1. BUSS2.1 Using Budgets Finance Using Budgets Budgets This unit follows on from the study of budgets in Unit 1- Setting Budgets “ Budgets are for cutting, that’s why you set them” Dr Laurence Buckman

2. BUSS2.1 Using Budgets Using Budgets In this topic you will learn about:  The benefits and drawbacks of using budgets  The calculation and interpretation of favourable and adverse variances  Using variance analysis to inform decision making

3. BUSS2.1 Using Budgets Income, Expenditure and Profit Budgets  Income Budgets A target set for the amount of revenue (income) to be achieved in a set period of time  Expenditure Budgets A limit set for the amount of money that can be spent (expenditure) in a set period of time  Profit Budgets A target set for the amount of profit (income in excess of expenditure) to be achieved in a set period of time Revise budgets from unit 1?

4. BUSS2.1 Using Budgets The benefits of using budgets  Improves financial control Reduces overspending Better forecasting ability More efficient allocation of money  Delegates spending power Motivates staff Opportunity cost of manager’s time  Sets targets and goals Improves cash flow forecasting Allows for monitoring of performance

5. BUSS2.1 Using Budgets The benefits of using budgets “We have always found that people are most productive in small teams with tight budgets, time lines and the freedom to solve their own problems.” John Rollwagen American Businessman, CEO of Cray Research You will need access to the internet to watch this video? Is sticking to a budget and deadline always the right move? Watch this video where the CEO of BA defends the first day of T5 Analyse two reasons why people may be more productive in these circumstances? Analyse two reasons why people may not be more productive in these circumstances? On balance which of the arguments do you think is stronger? Justify your answer. What factors might influence whether people are more or less productive in these circumstances?

6. BUSS2.1 Using Budgets The drawbacks of using budgets  Potential for conflict Lack of transparency Short term saving may be detrimental to long term objectives May be too easy or too hard to achieve  May be restrictive Opportunities may be missed Inappropriate cost cuts  Time consuming to set and monitor “ The budget evolved from a management tool into an obstacle for management.” Frank C Carlucci, American Secretary of Defence

7. BUSS2.1 Using Budgets Variance The calculation and interpretation of variances  An advantage of budgets was that they allow for monitoring of performance  This is achieved by comparing the budget to the actual  Any difference is known as a variance Profit Budget Profit Actual Expenditure Budget £25000 Variance £2000 Expenditure Actual £27000

8. BUSS2.1 Using Budgets The calculation and interpretation of variances  Variance is therefore the difference between the actual income, expenditure or profit and the figure that had been budgeted  Variance Analysis is the process of calculating and interpreting these variances BudgetActualVariance Income£60000£62000£2000 Expenditure£32000£32800£800 Profit£28000£29200£1200

9. BUSS2.1 Using Budgets Variances can be Adverse or Favourable Adverse  An adverse variance is one that is bad for the business Expenditure higher than budget Income lower than budget Profit lower than budget Favourable  A favourable variance is one that is good for the business Expenditure lower than budget Income higher than budget Profit higher than budget BudgetActualVariance Income£60000£62000£2000 Favourable Expenditure£32000£32800£800 Adverse Profit£28000£29200£1200 Favourable

10. BUSS2.1 Using Budgets Interpreting Variances  Once a variance has been identified it is important to 1) Identify the cause of the variance 2) Consider the effect of the variance 3) If appropriate look for a solution Use either the internet link or word doc to read about overspending at the BBC What is the cause, effect and possible solution?

11. BUSS2.1 Using Budgets Possible causes of variances  Action of competitors Lower prices Introduce a new product Close a store  Action of suppliers Change prices Offer a discount  Changes in the economy Change in interest rates Increase to minimum wage  Internal inefficiency Poor management of a budget Demotivated sales team  Internal decision making Change suppliers Special promotions In each of these cases consider the possible impact on actual expenditure and/or income and explain whether you think the variance will be adverse or favourable You need access to the internet to watch this video What factors prompted NZ Tourism board to increase its budget? Do you think this was a wise decision?

12. BUSS2.1 Using Budgets Using variance analysis to inform decision making  Having identified variances managers now need to decide how to respond Change budgets? Staff training? Reward staff? Change suppliers? Reallocate budgets? New marketing tactics? Review product portfolio? Can you think of an adverse or favourable variance where each of these might be an appropriate course of action? Biz24 offers guidance to small businesses on variance analysis

13. BUSS2.1 Using Budgets Activity – Del Rio Pizzeria Del Rio Pizzeria has been trading for 6 months. Toni, the owner, is worried that waste levels in the kitchen are high and customer numbers low. He decides it is time to sit down and look at the books. 6 MonthsBudgetActualVariance Pizza Sales£55000£48000 Drinks Sales£18000£20500 Materials£27500£1500 Favourable Drinks stock£9000£10250 Wages£23000£1000 Adverse Overheads£40000£43000 Profit / Loss Fill in the gaps Identify possible causes of the variances Identify possible solutions Toni is considering lowering the materials expenditure budget for the next 6 months, discuss the arguments for and against this course of action