Importance of Using Budgets
There are several types of budgets which businesses use to formulate plans to grow and develop the business. Zero budgeting, Historical budgeting, Flexible budgeting.
Zero budgets set the business budget at zero. It's very useful in enhancing the business co ordination and to enhance the activities of the business.
Flexible budgetting is used to amend any circumstances that could change the business focus. Whatever might cause the business to re evaluate its activities and action plans can be taken into account for by the flexible budget.
The other way for budgets to be used is through historical budgets which use the figures from the previous year in setting the budget. It takes into account the revenues and costs and figures and uses this to establish the budget figures for the following year.
Benefits and Drawbacks
There are several benefits of budgeting.
Budgets are useful in the coordination of departmental budgets to get an instant picture of the overal business.
Budgets are used to monitor and control cost.
This is because any expenses have to be approved by the person who is responsible for executing the budget.
The motivation of the business has a strong link to the budget.
The drawbacks of budgeting.
There may be the need to take short term actions to be within the budget in the event that the information which is provided in the budget is not accurate.
There can be power struggles within the business by those who are more favourably places to influence the budget decision than other less favoured work colleagues and counterparts who have little or no influence in the business.
Calculate and Interpret Favourable and Adverse Var
Variances occur due to differences between the actual figures which the business obtains and the figures projected in the budget. Errors in the budgetary calculations can lead to variances. Such variances can be detected in a timely manner to ensure that the business doesn't suffer any adverse effects.
The use of statistical and accounting information is very useful in showing any budget variances. The use of budget reports and adequate measures to ensure co operation at all levels to the success of the business is very important to the business.
Variance types: Labour, Overhead, Sales, Profit.
Each of these variances is caused by fluctuations in the price or the change in the level of volumes as outlines in the budget.
The difference between the positive and negative variances are the effect of the budget and business performance.
Positive variances reflect that business is performing better than expected. Negative variances show the opposite and reflect poor performance of the business.
Through the calculation of the different types of variance, business can make informed decisions about the course of direction in which to steer the business.
Labour Efficiency Variance: used to measure whether the more or less labour is needed to produce a specified amount of units. (AH-BH) x BR. AH is the actual number of hours, the budgeted wage rate is BR and BH is the budgeted hours in which the work should be completed.
Total Labour Cost Variance: shows the difference that exists between the anticipated cost of direct labour, in other words. (AR x AH) - (BR x BH). AR is the actual wage rate and AH is the actual number of hours. The budgeted wage rate is BR and BH is the budgeted hours in which the work should be completed.
Labour Rate Price Variance: is the variance between the wage rate which was expected and the actual amount which was paid. (AR-BR) x AH. AR is the actual wage rate and AH is the actual number of hours. The budgeted wage rate is BR.
Overhead Variances are calculated using the product of the budgeted variable overheads per unit and the actual production less the actual variable overhead cost.
(Budgeted variable overheads per unit x Actual production) - Actual variable overhead cost.
The volume of overhead variances is calculated using
(Budgeted quantity of input hours for actual production - Actual input hours) x Variable overhead rate.
This type of variance examines the total cost of materials against the budgeted costs of material in the business.
(AQ x AC) - (BQ-BC)
AQ is the actual quantity and AC is the actual cost. The budgeted quantity is BQ and the budgeted cost is BC.
A business uses 800 units at 8.00 giving a total of 6400.00 it had budgeted to use 860 units at 7.00 with a total cost of 6020.00. Therefore (8.00 x 800) - (7.000 x 860) = 6400.0 -6020.00. Adverse Variance= 380.00.
For direct materials the calculation of price variance is (AC-BC) x AQ. AQ is the actual quantity and AC is the actual cost. BC is the budgeted cost. (8.00 x 7.00) x 800) = 1.00 x 800. Adverse Variance = 800.00.
To calculate the variance on the materials which are used the equation is (AQ-BQ) x BC. AQ is the actual quantity and BQ is the budget quantity. BC is the budgeted cost. (800-860) x 7.00 = -60 x 7.00. Favourable Variance = 420.00
This can be calculated on the sales variance of the price or the sales variance of the volume. The impact of either of these two variances on the sale can be determines using the formula.
Sales Revenue Variance = (APx AQ) - (BP x BQ)
Where AQ is the actual quantity which is sold and AP is the actual price per unit. The budget price anticipated is BP and the budget quantity that is sold is BQ.
Clothing shop budgets to sell 200,00 units of clothes but instead sells 180,000 units. It was expected that the price for every unit of clothing would be 5.00 but instead this was 4.50. The revenue from sales was budgeted at 1000,000 but the actual sales revenue was 810,000. There was a variance in the sales revenue due to both a lower quantity sold and a lower actual sales price.
Sales revenue variance = (AP x AQ) - (BP x BQ)= (4.50 x 180,000)- (5.00 x 200,000) = 810000 - 1000000= 190000.
Price Variable Uses
Price Variance= (AP-BP) x AQ
Based on the above example this will be (4.50-5) x 180000= 90000
Quantity or volume variances uses
Quantity Variance= (AQ-BQ) x BP
Based on the above example this will be
(180000- 200000) x 5.00 = - 100000
It should be noted that the price variance was of a much lesser significance than the volume variance. The volume variance contribute 100,000 significantly more in comparison to the price variance that contributed 90,000.