2. 1 Budgeting Learning Objective: Understand the function of financial budgets. Awareness of the concept of a financial budget Pg 189 - 192

3. 2 What is a Budget? Describe in your groups what you think a budget is:

4. 3 Budget Defined - A financial plan for the future 1. A Budget is a target for cost or revenue that a business or department must aim to reach over a period of time. 2. 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.

5. 4 Key features of budgets Budgets are plans for 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

6. 5 Types of Budget: Income Sales Budget Expenditure Production Distribution Budget Marketing Budget Cash Budget Master Budget Material purchases Staff Budget Overheads Budget

7. 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.

8. 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

9. 8 Activity 1 Individually Analyse three problems that ‘AIS’ might have in setting up budgets for the next financial year.

10. 9 Activity 2 Move into pairs Pick one problem from the group. Analyse it. (B Grade) Try to come up with a solution (A Grade)

11. 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.

12. 11 Budget plan PRODUCTION DEPARTMENT BUDGET MARCH 2008 - FEBRUARY 2009 ItemMonthly expenditure $ Sheet aluminium Wheels Tyres Wages Maintenance Electricity Moulds 12,000 8,900 9,500 16,500 4,000 1,750 850 Total53,500

13. 12 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. 13 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

15. 14 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.

16. Why are Budgets important? Write two paragraphs (as if an exam answer) Pg 189 – 191 will help 15

17. 16 Extension Question: 8 marks Your best mate has a great idea… he wants to open a ballerina shop. Tell him why you think he should set up a budget before he starts.. And what problems he might face

18. 17 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

19. 18 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 Budgeted amount: $200 Actual spending: $250 Variance:– $50 The use of a minus sign can be confusing, there is a better way.

20. 19 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.

21. 20 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.

22. 21 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.

23. 22 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?

24. 23 WHY, oh Why… does this happen???

25. 24 VarianceReason? Sales variance Cost variance Materials variance Labour variance Overheads variance Profit variance 1.A price is greater/less than expected 2.Volume is greater than or less than expected Can be a Combination of the two!

26. 25 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.

27. 26 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

28. 27 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