Chapter 16: Using Budgets

What is a budget?

An agreed plan establishing, in numerical or financial terms, the policy to be pursued and the anticipated outcomes of that policy.

Advantages and Disadvantages of using a Budget

Features of Good Budgeting

• Be consistent with the aims of the business - meaning managers cannot fund projects that will boost their own careers or interests, rather than meet the needs of the company.
• Be based on the opinions of as many people as possible - Different people can provide different ideas and expertise. Helps budget holder come up with a realistic set of targets.
• Set challenging but realistic targets - SMART (Specific, measurable, agreed/achievable, realistic, timed)
• Be monitored at regular intervals, allowing for changes in the business and its environment - Remedial action can be taken or reasons for beating a target can be looked at.
• Be flexible - Allows for changing circumstances. Adjusting a inadequate budget (due to unforeseen circumstances) to a more realistic level.

Budgetary Control

Budgetary control is the establishment of the budget and the continuous comparison of actual and budgeted results in order to ascertain variances from the plan and to provide a basis for revision of the objective or strategy.


Variance Analysis

Variance analysis is the process by which the outcomes of budgets are examined and then compared with the budgeted figures. The reasons for an differences (variances) are then found.

• Favourable Variance: When costs are lower than expected or revenue is higher than expected. More profit than expected. Shown by 'F'.
• Adverse (Unfavourable) Variance: When costs are higher then expected or revenue is lower than expected. Less profit than expected. Shown by 'A'.

Variance is calculated by this formula:

Variance = Budget figure - Actual figure


Important Points to remember:

• A negative variance for an expenditure budget is an adverse variance (as you have spend more than you budgeted), while a negative variance for a revenue budget is favourable (as you have gained more income than you expected)
• Similarly, a positive variance for an expenditure budget is a favourable variance, while a positive variance for a revenue budget is an adverse variance.
• Other names for income budgets: Revenue budget and sales budget
• Other names for the expenditure budget is a cost budget.

For an adverse variance, providing the factor that caused it is under the firm's control, alternative methods can be investigated.
Favourable variances can be used to identify efficient methods that can be adopted more widely in the company.


Causes of variances in costs

Practice questions on this chapter here - it is a fun multiple choice quiz:

http://www.tutor2u.net/business/quiz/usingbudgets/quiz.html