Budgets and Budgeting

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What is a budget?
A financial plan for the future concerning the revenues and costs of a business.
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Budgeting is a process
The process which financial control is exercised / Prepared in advance then compared with actual performance to establish any variances / Managers are responsible for the departments budget and should take action if the adverse variance is excessive
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Budgets are used for ...
Establishing priorities / Setting objectives / Providing direction / Communicating targets / Allocating resources / Motivating staff / Controlling income and expenditure / Monitoring performance / Improving efficiency / Forecasting outcomes
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Principles of good budgeting
Responsibilities are clearly defined / Managers follow the budgets / Performance is monitored against the budget / Corrective action is taken / Unaccounted variances are investigated / Departures from budgets are cleared by senior management
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The two main types of budgeting are ...
Historial and Zero budgeting
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Historical budgeting is ...
Using last year's figures as the basis for the budget
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Historical budgeting positives and negatives
Positives - realistic as it is based on actual results / Negatives - circumstances may have changed ,does not encourage efficiency
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Zero budgeting is ...
Budgeted costs and revenues are set to zero.
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Zero budgeting positives and negatives
Positive - budget is based on new proposals for sales and costs, more realistic / Negatives - makes budgeting more complicated and time consuming
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The three main types of budget
Revenue (income) / Cost (expenditure) / Profit
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Revenue (income) budget
Expected revenues and sales / Broken down into more details (e.g. products, locations)
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Cost (expenditure) budget
Expected costs based on sales budget / Overheads and other fixed costs
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Profit budget
Based on the combined sales and cost budgets / Of great interest to stakeholders / May form basis for performance bonuses
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How a profit budget is constructed
Analyse markert (size, growth, share, prospects) / Draw up sales budget (sales forecast, new products, pricing changes) / Draw up cost budget (based on sales budget, allow for known changes in supplier prices, include contingencies)
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Sources of budget information
Financial performance in previous periods - good for established businesses, lots of data likely to be available / Market research - trends in market size/growth/segmentation/product life cycles, competitor activity, customer feedback
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Difficulties in budgeting accurately
Sales forecasting - harder when the market rapidly changes, hard for start-ups , competitor actions are hard to predict / Costs - unexpected costs, varies depending on the sales budget, changes in the external environment will impact costs
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Variance analysis
Calculating and investigating the differences between actual results and the budget.
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Variances
A variance arises when there is a difference between actual and budget figures.
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Variances can be ...
Postive (favourable) - better than expected or Adverse (unfavourable) - worse than expected
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Favourable variances
Actual figures are better than budgeted figures e.g. costs lower than expected, revenue/profits higher than expected
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Adverse variances
Actual figure worse than budget figure e.g. costs higher than expected, revenue/profits lower than expected
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Possible causes of favourable variances
Stronger market demand than expected = higher actual revenue / Selling prices higher than budgeted / Cautious sales and cost assumptions / Competitor weakness leading to higher sales / Better than expected productivity or efficiency
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Possible causes of adverse variances
Unexpected events lead to unbudgeted costs / Over-spends by budget holders / Sales forecasts prove over-optermistic / Market conditions (e.g. competitor actions) mean selling prices are lower than budgeted
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Do variances matter?
Was the variance foreseen? / Size- absolute in money terms or relative in percentage terms / Cause / Is it a temporary problem or the result of a long term trend
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Variance allows management by exception
Focus on actives that require attention not ones that are running smoothly / Analysis of budgets and variances allow management by exception as they highlight problems / Small variations require no action / Large variances require action
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What should management do with a variance?
Act if the variance is outside the agreed margin / Investigate the cause of significant variances / Was it avoidable or unavoidable? / Act to remedy the problem - if appropriate
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A point to remember about adverse variances ...
It may result from something that is good e.g higher production costs than budgeted (adverse) that occur because sales are significantly higher than budgeted (favourable)
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The limitations of budgets
Are only as good as the data being used / Can lead to inflexibility in decision-making / Need to be changed as circumstances change / Take time to complete and manage / Can result in short term decisions to keep within the budget
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Some behavioural implications of budgets
Demotivating if they are imposed rather than negotiated / Demotivating if the targets are seen as demotivating / Can contribute to departmental rivalry / Spending up to the budget can result in a use or lose it mentality
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Final thoughts ...
A well-established and important management activity / Relevant for all kind of business - especially start-ups / The cost of budgeting can rise as the business grows and becomes more complex / Budgets should not get in the way of business strategy
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Other cards in this set

Card 2

Front

Budgeting is a process

Back

The process which financial control is exercised / Prepared in advance then compared with actual performance to establish any variances / Managers are responsible for the departments budget and should take action if the adverse variance is excessive

Card 3

Front

Budgets are used for ...

Back

Preview of the front of card 3

Card 4

Front

Principles of good budgeting

Back

Preview of the front of card 4

Card 5

Front

The two main types of budgeting are ...

Back

Preview of the front of card 5
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