Budgets and Balance sheets

• What is a budget?


  The firm's estimate of income and expenditure over a period of time
• How is a budget typically created?


  It is based on past levels and managers' expertise to identify likely figures
• What is a variance in financial performance?


  A difference between estimated and actual levels of income and expenditure
• How do you calculate variance for income?


  Subtract the budget figure from the actual figure
• What does a positive variance indicate for income?


  It is a good thing and is therefore a favourable variance
• What does a negative variance indicate for income?


  It is a bad thing and is therefore an adverse variance
• What can a firm do with variance information regarding underperforming areas?


  Investigate areas that are underperforming to find solutions
• What can a firm do with variance information regarding overperforming areas?


  Put more emphasis on departments that are overperforming
• What are the key components of variance analysis for income?


  • Actual income greater than budget: Favourable variance (F)
  • Actual income less than budget: Adverse variance (A)
• What does a negative variance indicate for expenditure?


  It is a good thing and is therefore a favourable variance
• What does a positive variance indicate for expenditure?


  It is a bad thing and is therefore an adverse variance
• What can a firm do with variance information regarding overspending areas?


  Investigate areas that are overspending to identify issues
• What can a firm do with variance information regarding underspending areas?


  Trim the budgets of areas that are underspending
• What is the formula for calculating working capital?


  Working capital = current assets - current liabilities
• What is the significance of positive working capital?


  It means the firm can respond to sudden changes effectively
• What is the significance of negative working capital?


  It means the firm is less able to respond to sudden changes
• What is capital employed?


  The total money that has been invested in the business
• How is capital employed calculated?

  Capital employed = shareholders’ funds + long-term liabilities
• What is depreciation?


  The amount that an asset has fallen in value due to use or time
• What is the formula for straight-line depreciation?


  Depreciation = (original cost - residual value) / expected asset life
• If a firm buys a computer for £9,000 and plans to sell it for £1,000 after 4 years, what is the annual depreciation?


  £2,000 per year
• How much will the computer be worth after 2 years if it depreciates at £2,000 per year?


  £5,000
• If a firm buys a van for £20,000 and plans to sell it for £2,000 after 6 years, what is the annual depreciation?


  £3,000 per year
• How much will the van be worth after 3 years if it depreciates at £3,000 per year?


  £11,000
• What are the benefits of using depreciation?


  • Helps identify when an asset can be sold and replaced
  • Gives a more accurate value of the business
  • Fairly simple to calculate
  • Legal requirement for business valuation
• What are the issues with using depreciation?


  • Assets may not depreciate steadily
  • Outside factors can affect depreciation
  • May lead to premature asset replacement
• What is the importance of considering the size of the variance?


  The larger the firm, the larger the variance may need to be before it becomes important
• Why should past trends be considered when analyzing variances?


  A firm shouldn’t make a snap decision based on one variance; past trends provide context
• What should be investigated when a variance occurs?


  The cause of the variance should be investigated before taking action
• What is a balance sheet?


  A summary of a firm’s assets and liabilities at a particular moment in time
• What is an asset?


  Something that adds financial value to a business
• What is a liability?


  A financial commitment the business must honour
• What are non-current (fixed) assets?


  Anything the firm owns that cannot be easily converted into cash
• What are current assets?


  Things the firm owns that can be converted into cash fairly quickly
• What are current liabilities?


  Anything the firm owes that needs to be paid in the next 12 months
• What is working capital?


  The amount of money the firm has easy access to
• How is total net assets calculated?

  Total net assets = total assets - total liabilities
• What is total equity/shareholder funds?


  The amount of money that has been introduced into the business that year
• What is the relationship between total equity and total net assets?


  Total equity equals total net assets
• What are the key components of a balance sheet?


  • Assets: financial value to the business
  • Liabilities: financial commitments to be honored
  • Non-current assets: not easily converted to cash
  • Current assets: easily convertible to cash
  • Current liabilities: due within 12 months
  • Long-term liabilities: due after 12 months