Budgets

Question 1

What’s a budget

Answer 1

Forecasts future earnings and spending, usually over a year period

Question 2

Businesses use different budgets to estimate different things

What are the three types of budget

Answer 2

1) Income budgets
2) Expenditure budgets
3) Profit budgets

Question 3

What’s an income budget

Answer 3

They forecast amount of money that will come into the business as revenue

Question 4

what does a business need to do to forecast the amount of money that’ll come into the business as revenue (income budget)

How will they predict this

Answer 4

• Needs to predict how much it will sell
• What price the products will sell at
• Managers usually estimate this using sales figures from previous years, as well as market research

Question 5

What’s an expenditure budget

Answer 5

They predict what the business’s total costs will be for the year,

Taking into account both variable and fixed costs

Question 6

What do businesses need to take into account when making an expenditure budget

Answer 6

That variable costs increase with output, therefore managers must predict output based on sales estimates

Question 7

What’s a profit budget

Answer 7

Uses the income budget minuses the expenditure budget to calculate the expected profit (or loss) will be for that year

Question 8

How are budgets a good communication tool

Answer 8

They help everyone see what needs to be achieved, to reach profit targets

Everyone= employees, sources of finance

Question 9

What is the expenditure budget often broken down into

Answer 9

Broken down into department expenditure budgets

Each department has a limit amount to spend

Question 10

What are budget holders

Answer 10

People responsible for spending the money for each budget

E.g. the budget holder for marketing could be the head of the marketing department

Question 11

These department expenditure budgets are broke down further to what

Answer 11

Budgets for specific activities within the department

• This helps local manager control and coordinate their work

Question 12

Budget setting involves what

Answer 12

Research

Question 13

How is income budget set

Answer 13

• Businesses research and predict how sales are going to go up and down through the year, so can make a good prediction of sales revenue

Question 14

How is expenditure budget for production set

Answer 14

• Businesses research how labour costs, raw materials costs, taxes and inflation are going to go up over a year
• Then they can figure the cost of producing the volume of product that they think they’re going to sell

Question 15

What are budgets influenced by

Answer 15

Business’s objectives

E.g. if they’re trying to raise sales, they may allocate more of expenditure budget to marketing

Question 16

What if budgets are unrealistic and not achievable

Answer 16

Then it’ll demotivate staff

Question 17

Budget holders check performance against the budget using what

Answer 17

Variance analysis

Question 18

Advantages of budgets

Answer 18

• Can be motivating, giving employees targets
• Helps control income and expenditure
• Allows departments to coordinate spending
• Help persuade investors that the business will be successful

Question 19

Disadvantages of budgets

Answer 19

• Can cause rivalry if departments have to compete for money
• budgeting is time-consuming. Managers can forget to focus on real issues such as understanding the focus
• Inflation is hard to predict- some prices can change by levels much greater than average
• Start-Up Businesses may struggle to get data such as lack of history, so budget may be inaccurate

Question 20

What’s zero-based budgeting

Answer 20

Developing budgets from scratch

E.g. a start-up business

Question 21

Why’s zero-based budgeting difficult to do

Answer 21

• Don’t have much information to base their decisions on
• They can’t take into account the previous years sales or expenditure
• Overall, meaning budgets are likely to be inaccurate

Question 22

After a year of a business being set up, the business has to decide between two budgeting methods

Name them

Answer 22

Zero-based budgeting

Historical budgeting

Question 23

What’s historical budgets

Answer 23

• A budget thats updated each year

- Historical budgeting is quick and simple, but assumes business conditions stay unchanged each year

Question 24

What’s zero-based budgeting

Answer 24

• Means starting from scratch each year
• Figures used are based on potential performance
• Takes much longer to complete
• If done properly, it’s more accurate than historical budgeting

Question 25

Budgets can be fixed or flexible

What’s fixed budgeting

Answer 25

Means budget holders have to stick to their budget plans throughout the year- even if market conditions change

• This can prevent a firm reacting to new opportunities or threats that they didn’t know about when the budget was set
• However, it provides discipline and certainty. Important for a business with liquidity problems- Fixed budgets help control cash flow

Question 26

What’s flexible budgeting

Answer 26

Allows budgets to be altered in response to significant changes in market or economy

• Zero-based budgeting gives a business more flexibility than historical budgeting

Question 27

What’s a variance

Answer 27

Difference between actual figures and budgeted figures to see whether the business is performing better or worse than expected

Question 28

What’s a favourable variance

Answer 28

When a firm performs better than expected

E.g. - revenue or profit is more than the budget
- If costs are below cost predictions in the budget

Question 29

What’s an adverse variance

Answer 29

When a firm performs worse than expected

E.g. - Selling fewer items than the income budget predicts
- Spending more on an advert than the budgeted value

Question 30

Formula for variance

Answer 30

Actual figure - budgeted figure

Question 31

Can variances add up

Example

Answer 31

Yes

E.g. if actual sales exceed budgeted sales by £3000 and expenditure on raw materials is £2000 lower than budget, the variance is:
£3000 + £2000 = £5000

Therefore a combined favourable variance of £5000

Question 32

What’s the variance called that’s added up

Answer 32

Cumulative variance

E.g. Cumulative variance = £10k (F)

Question 33

Why are variances bad

Answer 33

It means what has happened is not what the business was expecting

Question 34

External factors that cause variances

Answer 34

1) competitor behaviour and changing fashions
2) changes in economy can change wages costs
3) cost of raw materials can go up. E.g. a harvest fails

Question 35

Internal factors that cause variances

Answer 35

1) Improving efficiency causes favourable variances (automates production)
2) Underestimation of cost of making a change in the business
3) changing selling price changes revenue- creates a variance if it happens after budget set

Question 36

Whats Variance analysis

Answer 36

Means spotting variances and figuring out why they’ve happened, so action can take place to fix them

Question 37

Why aren’t small variances a big problem

Answer 37

They can motivate the workers

• Staff try to catch up and sort out small adverse variances themselves
• Small favourable variances can motivate staff to keep up what they’re doing

Question 38

Why are Large variances a problem

Answer 38

Can demotivate workers

• Large favourable variance, staff don’t work hard as they don’t feel the need to
• Large adverse variance, they may feel the task is impossible, or that they’ve already failed

Question 39

Businesses need to react to variances quickly.

They can either change budget to make it fit the business or change what the business is doing to make it fit the budget

What are the 3 factors they need to take into account to make this decision

Answer 39

1) Businesses need to be aware of changing the budget too much
2) Changing the budget removes certainty - Which removes a big benefit of budgets
3) Altering budgets can make them less motivating. When staff start to expect that management will change the budget instead of changing performance to

Question 40

Decisions based on adverse variances

Answer 40

1) They can change the marketing mix. Cutting prices will increase sales, only if demand is price elastic. Updating product make it more attractive.
2) Streamlining production makes the business more efficient, reducing costs
3) Motivate employees to work harder
4) Additional market research to improve forecasts in future

Question 41

Decisions based on favourable variances

Answer 41

1) Causes by a pessimistic budget, then they can set more ambitious targets next time
2) Favourable variance could indicate more sales than predicted, so a business may need to increase production of a product or take on additional staff to meet demand
3) If favourable variance was because of increased productivity in a department of a business, they can try get everyone else doing it and set higher targets