The Government sets an annual budget. What is the purpose of this? Why will businesses also set budgets? AO3: Consider how managers and entrepreneurs monitor the financial performance of an enterprise http://www.bbc.co.uk/news/uk-politics-35824830 Budgets

Budgets In this topic you will learn about Interpreting budgets: income and expenditure cash-flow what if analysis Value of variance analysis to evaluate success calculating adverse and favourable variances interpreting variances for decision making

budgets Budgets are forecasts or plans for the future finances of a business These can be for the business as a whole or set for specific functions e.g. a marketing budget Budgets can be: Income Expenditure Profit http://www.bbc.co.uk/news/business-32116506 How much? The crazy cost of children's parties What budget would you set for a child’s birthday party?

budgets Income budgets a target set for the amount of revenue to be achieved in a set time period can be split by products, services or departments may be translated into individual sales targets for staff informed by market research and sales forecasts informs predicted cash inflows in the cash flow forecast

Why have budgets been cut for UK television dramas? Expenditure budgets a limit placed on the amount to be spent in a given period of time can be split by department, function or product responsibility can be passed to individual managers a separate expenditure budget may be set for running costs and start up costs informs predicted cash outflows in cash flow forecast allows for monitoring of under spending as well as overspending Why have budgets been cut for UK television dramas? http://www.theguardian.com/media/2015/jul/02/uk-tv-drama-budgets-slashed-bbc-itv-channel-4 UK TV drama budgets 'slashed by 44% in six years'

budgets Profit budgets a target set for the surplus between income and expenditure in a given period of time calculated based upon the income and expenditure budget may be set for the business as a whole or for individual departments, products or branches will be used to inform decision making on products to include in the businesses portfolio as well as were cuts may need to be made

Sample budget Jan Feb Mar Income Budget 5000 6000 Expenditure Budget 2500 3500 Profit Budgets 1500

Interpreting budgets - Cash Flow Problems Explain why a cash-flow forecast is a type of budget. Managers and entrepreneurs will monitor the cash-flow to identify any problems and potential solutions. Businesses need to have sufficient cash to meet day to day financial obligations Buying stock Paying wages Utility bills Insufficient liquid cash funds may mean an inability to meet short term debts Bank overdraft Payables (trade creditors) Limited cash may result in missed opportunities A key consideration should be whether the cash flow problem is short term or long term A firm may be able to survive short term cash flow problems Long term cash flow problems may be insurmountable

Improving Cash Flow Increasing the volume of the inflow of cash Speeding up the timing of the inflow of cash Inflows Capital invested Loans Cash sales Debtor payments Reducing the volume of the outflow of cash Slowing down the timing of the outflow of cash Outflows Loan repayments Day to day running expenses Interest payments

Improving Cash Flow - Inflows Using financial institutions i.e. banks Overdraft – an arrangement with the bank allowing the business to withdraw money above the amount available Provides some financial peace of mind Backed by a cash flow forecast to show ability to repay Allows flexibility Incurs interest and possible arrangement fee Can be ordered to repay immediately Short-term loan – an arrangement with a bank to lend money for a set period of time Pre agreed repayment terms Incorporated into budget and cash flow Interest rate may be lower than an overdraft Interest is paid on the total value of the loan May need to be backed by collateral Biz Link Overdrafts An overdraft is a borrowing facility attached to your bank account, set at an agreed limit. It can be drawn upon at any time and is ideal for your day-to-day expenses, particularly to see you through cashflow problems. Loans A loan is an amount of money borrowed for a set period within an agreed repayment schedule. The repayment amount will depend on the size and duration of the loan and the rate of interest.

Improving Cash Flow - Inflows Factoring Debt factoring – the process of selling a business’ debts i.e. the money owed to it, to a factor house at a reduced amount in order to receive immediate payment Immediate payment of debt Reduced risk of non payment (bad debt) Factor house takes a % as their profit May alter customer’s image of business http://www.rbsif.co.uk/invoice-financing/factoring Factoring is a service offered by banks. Read what RBS says about factoring.

Improving Cash Flow - Inflows Cash payments from customers Reducing credit terms – credit terms refers to the amount of time a customer is given to pay for their goods and services Some businesses offer customers a discount for immediate or quick payment Quick cash inflow Reduced risk of bad debt May need to offer a discount May lose customers Credit control – the process of chasing payments from debtors (people who have bought from you on credit) Brings cash into the business Full amount received May alienate customers Administratively demanding https://www.youtube.com/watch?v=CgU7ukGiVi4 Should businesses enrol the help of experts in credit control?

Improving Cash Flow - Outflows Delaying payment to suppliers Negotiating longer payment terms May incur penalties Need to maintain positive relationship Stock management Reducing money tied up in stock Need reliable stock deliveries Reduce overhead spending Cut unnecessary expenditure Should not have negative impact on productivity Consider any knock on effect on sales

Difficulties improving cash flow Damage to the business’ reputation Potential loss of customers if payment terms affect competiveness Administrative costs and time Loss of discounts or need to offer discounts May affect profitability e.g. only receive part of debt or more expensive to lease assets in the longer run

In pairs Method of improving cash flow Potential difficulties of improving cash flow Overdraft Short term bank loan Factoring Sale of assets Sale and leaseback Cash payments from customers Credit control Delay payment to suppliers Stock management Reduce overhead spending

What-if analysis What-if analysis is the process of systematically changing variables to calculate a range of possible financial outcomes Often used to consider best and worst case scenarios Examples of changing variables include: Costs e.g. raw materials or utilities, introduction of the living wage Prices e.g. raise or lower prices in response to competitors actions External economic changes e.g. interest rates payable on a bank loan or taxes

The calculation and interpretation of variances An advantage of budgets was that they allow for monitoring of performance This is achieved by comparing the budget to the actual Any difference is known as a variance Profit Budget Variance Expenditure Budget £25000 Variance £2000 Profit Actual Expenditure Actual £27000

The calculation and interpretation of variances Variance is therefore the difference between the actual income, expenditure or profit and the figure that had been budgeted Variance Analysis is the process of calculating and interpreting these variances Budget Actual Variance Income £60 000 £62 000 £2 000 Expenditure £32 000 £32 800 £800 Profit £28 000 £29 200 £1 200

Variances can be Adverse or Favourable An adverse variance is one that is bad for the business Expenditure higher than budget Income lower than budget Profit lower than budget Favourable A favourable variance is one that is good for the business Expenditure lower than budget Income higher than budget Profit higher than budget Budget Actual Variance Income £60 000 £62 000 £2 000 Favourable Expenditure £32 000 £32 800 £ 800 Adverse Profit £28 000 £29 200 £1 200 Favourable

Interpreting Variances Once a variance has been identified it is important to 1) Identify the cause of the variance 2) Consider the effect of the variance 3) If appropriate look for a solution http://www.thisismoney.co.uk/money/news/article-2629579/Is-controversial-HS2-rail-line-budget-Firm-tasked-managing-project-accused-blowing-funds-consultants.html High Speed 2 rail line project blows £87m too much on consultants as it already goes over budget Read more: http://www.thisismoney.co.uk/money/news/article-2629579/Is-controversial-HS2-rail-line-budget-Firm-tasked-managing-project-accused-blowing-funds-consultants.html#ixzz3eoOCNmJm Follow us: @MailOnline on Twitter | DailyMail on Facebook What are the causes, effects and possible solutions to the overspending of budgets on the HS2 project?

Possible causes of variances Action of competitors Lower prices Introduce a new product Close a store Action of suppliers Change prices Offer a discount Changes in the economy Change in interest rates Increase to minimum wage Internal inefficiency Poor management of a budget Demotivated sales team Internal decision making Change suppliers Special promotions In each of these cases consider the possible impact on actual expenditure and/or Income and explain whether you think the variance will be adverse or favourable.

Using variance analysis to inform decision making Having identified variances managers now need to decide how to respond Change budgets? Staff training? Reward staff? Change suppliers? Reallocate budgets? New marketing tactics? Review product portfolio? Bringing the Budgets Together Once the Materials Purchase budget (no.3), the Staff budget (no.4) and the Overheads budget (no.5) has been compiled, they can be put together to be summarized in a Production Cost Budget. To obtain a clearer view of this, and how the whole budgeting system fits together, visit: The Budget Hierarchy (A new window will be opened) Can you think of an adverse or favourable variance where each of these might be an appropriate course of action?

Activity – Del Rio Pizzeria Del Rio Pizzeria has been trading for 6 months. Toni, the owner, is worried that waste levels in the kitchen are high and customer numbers low. 6 Months Budget Actual Variance Pizza Sales £55 000 £48 000 Drinks Sales £18 000 £20 500 Materials £27 500 £1 500 Favourable Drinks stock £9 000 £10 250 Wages £23 000 £1 000 Adverse Overheads £40 000 £43 000 Profit / Loss Fill in the gaps Identify possible causes of the variances Identify possible solutions Toni is considering lowering the materials expenditure budget for the next 6 months, discuss the arguments for and against this course of action

The value of setting budgets Advantages Provides a quantifiable target against which actual outcomes can be measured e.g. Are sales targets being achieved? Are managers keeping expenditure under control? Is the businesses operating efficiently to achieve profit targets? Informs decision making e.g. What are this year’s priorities? Where were budgets met or missed in previous years? Where can cuts be made or extra funds channelled? Motivates budget holders due to increased responsibility

The value of setting budgets Disadvantages Potential for conflict Lack of transparency Short term saving may be detrimental to long term objectives May be too easy or too hard to achieve May be restrictive Opportunities may be missed Inappropriate cost cuts Time consuming to set and monitor

Budgets In this topic you have learnt about Interpreting budgets: income and expenditure cash-flow what if analysis Value of variance analysis to evaluate success calculating adverse and favourable variances interpreting variances for decision making