1. The Government sets an annual budget. What is the purpose of this?
Why will businesses also set budgets?
AO3: Consider how managers and entrepreneurs monitor the financial performance of an enterprise
Budgets

2. Budgets In this topic you will learn about Interpreting budgets:
income and expenditure
cash-flow
what if analysis
Value of variance analysis to evaluate success
calculating adverse and favourable variances
interpreting variances for decision making

3. budgets
Budgets are forecasts or plans for the future finances of a business
These can be for the business as a whole or set for specific functions e.g. a marketing budget
Budgets can be:
Income
Expenditure
Profit
How much? The crazy cost of children's parties
What budget would you set for a child’s birthday party?

4. budgets Income budgets
a target set for the amount of revenue to be achieved in a set time period
can be split by products, services or departments
may be translated into individual sales targets for staff
informed by market research and sales forecasts
informs predicted cash inflows in the cash flow forecast

5. Why have budgets been cut for UK television dramas?
Expenditure budgets
a limit placed on the amount to be spent in a given period of time
can be split by department, function or product
responsibility can be passed to individual managers
a separate expenditure budget may be set for running costs and start up costs
informs predicted cash outflows in cash flow forecast
allows for monitoring of under spending as well as overspending
Why have budgets been cut for UK television dramas?
UK TV drama budgets 'slashed by 44% in six years'

6. budgets Profit budgets
a target set for the surplus between income and expenditure in a given period of time
calculated based upon the income and expenditure budget
may be set for the business as a whole or for individual departments, products or branches
will be used to inform decision making on products to include in the businesses portfolio as well as were cuts may need to be made

7. Sample budget
Jan
Feb
Mar
Income Budget
5000
6000
Expenditure Budget
2500
3500
Profit Budgets
1500

8. Interpreting budgets - Cash Flow Problems
Explain why a cash-flow forecast is a type of budget.
Managers and entrepreneurs will monitor the cash-flow to identify any problems and potential solutions.
Businesses need to have sufficient cash to meet day to day financial obligations
Buying stock
Paying wages
Utility bills
Insufficient liquid cash funds may mean an inability to meet short term debts
Bank overdraft
Payables (trade creditors)
Limited cash may result in missed opportunities
A key consideration should be whether the cash flow problem is short term or long term
A firm may be able to survive short term cash flow problems
Long term cash flow problems may be insurmountable

9. Improving Cash Flow Increasing the volume of the inflow of cash
Speeding up the timing of the inflow of cash
Inflows
Capital invested
Loans
Cash sales
Debtor payments
Reducing the volume of the outflow of cash
Slowing down the timing of the outflow of cash
Outflows
Loan repayments
Day to day running expenses
Interest payments

10. Improving Cash Flow - Inflows
Using financial institutions i.e. banks
Overdraft – an arrangement with the bank allowing the business to withdraw money above the amount available
Provides some financial peace of mind
Backed by a cash flow forecast to show ability to repay
Allows flexibility
Incurs interest and possible arrangement fee
Can be ordered to repay immediately
Short-term loan – an arrangement with a bank to lend money for a set period of time
Pre agreed repayment terms
Incorporated into budget and cash flow
Interest rate may be lower than an overdraft
Interest is paid on the total value of the loan
May need to be backed by collateral
Biz Link
Overdrafts
An overdraft is a borrowing facility attached to your bank account, set at an agreed limit. It can be drawn upon at any time and is ideal for your day-to-day expenses, particularly to see you through cashflow problems.
Loans
A loan is an amount of money borrowed for a set period within an agreed repayment schedule. The repayment amount will depend on the size and duration of the loan and the rate of interest.

11. Improving Cash Flow - Inflows
Factoring
Debt factoring – the process of selling a business’ debts i.e. the money owed to it, to a factor house at a reduced amount in order to receive immediate payment
Immediate payment of debt
Reduced risk of non payment (bad debt)
Factor house takes a % as their profit
May alter customer’s image of business
Factoring is a service offered by banks. Read what RBS says about factoring.

12. Improving Cash Flow - Inflows
Cash payments from customers
Reducing credit terms – credit terms refers to the amount of time a customer is given to pay for their goods and services
Some businesses offer customers a discount for immediate or quick payment
Quick cash inflow
Reduced risk of bad debt
May need to offer a discount
May lose customers
Credit control – the process of chasing payments from debtors (people who have bought from you on credit)
Brings cash into the business
Full amount received
May alienate customers
Administratively demanding
Should businesses enrol the help of experts in credit control?

13. Improving Cash Flow - Outflows
Delaying payment to suppliers
Negotiating longer payment terms
May incur penalties
Need to maintain positive relationship
Stock management
Reducing money tied up in stock
Need reliable stock deliveries
Reduce overhead spending
Cut unnecessary expenditure
Should not have negative impact on productivity
Consider any knock on effect on sales

14. Difficulties improving cash flow
Damage to the business’ reputation
Potential loss of customers if payment terms affect competiveness
Administrative costs and time
Loss of discounts or need to offer discounts
May affect profitability e.g. only receive part of debt or more expensive to lease assets in the longer run

15. In pairs Method of improving cash flow
Potential difficulties of improving cash flow
Overdraft
Short term bank loan
Factoring
Sale of assets
Sale and leaseback
Cash payments from customers
Credit control
Delay payment to suppliers
Stock management
Reduce overhead spending

16. What-if analysis
What-if analysis is the process of systematically changing variables to calculate a range of possible financial outcomes
Often used to consider best and worst case scenarios
Examples of changing variables include:
Costs e.g. raw materials or utilities, introduction of the living wage
Prices e.g. raise or lower prices in response to competitors actions
External economic changes e.g. interest rates payable on a bank loan or taxes

17. 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
Variance
Expenditure
Budget
£25000
Variance
£2000
Profit
Actual
Expenditure
Actual
£27000

18. 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
Budget
Actual
Variance
Income
£60 000
£62 000
£2 000
Expenditure
£32 000
£32 800
£800
Profit
£28 000
£29 200
£1 200

19. Variances can be Adverse or Favourable
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
Budget
Actual
Variance
Income
£60 000
£62 000
£2 000 Favourable
Expenditure
£32 000
£32 800
£ Adverse
Profit
£28 000
£29 200
£1 200 Favourable

20. 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
High Speed 2 rail line project blows £87m too much on consultants as it already goes over budget
Read more: Follow on Twitter | DailyMail on Facebook
What are the causes, effects and possible solutions to the overspending of budgets on the HS2 project?

21. 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.

22. 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?
Bringing the Budgets Together
Once the Materials Purchase budget (no.3), the Staff budget (no.4) and the Overheads budget (no.5) has been compiled, they can be put together to be summarized in a Production Cost Budget.
To obtain a clearer view of this, and how the whole budgeting system fits together, visit: The Budget Hierarchy (A new window will be opened)
Can you think of an adverse
or favourable variance where each of these might be an appropriate course of action?

23. 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.
6 Months
Budget
Actual
Variance
Pizza Sales
£55 000
£48 000
Drinks Sales
£18 000
£20 500
Materials
£27 500
£1 500 Favourable
Drinks stock
£9 000
£10 250
Wages
£23 000
£1 000 Adverse
Overheads
£40 000
£43 000
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

24. The value of setting budgets
Advantages
Provides a quantifiable target against which actual outcomes can be measured e.g.
Are sales targets being achieved?
Are managers keeping expenditure under control?
Is the businesses operating efficiently to achieve profit targets?
Informs decision making e.g.
What are this year’s priorities?
Where were budgets met or missed in previous years?
Where can cuts be made or extra funds channelled?
Motivates budget holders due to increased responsibility

25. The value of setting budgets
Disadvantages
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

26. Budgets In this topic you have learnt about Interpreting budgets:
income and expenditure
cash-flow
what if analysis
Value of variance analysis to evaluate success
calculating adverse and favourable variances
interpreting variances for decision making