Budgeting. What is a budget? A forward financial plan that covers all the aspects of a businesses costs and revenues.

Budgeting

What is a budget?

A forward financial plan that covers all the aspects of a businesses costs and

revenues.

Why prepare a budget?

• To exercise financial control within a business.• It can provide direction and coordination.• To ensure that no department has an overspend.• Sets targets that performance can be judged against,

which can motivate workers.• To delegate spending power to individuals or

departments.

Budgetary control

• The process by which financial control is exercised within an organisation.

• Budgets for revenue and expenditure are prepared in advance and compared with actual performance to establish any variances.

• Managers are held responsible for any adverse variances and will need to take action.

Types of budgetZero Budgeting• Budgeted costs and revenues are set to zero.• Budget is based on new proposals for cost and sales.• Time consuming, but starting from scratch can ensure that funds

are allocated in the right way.

Historical Budgeting• Use last years figures and add a little for inflation.• It is much quicker and simple but may not focus on problem

areas of the business.• It does not encourage efficiency.

Budget allocationThe level of expenditure will depend on the following

factors:• the amount available• inflation• external factors

This is a difficult task for certain businesses, as prices

fluctuate and sales figures are unpredictable, e.g. restaurants,

agriculture and clothing companies.

Exam focus

In terms of BUSS2, variances are often the main focus of an examiner’s questions.

It is essential that you can calculate variance analysis questions with confidence in preparation for the exam.

VariancesThese measure the anticipated performance (the budget) against what actually happened. The variance is the difference between the two.

Favourable (positive) variance is better than expected: costs lower than expected revenue higher than expected

Adverse (negative) variance is worse than expected: costs higher than expected revenue lower than expected

You need to use these two terms within the exam.

Worked example: beginner

January–March 2013

Budget(£)

Actual(£)

Variance Favourableor adverse?

Sales income 5,000 4,500 500 A

Cost of materials 1,000 900 100 F

Wages/salaries 1,000 1,500 500 A

Marketing costs 1,000 800 200 F

Other costs 1,000 1,200 200 A

Total costs 4,000 4,400 600 A

Profit 1,000 100 900 A

Sales Income is £500 lower than expected — this is an adverse (A) variance

The business limits its spending on marketing, which is £200 lower than expected — this is a favourable (F) variance

Overall, the variance is £900 (adverse), as the business budgeted a profit of £1,000 and only made £100

Practice qquestion 1January February

Budget Actual Variance Budget Actual Variance

Sales income 50,000 60,000 60,000 60,000

Cost of materials 20,000 25,000 20,000 30,000

Wages/salaries 10,000 10,000 10,000 10,000

Overheads 10,000 15,000 10,000 15,000

Total costs 40,000 50,000 40,000 55,000

Profit 10,000 10,000 20,000 5,000

AnswersJanuary February

Budget Actual Variance Budget Actual Variance

Sales income 50,000 60,000 10,000 F 60,000 60,000 0

Cost of materials 20,000 25,000 5,000 A 20,000 30,000 10,000 A

Wages/salaries 10,000 10,000 0 10,000 10,000 0

Overheads 10,000 15,000 5,000 A 10,000 15,000 5,000 A

Total costs 40,000 50,000 10,000 A 40,000 55,000 15,000 A

Profit 10,000 10,000 0 20,000 5,000 15,000 A

Practice question 2March April

Budget Actual Variance Budget Actual Variance

Sales income 30,500 29,700 26,100 28,520

Cost of materials 10,000 11,000 6,000 7,000

Wages/salaries 5,000 5,525 10,000 10,500

Overheads 12,000 11,700 10,000 9,700

Total costs 27,000 28,225 26,000 27,200

Profit 3,500 1,475 100 1,320

AnswersMarch April

Budget Actual Variance Budget Actual Variance

Sales income 30,500 29,700 800 A 26,100 28,520 2,420 F

Cost of materials 10,000 11,000 1,000 A 6,000 7,000 1,000 A

Wages/salaries 5,000 5,525 525 A 10,000 10,500 500 A

Overheads 12,000 11,700 300 F 10,000 9,700 300 F

Total costs 27,000 28,225 1,225 A 26,000 27,200 1,200 A

Profit 3,500 1,475 2025 A 100 1,320 1,220 F

BudgetsBenefits• Budgets are an effective way to control and monitor costs.• Can be used as a motivational tool.• Can be used to set targets and judge performance.

Drawbacks• Budgets are based on assumptions and are not exact.• External factors, e.g. the economy, make it almost impossible

to set accurate budgets, so could be classed as time wasting.• Could be demoralising if set incorrectly.• Managers take short-term decisions in order to meet

budgetary requirements.