224 BudgetsAS Edexcel New Specification 2015 Business

By Mrs Hilton for

Lesson Objectives

• To be able to identify the purpose of a budget to a business

• To be able identify the types of budgets; historical figures and zero based

• To be able calculate variance analysis • To be able to discuss the difficulties of

budgeting• To be able to answer sample exam questions

based on the topic area

From the specification

a) Purpose of budgetsb) Types of budget:

historical figureszero based

c) Variance analysisd) Difficulties of budgeting

Guidance from Edexcel

PURPOSE OF BUDGETS

The purpose of budgets• This is a financial plan and an agreed spending

limit within a business• Heads of Department in a school get a budget

for books, folders, speakers and trips • Budgets are based on the objectives of the

business or organisation• It means managers must think ahead and not

just spend an unlimited amount of money in their department

• Usually 12 months so that it fits with the accounting period of a year, but research and development budgets (e.g. a cure for cancer) might have a longer term budget

Why would a business set a budget?• Planning; to anticipate problems and develop

solutions before they arise e.g. New business books are needed for a new spec

• Motivation; for managers to be in control of their own budget shows that the business feels they are responsible and will hold them accountable for the money

• Decisions; gives power to make financial decisions to those in the best position to make them e.g. a Headteacher may not know what kinds of books need to be ordered

• Control: Budgets are set against objectives and targets and can be used as a comparison tool to measure success

HISTORICAL FIGURES

Historical figures budget

• This is a budget set for the business using current financial figures

• Realistic in that it is based on last years sales• Business is dynamic so the figures may be wrong• How much money will you spend?• How much will you sell?• How can you cut costs?• Not about Henry Eighth he’s just here to help you

remember the name of the budget

ZERO BASED

Zero based budgeting

• This is a budget set for a business by using figures based on potential performance

• This method takes away all historical assumptions and starts with a clean slate

• May also be used by a start-up with no historical data

• Managers must justify levels of expenditure based on the number of customers they are likely to serve in the next year

VARIANCE ANALYSIS

Variance analysis

• Analyse the budget figures against what actually happens – there might be a variance

• Favourable variance – the manager has underspent in his department, this would be regarded as a success as any costs cut will have an impact on profit

• Adverse variance – the manager has overspent and it would depend on the reasons, perhaps they needed more staff than was budgeted for and had to hire during the year

Looking at variances and

finding reasons behind them can

improve the performance of a

business

Calculate the variance on these figures and say if they are adverse or favourable

Jan £ Feb £ Mar £Budgeted income 19,000 20,000 30,000Actual income 16,600 22,000 19,000VarianceFavourable or adverse?

Jan £ Feb £ Mar £Budgeted expenditure

11,000 11,000 11,000

Actual expenditure

11,500 12,000 9,000

VarianceFavourable or adverse?

Goal here is to make

more income

than budgeted

Goal here is to

spend less than budgeted

DIFFICULTIES OF BUDGETING

Difficulties of budgeting• Budgets are often fixed for a year and as such

inflexible, difficult when business is dynamic• Tendency for managers to spend up to the limit • Time consuming to prepare, monitor and control• Cannot include unexpected events – can just provide

a contingency fund• Unrealistic budgets can be demotivating• Budgets can cause inter-department rivalry as some

departments get more money than others• Can make managers short-term and short-sighted,

they become budget driven rather than customer driven

• Some industries its difficult to plan ahead because of large unplanned changes e.g. in farming the weather can have a huge impact on crops

Sample questions

Sample question 1

8 marksCase study for Ocado on next slide

Sample question 2

4 mark questionFigure 1 on next slideCase study on slide after that

Answer question 2

Revision Video

Glossary

• Budgets; the purpose of a budget is as a forecasting, planning and motivational tool, they can be on income or expenditure

• Zero based; Budget is based on a prediction of performance usually for a start up

• Historical figures; Budget is based on previous performance of sales and costs

• Variance analysis; Variance is the difference between the budgeted and the actual figure