A budget is an agreed plan establishing in numerical or financial terms the policy to be pursued and the anticipated outcomes of that policy.
Budgets are usually stated in terms of financial targets, relating to money allocated to support the organisation of a particular function. They also include targets for revenue and output or sales volume.
There are three types of budgets
·Income budget –this show the agreed planned income of a business or division of a business over a period of time. It may also be described as a revenue budget or sales budget.
·Expenditure budget- this shows the agreed planned expenditure of a business or division of a business over a period of time.
·Profit budget – this shows the agreed, planned profit of a business or division over a period of time.
Benefits of using budgets
Drawbacks of using budgets
To provide direction and co ordination by ensuring that spending is geared towards the firms aims
If budgets are too ridged things could go wrong
To assign responsibility for the success or failure
Incorrect allocations a budget that is too generous may encourage inefficiency.
To motivate staff and set targets
A budget that is insufficient could demotivate staff
To improve efficiency by investigating reasons for failure and success
Poor communication could lead to non compliance
To encourage forward planning by studying possible outcomes
Budgetary control is the establishment of the budget and the continuous comparison of actual and budgeted results in order to ascertain variances from the plan and to provide a basis for he revision of the objective or strategy.
This represents the difference between the planned standard and the actual performance. If the variance shows a poor performance is known as an adverse or unfavourable variance. If it does better it is known as a favourable variance.
Causes of variances in cost
Interpretations of variances
Identity of budget
Cost of sales
Rent and rates
Account for the other variances to the planned budgets shown I the budget table above, indicating apparent areas of efficiency and inefficiency what reason could there be for a £2000 adverse variance for materials.
Analysis may also take the form of showing the :
Implications of budget variances
Benefits of budgeting to the firm
Difficulties and problems of budgeting.
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INTERPRETATION OF VARIANCES
·Identify the key cause of variances
·Assess the best solutions to adverse variances
·Judge the usefulness of budgeting, the difficulties of projecting and so on
·Evaluate the pro and cons of profit centre and cost centres
·Discuss the feasibility of solving problems
Budgets imply CONTROL.
A MAJOR LIMITATION OF BUDGETS IS THE TIMEING. BUDGETS ARE SET BEFORE THE EVENT ANS SO PEOPLE ARE GUESSING WHAT WILL HAVPPEN INA THE FUTURE. VARIANCES ARE ASSESSED AFTER THE EVENT BY WHICH TIME THE PROBLEMS HAVE PASSED.
IMPROVING CASH FLOW
Cash flow management includes careful control of cash in the short term. It is the ability of a firm to meet its short term debts. There must be liquid cash.
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IMPROVING CASH FLOW
Causes of cash flow
Over investment – in fixed assets, leaving no money to pay bills.
Over trading – producing too many goods and running out of cash
Credit sales – increasing sales and thus expenses, but with no cash received until a later date
Stockpiling – tying up assets in stock
Seasonal factors- low sales revenue or high costs during part of the year
Changing tastes – product do not sell
Management errors – poor market research or budgetary control leading to cash shortages
Methods of improving cash flow
Bank overdraft – its easy to organise and can be flexible, it is cheaper than a loan.
Short term loan/bank loan – loans are made at fixed rates making it simple to budget the rate of interest charged on a loan is less than an overdraft
A bank loan may be set up for a significant period of time to suit the needs of the business
The drawbacks are the interest is paid on the whole of the loan borrowed. There may be a loan penalty if we pay back early. The business will have to secure the bank with security [collateral] in order to secure the loan.
Factoring [debt factoring]
Factoring is when a company usually the bank buys the right to collect the money from the credit sales of an organisation.
Benefits the firm gains improved cash flow. Admin costs are lower because the factoring company chases any bad debts
The drawbacks of factoring. Is that the business will lose between 5 and 10% of its revenue
The factoring company will charge more for factoring that it would for a loan.
Sale of assets
This process can improve cash flow by converting an asset, such as property or machinery into cash which can then be used to ease the cash flow problem. The benefits are the sale of fixed assets can raise considerable sums of money. The drawbacks are that assets such as building or machinery may be difficult to sell quickly. Fixed assets enable a firm to produce the goods and services that create its profit.
Sale and leaseback of assets. The benefits are: this will overcome the cash flow problem by providing an immediate inflow of cash. Drawbacks re the rent paid is likely to exceed the sum received.
A firm can also improve its cash flow in the following ways;
Diversifying its portfolio to create a range that sells throughout the year. Controlling stock carefully to reduce the costs incurred in holding too much.
Measuring and increasing profit
Net profit margings = net profitx100% over sales [turnover] if a business has £18,000 in sales, variable costs of £8,000 and fixed costs of £6,400 then the net profit will be £18,000-[£8000 +£6,400] = £3,600 so the net profit is 3,600 = 20%
Return on capital
Capital is the money put into a business by the owners when it is first established. Return on capital means the percentage return on the capital investment.
There are many methods a business can utilise to try to improve profitability these include, increasing prices to widen the profit margin, decreasing costs by sourcing cheaper supplies, employing fewer people, outsourcing other costs.