Flashcards in UNIT 5. Chapter 30. Budgets Deck (14)
A detailed financial plan for the future
What are the purposes of setting budgets? (6)
• Effective allocation of resources
• Setting targets
• Co-ordination between departments and divisions
• Assessing performance
Def. Budget holder
Individual responsible for the initial setting and achievement of a budget.
Def. Delegated budgets
Giving some delegated authority over the setting and achievement of budgets to junior managers. (Link with Herzberg's motivational approach)
What are the stages of preparing budgets? (6)
1. Organisational objectives are established based on past performance, forecasted sales, and external factors.
2. Set key factor - e.g. sales.
3. The sales budgets is prepared after discussion of sales managers in all branches.
4. Subsidiary budgets are prepared e.g. cash budget, labour cost budget.
5. Budgets are coordinated with each other.
6. Master budget is prepared - budget profit and loss account and balance sheet.
What are the three main ways of setting budgets?
• Incremental budgeting
• Zero budgeting
• Flexible budgeting
Def. Incremental budgeting
+ Benefits and limitations (2 each)
Uses last year's budgets as a basis and an adjustment is made for the coming year.
•Easy and quick to come up with.
•Puts pressure on staff to achieve greater productivity.
•Does not allow unforeseen events.
•By using last year's figure, the department doesn't justify the whole budget but just the change in it => lack of planning.
Def. Zero budgeting
+ Benefits and limitations (3 1)
Setting budgets to zero each year and budget holders have to argue their case to receive any finance.
•Requires all departments and budget holders to justify their budget.
•Takes into account any external changes.
•Gives managers incentive to defend their work -> motivation.
Def. Flexible budgeting
+ Benefits and limitations (3 1)
Cost budgets for each expense are allowed to vary is sales or production vary from budgeted levels.
E.g. Fixed budget: $20 000 for 100 units of output.
Flexible budget of $16 000 for 80 units of output (20% variance)
Actual costs were $18 000 for 80 units.
Hence the business went over budget by $2 000.
• More realistic
• Motivated middle and junior managers as they would be criticised for adverse variances
• Give more accurate variance analysis
• Time consuming to produce
Potential limitations of budgeting (4)
• Lack of flexibility: If budgets are set with no flexibility, any sudden external changes will make them unrealistic.
• Focused on short term: Budgets are usually set for a 12 month period. Managers may avoid the long term benefits to achieve the budgets.
• May lead to unnecessary spending: If by the end of the year managers realise they have under spent their budget, they can to impulsive purchasing.
• Setting budgets for new projects can be difficult to do
Def. Variance analysis
Calculating differences between budgets and actual performance, and analysing reasons for such differences.
Why is variance analysis essential? (4)
• Continuous monitoring of the business's performance
• Assists in analysing the causes of deviations from budget.
• The understanding of reasons of deviations can aid future budget setting
• Identifying problems quickly can help remedial actions to be taken immediately
Def. Adverse variance
Exists when the difference between the budgeted and actual figure leads to lower profits.
Eg. of causes:
• Sales revenues are less because less units were sold or prices had to be lowered.
• Raw materials costs were higher