using budgets

• BUDGET- an agreed forward financial plan
• VARIANCE ANALYSIS- the process of comparing forecasted budgetary values with the actual values for the year and working out if the differences are favourable or adverse.
• FAVOURABLE ANALYSIS- when costs are lower than expected or when revenues are higher than expected.
• ADVERSE ANALYSIS- when costs are higher than expected or when revenues are lower than expected.

Benefits

• they provide targets and give each area of the business a sense of direction
• they can motivate staff via responsibility for meeting targets
• they improve financial efficiency by reducing waste

Drawbacks

• budget allocations can create conflict between functional areas
• they are time consuming to manage
• they might set unrealistic targets
• they can restrict the ability to respond to sudden opportunities or threats in the market

If the variance analysis seems to suggest that business costs are consistently higher than expected then consider whether the business has carried out sufficient research before they set their budgets. Or perhaps, there are other reasons for costs rising e.g. shortage of supply.

Possible solutions might include finding a new and cheaper source of supplies but you must then consider whether this will affect the level of quality for your goods and if this in turn will mean lower long-term sales and profits.