Budgeting - HL Only

1. Budgeting - HL Only Learning Objective:

2. What is a Budget? • Describe in your groups what you think a budget is:

3. Budget Defined - A detailed financial plan for the future • A Budget is a target for cost or revenue that a business or department must aim to reach over a period of time. • It is an agreed pattern of income and expenditure which sets targets for revenue and expenditure over a given time in the future. • It a method of turning a business’ strategy into reality. • A budgeting system should allocate and monitor costs and revenue. IT is NOT a forecast… it is a TARGET.

4. Key features of budgets • Budgets are plansfor how much money should be spent on various items • They normally cover a 12 month period • They are broken down into weekly or monthly intervals • They are set for each department in a firm • The departmental manager is responsible for ensuring that money spent is within budget limits • The manager is called the budget holder

5. Income Sales Budget Expenditure Production Distribution Budget Marketing Budget Types of Budget: Material purchases Staff Budget Overheads Budget Cash Budget Master Budget

6. What is a budget for? • To ensure no department or individual spends more than the company expects. • To provide a yardstick against which a manager’s success or failure can be measured. • To enable spending power to be delegated to local managers who are in a better position to know how best to use the business’ money.

7. The Purpose: • Define business goals • Encourage analysis • Focus on the future • Communicate plans and instructions • Coordinate business activates • Provide basis for evaluating performance against either past or expected results. • Act as a motivating tool to exceed expectations. • Control and monitor • Planning • Efficiency • motivation

8. Activity 1 • Individually Analyse three problems that ‘AIS’ might have in setting up budgets for the next financial year.

9. Activity 2 • Move into pairs • Pick one problem from the group. • Analyse it. (Level 5) • Try to come up with a solution. (Level 6/7)

10. Creating a budget • Forecast level of activity, eg sales, for the next year • Each department then produces a suggested budget based on the forecast • Suggested budgets are discussed with senior management, modified and agreed • The ‘budget year’ begins and managers receive regular feedback on spending.

11. Budget plan

12. Flow diagram how to set a budget, explain each step in your own words. • - pg 207 - 208

13. Setting Budgets • This is not an easy job. How do you decide exactly what level of sales are likely next year? • How do you plan costs? – raw material could fluctuate? • Most business use last years Budget as a guide, and make minor adjustments. • This is great as it takes little time to do.

14. The best criteria for setting budgets • Incremental budgeting vs Zero Budgeting • Debate!

15. Feedback on performance • Shortly after the end of the month (or week), the budget holder is given a list of actual expenditure on each item • The budget holder compares this with the budgeted amount • If there is a major overspend, action must be taken to try to solve the problem Once a budget has been set up, the following events take place:

16. Advantages Disadvantages Limitations & Benfits of budgeting Article in pack.

17. Benefits of Budget control • Means of Controlling income and expenditure. • Management can Hand over responsibility • Ensure capital is fully employed • Help coordinate business and improve communication • Provide Clear targets

18. Drawbacks of Budget control (unit 2) • May lead to resentment of personnel (if not involved) • If inflexible business could suffer • If Budget results differ to budgeted amounts, may lose its control.

19. Question: • 8 marks • Your best mate has a great idea… he wants to open a ballerina shop at Ion. Tell him why you think he should set up a budget before he starts.

20. Your best mate has a great idea… he wants to open a ballerina shop at Ion. Tell him why you think he should set up a budget before he starts. • C2 Ap 3 An3 • Content • 2 marks Two or more points made and explained • 1 mark Relevant content made but not developed or one point made and explained • 0 marks No relevant content points made. • Application • 3 marks Points effectively applied to the case • 2 - 1 mark An attempt to apply knowledge to the case • 0 marks No attempt at application • Analysis • 3 – 2 marks Good analysis of issues • 1 mark Limited analysis of issues • 0 marks No analysis of issues demonstrated

21. VARIANCES

22. Budgeted amount: $200 Actual spending: $250 Variance: – $50 Budgets and variances • The difference between the planned and actual figures is called a variance. • A minus sign before the variance shows it is an overspend, eg The use of a minus sign can be confusing, there is a better way.

23. Variance Variance is the amount by which the actual results differs the budgeted figure. There are two types of variances: • Favourable Variance: is one, which leads to, higher than expected profit (revenue costs up or costs down). • Adverse Variance: is one that reduces profit, such as costs being higher than the budgeted level.

24. Examples: • An expenditure budget allocates $3,000 for stationary, but spends $3,600 • Adverse variance because costs $600 more than budgeted, so all other things being equal, the profit will be $600 less than budgeted.

25. Examples: • A sales budget targets $8,000, but achieves $9,000 • Favourable variance because sales are $1,000 more than budgeted, so all other things being equal, the profit will be $1,000 higher than budgeted.

26. Analysis of variances • Budgets variances need to be monitored throughout the year (along with performance ratios & other statistical information) • Business are looking for the underlying reasons behind the variances. • What are the possible reasons for variances?

27. Reasons for variances: • Calculation errors • Changes in plans • External factors – fluctuations in demns • Changes in interest rates • Inflation

28. Variance • Regular variance statements provide an early warning. • If a product’s sales are slipping below budgets, managers can respond by increasing marketing support, or by cutting back on production plans

29. Is budgeting worth while? • Pg 209 ‘Budget control & strategic planning’

30. Managers need to be mindful: • Managers responsible for budgets should be clear of their responsibilities • Budget holders need to be accountable and must negotiate and inform when prices increase are affecting areas they have responsibility for. • If the business has made changes these need to be passed on. • All budget holders are responsible for contributing to the budget setting process. • Time tables for monitoring

31. Types of variances and interpretation • A Business will begin by constructing a budget and then monitor the results of the budget. • It should be relatively easy to identify a variance and then calculate the exact variance. • The next problem is to analyse it and explain it and evaluate the significance. • A business will then seek to attribute responsibility for the variance and take corrective action.

32. WHY, oh Why… does this happen???

33. Sales variance Cost variance Materials variance Labour variance Overheads variance Profit variance Variance Reason? Can be a Combination of the two! • A price is greater/less than expected • Volume is greater than or less than expected

34. Sales revenue variances • Sales revenue variances can be caused by: • Sales volume - Actual sold is difference from planned volume. • Sales price – difference in price being paid. It is possible to work out the precise impact of the changes.

35. It is possible to work out the precise impact of the changes. Sales revenue variance = (AQ x AP) – (BQ x BP)

36. Sales revenue variance = (AQ x AP) – (BQ x BP) • AP = Actual price per unit • AQ = Actual Quantity sold • BP = Budgeted price per unit • BQ = Budgeted Quantity sold

37. TYPES OF VARIANCE • DIRECT MATERIALS VARIANCE (AC – BC) × AQ • PRICE VARIANCE (AP – BP) × AQ • COST VARIANCE OF MATERIALS (AQ – B2) × BC • TOTAL LABOUR COST VARIANCE (AR × AH) – (BR × BH) • LABOUR RATE PRICE VARIANCE (AR – BR) × AH • MATERIALS VARIANCE (AQ × A2) – (BQ × BC) • SALES REVENUE VARIANCE (AQ × AP) – (BQ × BP) • VOLUME OR QUANTITY VARIANCE (AQ – BQ) × BP

38. Budget Control… Why bother?

39. Benefits of Budget control • Means of Controlling income and expenditure. • Provides a measure of performance • Management can hand over responsibility • Ensure capital is fully employed • Help coordinate business and improve communication • Provide Clear targets • Highlight problems early Use this for analysis

40. Drawbacks of Budget control • Planned in advanced therefore could be inaccurate • May lead to resentment of personnel (if not involved) • Failure to ‘hit’ budget’ might be de-motivating • If inflexible business could suffer • If Budget results differ to budgeted amounts, may lose its control. Use this for analysis

41. Budgets and cashflow forecasts Similarities • Estimated expenditure is forecast • Both are broken down into monthly intervals • Actual performance is compared with the plan

42. Budgets and cashflow forecasts Differences • Budgets are for individual departments – not the business as a whole • One person is responsible for each budget • Most budgets are concerned only with expenditure. Cashflow forecasts cover both income and expenditure

43. Different types of Budgets: • Historical budgeting • Zero budgeting • Flexible budgeting

44. Historical Budgeting • Use last years figures • Probable costs & revenue • Need small increase for inflation • Seen as realistic • Current circumstance can differ • Doesn’t take into account new aims and objectives • Doesn’t encourage efficiency

45. Zero Budgeting An alternative method is Zero Budgeting. • Zero Budgeting sets each department budget at zero, and demands that budget holders, in setting their budget, justify every pound they ask for. • This helps to avoid the common occurrence of budgets going up each year.

46. Zero budgeting • Cost efficient • Incorporates aims • Everything is examined • Is complicated and time consuming • Managers have to compete.

47. Flexible Budgets Another type of Budgeting These adjust the Budgeted figures in line with the actual sales volume achieved. This insures that variances show changes in costs rather than a mixture of costs and sales volumes Look at the following example:

48. Flexible Budgets How can a manger identify the cause of the costs over run? Costs are $12, 000 higher than forecasted, but that would be understandable if the demand had increased by 10 %. But if demand was the same if could be because they were paying more for raw material.

49. Flexible Budgets In flexible budgeting they allow for changes in sales volume. Eg. If sales increased by 10% the flexed budget would add 10% to the budgeted figure.

50. Flexible Budgets • Budgets are kept up-to-date • No set budget, no agreed targets • Can use uncontrollable external factors as excuses • Try to impress by reducing targets that they know they can exceed.