Balancing budgets

Question 1

What are budgets?

Answer 1

Financial plans for a future period of time. They usually forecast:
- Revenue (or income budget)
- Cost (or expenditure budget)
- Profit

Question 2

Why does a business use budgeting?

Answer 2

• To control income and expenditure
• Establishes priorities and sets targets in numerical terms
• Provides direction and co-ordination, so that business objectives can be turned into practical reality
• Assign responsibility to budget holders (managers) and allocate resources
• Communicate targets from management to employees
• Motivate staff
• Improve efficiency
• Monitor performance

Question 3

How is a budget constructed?

Answer 3

• Construct sales budgets showing revenues from planned sales
• Draw up production budgets showing costs incurred in meeting sales targets
• A business can compare sales and production budgets to give a figure for planned profits/losses

Question 4

Where does a business get information from to construct budgets?

Answer 4

• Government data
• Bank of England data on inflation
• Market research data
• Historical sales and costs data
• Specialist market data
• Hunch and Intuition

Question 5

Potential disadvantages of budgeting

Answer 5

• Inaccurate or unreasonable assumptions can quickly make a budget unrealistic
• Budgets can lead to inflexibility in decision-making
• Budgets need to be changed as circumstances change
• Budgeting is a time-consuming process
• Budgets can result in short term decisions to keep within the budget rather than the right long term decision which exceeds the budget
• Managers become too preoccupied with setting and reviewing budgets and forget to focus on winning customers

Question 6

What behavioural changes are caused by budgeting?

Answer 6

• It can affect the motivation of employees - budgets can be de-motivating if they are imposed on employees instead of being negotiating
• Also setting unrealistic targets can be de-motivating
• Budgets contribute to departmental rivalry - battles over budget allocation
• Budgetary slack can occur if targets are set too low

Question 7

Variance analysis

Answer 7

A variance can arise when there is a difference between actual and budget figures. Variance can either be:
- Favourable/positive (better than expected)
- Adverse/unfavourable (worse than expected)

Question 8

What does a favourable variance mean?

Answer 8

• Costs were lower than expected in the budget or
• Revenue/profits were higher than expected

Question 9

What does an adverse variance mean?

Answer 9

• Costs were higher than expected or
• Revenue/profits were lower than expected

Question 10

Is variance important?

Answer 10

The significance of a variance will depend on factors such as:
- Whether it is positive or negative
- Was it foreseen?
- Was it foreseeable?
- How big was the variance
- The cause
- Whether it is temporary or the result of a long term trend