Budgets and Variance

Keana Campbell
Mind Map by Keana Campbell, updated more than 1 year ago
Keana Campbell
Created by Keana Campbell almost 4 years ago
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AS level Business Studies Mind Map on Budgets and Variance, created by Keana Campbell on 04/05/2018.

Resource summary

Budgets and Variance
  1. Reasons for Budgeting
    1. Measuring the money entering and leaving the business in all areas, using the information to indicate the level of efficiency and effectiveness of the business's activity.
      1. Giving information on the productivity levels of staff and providing one possible means of appraising and rewarding workers.
        1. Providing information for current and prospective shareholders and investors.
          1. Ensuring that the cashflow is adequate to meet the day-to-day needs of the business.
            1. Providing managers with the information they need to manage their departments and monitor their performance.
              1. Giving the whole business a strategic perspective and target what focuses on where it is now and where it would like to be after a specific period of time.
                1. Providing the basis of control and meeting objectives.
                2. Decision Making and Strategic Planning
                  1. Cashflow information can be useful in all the following budgeting situations:
                    1. Improving Liquidity: cashflow can be improved by delaying payments to suppliers and demanding payments from customers. This option is often unavailable to new businesses because of their weak bargaining position with with larger and more established firms.
                      1. Dealing with Lenders: The preparation of a cashflow chart will highlights the need for borrowing, and ensures the business takes action before the event rather than when forced to react to unforeseen circumstances.
                        1. Making Changes: Sometimes cashflow forecast may highlight a need for change. For example, a theme park may decide that it's not worth opening at certain times because the revenue generated in insufficient - the business needs to take account of the costs and benefits of its actions.
                          1. Budgeting in Other Areas: Budgeting ensures that spending is controlled and to provide forecasts of likely costs and returns.
                            1. Budgeting by department makes it possible to split the business into smaller units and pass responsibility to departmental heads. Delegation of responsibility is useful as individual managers are likely to have better immediate knowledge of their department and are able to ensure budgets are realistic and achievable. Responsibility to budgeting can also be a motivator, showing that senior management trust the judgement of their more junior managers.
                              1. Can be used to judge the performance of a particular department, its employees and its managers. However, such figures don't take into account reasons why the department may have failed to meet the budget. Therefore, in such situations using common sense is needed.
                            2. Need for liquidity: From a cashflow forecast a business firstly needs to assess what demand for cash is likely to be at any time, to allow the business to meet the demands for payment.
                              1. Zero Budgeting: Involves setting all budgets at zero, requiring managers to justify any requirement funds. This prevents a situation where the same money is given each year without any consideration of actual need.
                                1. May be used in a business where it has a number of potential developments planned but is only prepared to proceed with those that are cost-justified (it would be wrong to budget for all alternatives due to the amount of management time that would be taken in preparing the budgets.
                                  1. Main problem is the amount of time it takes for budget holders and financial co-ordinator to manage the system. The need to review items of expenditures and decide whether to pass them will be ongoing and may become tiresome for the person responsible. It may also mean that the business has a ST perspective of the situation.
                                  2. Flexible Budgets: Allows a business to make allowances for changes in the level of sales volume so that adverse variances are avoided.
                                    1. Variance Analysis: This is the amount by which the actual financial results for an item differ from the amount in the budget.
                                      1. Variance can be adverse or favourable: For revenue, if actual sales exceed the budgeted figures the variance will be favourable, whereas for costs if actual costs exceed the budgeted figure the variance will be negative. A positive variance improves profit and a negative variance reduces actual profit.
                                    2. Three Main Types of Budgets
                                      1. Revenue Budget - expected revenues or sales and is broken down into more detail (products, locations etc).
                                        1. Cost (or expenditure) budget - expected costs based on sales budget; overheads and other fixed costs.
                                          1. Profit Budget - based on the combined sales and costs budgets, of great interest to stakeholders and may form basis for performance bonuses.
                                          2. Key sources of Information for Budgets
                                            1. Financial performance in previous years - particularly for established businesses where lots of relevant data is likely to be available.
                                              1. Market research - trends in market size, growth, segmentation, product lifestyles; competitor activity and customer feedback.
                                                1. Difficulties in Budgeting Accurately
                                                  1. Sales Forecasting
                                                    1. Harder when market experiences rapidly change (e.g. new technology).
                                                      1. Startup firms find it hard to estimate likely sales and revenues.
                                                        1. Competitor actions difficult to predict.
                                                        2. Costs
                                                          1. Always likely to be unexpected costs.
                                                            1. Will vary depending on the sales budget.
                                                              1. Changes in external environment will impact costs (e.g. taxes, exchange rates).
                                                            2. Problems and Limitations of Budgets
                                                              1. Are only as good as the data being used.
                                                                1. Can lead to inflexibility in decision-making.
                                                                  1. Need to be changed as circumstances and change.
                                                                  2. Variance Analysis - Calculating and investigating the differences between the actual results and the budget.
                                                                    1. A variance arises when there is a difference between actual and budget figures.
                                                                      1. Variances can be: positive/favourable (better than expected) and adverse/unfavourable (worse than expected).
                                                                      2. Possible Causes of Favourable Variances
                                                                        1. Stronger market demand than expected = higher actual revenue.
                                                                          1. Selling prices increased higher than budget.
                                                                            1. Cautious sales and cost assumptions (e.g. cost contingencies).
                                                                              1. Competitor weakness leading to higher sales.
                                                                                1. Better than expected productivity or efficiency.
                                                                                2. Possible Causes of Adverse
                                                                                  1. Unexpected events lead to unbudgeted costs.
                                                                                    1. Over-spends by budget holders.
                                                                                      1. Sales forecasts prove over-optimistic.
                                                                                        1. Market conditions (e.g. competitor actions) means selling prices are lower than budget.
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