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Budgets

  1. 1. Unit 2: Managing a businessFinanceWhat is a budget?A financial plan covering income and expenseThis unit is about using budgets is studied.How can budgeting help the business to improve its performance?
  2. 2. Unit 2: Managing a businessFinanceBenefits and drawbacksof using budgetsBenefits• They provide direction and coordination.• They can motivate staff.• They improve efficiency.• They encourage careful planning.Drawbacks• They are difficult to monitor fairly.• Allocations may be incorrect and unfair.• Savings may be sought that are not in the interests of the firm.• They may be inflexible.
  3. 3. Unit 2: Managing a businessFinanceFeatures of good budgetingA good budget should:• be consistent with the aims of the business• be based on the opinions of as many people as possible• set challenging but realistic targets (be SMARTA)• be monitored at regular intervals• be flexible
  4. 4. Unit 2: Managing a businessFinanceVariance analysisvariance analysis: the process by which the outcomes of budgets are examinedand then compared to the budgeted figures. The reasons for any differences(variances) are then found.favourable variance: when costs are lower than expected or revenue is higherthan expected.adverse (unfavourable) variance: when costs are higher than expected orrevenue is lower than expected.
  5. 5. Unit 2: Managing a businessFinanceCalculating variancesA variance is calculated by the following formula:variance = budget figure – actual figureFor variance analysis, use ‘F’ for favourable variances and ‘A’ for adverse variances,rather than positive or negative numbers.A favourable variance would happen when:• actual income is greater than budgeted income• actual costs are below budgeted costsAn adverse (or unfavourable) variance would be shown when:• actual income is less than budgeted income• actual costs are above budgeted costs
  6. 6. Unit 2: Managing a businessFinanceCalculating variances: the golden ruleThe golden rule: knowing the effect a variance has on profit tells you whether it isfavourable or adverse.A favourable variance will mean more profit than expected.An adverse variance will mean less profit than expected.
  7. 7. Unit 2: Managing a businessFinanceExample variance calculation:income budgetIncome budget for XYZ Ltd, April 2009Source ofincomeBudgetedincome (£)Actual income(£)Variance (£) F/AProduct A 7,500 7,600 100 FProduct B 6,000 5,700 300 ATotal income 13,500 13,300 200 A
  8. 8. Unit 2: Managing a businessFinanceExample variance calculation:expenditure budgetExpenditure budget for XYZ Ltd, April 2009Item ofexpenditureBudgetedexpenditure(£)Actualexpenditure(£)Variance (£) F/ARaw materials 2,700 2,500 200 FLabour costs 2,400 2,450 50 AAdministrationand other costs4,500 4,500 0 –Totalexpenditure9,600 9,450 150 F
  9. 9. Unit 2: Managing a businessFinanceExample variance calcualtion:profit budgetProfit budget for XYZ Ltd, April 2009Item ofincome/expenditureBudgetedprofit (£)Actual profit(£)Variance (£) F/ATotal income 13,500 13,300 200 ATotalexpenditure9,600 9,450 150 FBudgeted profit 3,900 3,850 50 A
  10. 10. Unit 2: Managing a businessFinanceInterpreting the variances1 What factors might have caused the variances for XYZ Ltd?In small groups find:a Two factors WITHIN the business that might have led to the variances inthe INCOME budget.b One factor OUTSIDE the business that might have led to the variances inthe INCOME budget.c Two factors WITHIN the business that might have led to the variances inthe EXPENDITURE budget.d One factor OUTSIDE the business that might have led to the variances inthe EXPENDITURE budget.2 Suggest two actions the business might take to improve matters.
  11. 11. Unit 2: Managing a businessFinanceInterpreting the variances:answersPossible answers include:1a• Successful marketing of product A.• Low-quality production of product B.1b• Adverse media publicity concerning product B.1c• Efficient production methods, leading to lower wastage of raw materials.• Workers being given a wage rise that was higher than expected.1dAn unexpected shortage of raw materials, leading to higher prices being charged by suppliers.2• Introduce new quality assurance measures for product B.• Investigate alternative suppliers or different raw materials.
  12. 12. Unit 2: Managing a businessFinanceCalculating variance: income budgetComplete the variance analysis for XYZ Ltd’s income budget.The budgeted income column has been provided.Actual income for XYZ’s two products were:• product A: 3,000 units were sold at a price of £2.70• product B: 6,400 units were sold at a price of £1.25Income budget for XYZ Ltd, May 2009Source of income Budgetedincome (£)Actual income(£)Variance (£) F/AProduct A (3,200 x £2.50) 8,000Product B (6,000 x £1.30) 7,800Total income 15,800
  13. 13. Unit 2: Managing a businessFinanceCalculating variance:expenditure budgetComplete the variance analysis for XYZ Ltd’s expenditure budget.The budgeted expenditure column has been provided.Actual expenditure was as follows:• Raw materials were 25% of the actual income.• Labour costs were 25p per unit (9,400 × 25p).• Administration and other costs were £4,200.
  14. 14. Unit 2: Managing a businessFinanceExpenditure budget for XYZ Ltd, May 2009Item of expenditure Budgetedexpenditure(£)Actualexpenditure(£)Variance (£) F/ARaw materials (25% of£15,800)3,950Labour costs (9,200 x 25p) 2,300Administration and othercosts4,600Total expenditure 10,850
  15. 15. Unit 2: Managing a businessFinanceCalculating variance: profit budgetComplete the variances for XYZ Ltd’s profit budget, based on your variancesfor the income and expenditure budgets.Profit budget for XYZ Ltd, May 2009Item ofincome/expenditureBudgetedprofit (£)Actual profit(£)Variance (£) F/ATotal income 15,800Totalexpenditure10,850Budgeted profit 4,950
  16. 16. Unit 2: Managing a businessFinanceIncome budget: answersIncome budget for XYZ Ltd, May 2009Source of income Budgetedincome (£)Actual income(£)Variance (£) F/AProduct A (3,200 x £25) 8,000 8,100 100 FProduct B (6,000 x £13) 7,800 8,000 200 FTotal income 15,800 16,100 300 F
  17. 17. Unit 2: Managing a businessFinanceExpenditure budget: answersExpenditure budget for XYZ Ltd, May 2009Item of expenditure Budgetedexpenditure(£)Actualexpenditure(£)Variance (£) F/ARaw materials (25% of£15,800)3,950 4,025 75 ALabour costs (9,200 x 25p) 2,300 2,350 50 AAdministration and othercosts4,600 4,200 400 FTotal expenditure 10,850 10,575 275 F
  18. 18. Unit 2: Managing a businessFinanceProfit budget: answersProfit budget for XYZ Ltd, May 2009Item ofincome/expenditureBudgetedprofit (£)Actual profit(£)Variance (£) F/ATotal income 15,800 16,100 300 FTotalexpenditure10,850 10,575 275 FBudgeted profit 4,950 5,525 575 F
  19. 19. Unit 2: Managing a businessFinanceInterpreting the variancesWhat were the main factors that led to the variance in XYZ’s profit for May2009?Possible answers are:• The price increase for product A led to a small fall in demand, which led to salesrevenue increasing. (Lower volume would also have saved on variable costs.)• The price cut for product B led to a significant rise in demand and an increase inincome (but a rise in variable costs too).• There was a major cut in administration costs of almost 10%.• Although variable costs rose per unit produced, they were the same as thebudget.Conclusion: the main reason for the favourable variance in profit was the significantsaving in administration and other costs. The price changes of both products alsohelped to boost income.

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