Budgets

• Budget

  Forecasts future earnings and spendings, usually over a 12 month period
• purpose of budgets- planning

  Helps business plan for expenses in the year, vital for small business to help them identify when and where they may run into financial problems.
• Purpose- forecasting

  Typically bases on combo of businesses sales history and how effective they expect their future trading to be. They can prepare projected profits over the next year
• Purpose- motivation

  Can be used to motivate firms to be more careful with finances. If staff are involved in setting of budgets, they are more likely to be cautious when spending company money
• types of budgets


  • Historical figures- budget set for the business using current financial figures based on historical performance of business
  • zero based budget- budget set from scratch each year. Figures based on potential performance
• Historical data

  Quick and easy but assumes the business conditions stay unchanged each year(not always the case)
• Zero-based budgeting

  Takes longer to complete than historical but if done properly it’s more accurate than historical budgeting
• Advantages of budgeting


  • Can be motivating- they give employees targets to work towards
  • Help control income and expenditure
  • Help attract investors that the business will be successful
  • Helps managers review their activities and make decisions
• disadvantages of budgeting

  • Budgeting can cause resentment and rivalry if departments have to compete for money
  • Time consuming
  • Inflation is hard to predict- some prices can change by levels greater than average
  • unrealistic budgets can be demotivating
• Variance

  The difference between the actual figures and budgeted figures
• Favourable variance

  • when a firm is performing better than expected- when manager has underspent in their department
  • If revenue or profit is more than the budget this is favourable.
  • Also if costs are below the cost prediction
• Adverse variance

  • Occurs when a firm is performing worse than expected- when manger has overspent in their department
  • Selling fewer items or spending more on an advert than in the budget are examples of adverse variance.
• External factors Causing variances

  • Competitor behaviour- changing fashions may increase or reduce demands for products
  • Changes in the economy- can change how much workers wages cost the business
  • Cost of raw materials may increase
• Internal factors causing variances

  • Improving efficiency (e.g. introducing new tech) causes favourable variances
  • Firm may overestimate the amount of money it can save
  • Changing selling prices may cause variance after budget is set
  • Firm may underestimate the cost of making a change to its product
• Variance analysis

  Spotting variances and figuring out why they’ve happened- so action can be taken to fix them
• Decisions based on adverse variances

  • Change marketing mix: cutting prices will increase sales if price is demand elastic
  • Update product might make it more attractive to customers.
  • Streamlining production makes the business more efficient- thus reducing costs
  • Try motivate employees to work harder
  • Asking suppliers for a better deal
  • Additional market research to improve forecasts in future
• Decisions made on favourable variances

  • Business may need to increase production of a product or take on additional staff to meet demand
  • Set higher targets for the next budget