026,10028,520 Cost of materials 10,00011,0006,0007,000 Wages/salaries 5,0005,52510,00010,500 Overheads 12,00011,70010,0009,700 Total costs 27,00028,22526,00027,200 Profit 3,5001,4751001,320
Answers MarchApril BudgetActualVarianceBudgetActualVariance Sales income 30,50029,700800 A26,10028,5202,420 F Cost of materials 10,00011,0001,000 A6,0007,0001,000 A Wages/salaries 5,0005,525525 A10,00010,500500 A Overheads 12,00011,700300 F10,0009,700300 F Total costs 27,00028,2251,225 A26,00027,2001,200 A Profit 3,5001,4752025 A1001,3201,220 F
Budgets Benefits Budgets are an effective way to control and monitor costs. Can be used as a motivational tool. Can be used to set targets and judge performance. Drawbacks Budgets are based on assumptions and are not exact. External factors, e.g. the economy, make it almost impossible to set accurate budgets, so could be classed as time wasting. Could be demoralising if set incorrectly. Managers take short-term decisions in order to meet budgetary requirements.