Finance Using Budgets

FinanceUsing Budgets Budgets This unit follows on from the study of budgets in Unit 1- Setting Budgets “ Budgets are for cutting, that’s why you set them” Dr Laurence Buckman BUSS2.1 Using Budgets

Using BudgetsIn this topic you will learn about: • The benefits and drawbacks of using budgets • The calculation and interpretation of favourable and adverse variances • Using variance analysis to inform decision making BUSS2.1 Using Budgets

Income, Expenditure and Profit Budgets • Income Budgets • A target set for the amount of revenue (income) to be achieved in a set period of time • Expenditure Budgets • A limit set for the amount of money that can be spent (expenditure) in a set period of time • Profit Budgets • A target set for the amount of profit (income in excess of expenditure) to be achieved in a set period of time Revise budgets from unit 1? BUSS2.1 Using Budgets

The benefits of using budgets • Improves financial control • Reduces overspending • Better forecasting ability • More efficient allocation of money • Delegates spending power • Motivates staff • Opportunity cost of manager’s time • Sets targets and goals • Improves cash flow forecasting • Allows for monitoring of performance BUSS2.1 Using Budgets

The benefits of using budgets “We have always found that people are most productive in small teams with tight budgets, time lines and the freedom to solve their own problems.” John Rollwagen American Businessman, CEO of Cray Research Analyse two reasons why people may be more productive in these circumstances? Analyse two reasons why people may not be more productive in these circumstances? On balance which of the arguments do you think is stronger? Justify your answer. What factors might influence whether people are more or less productive in these circumstances? Is sticking to a budget and deadline always the right move? Watch this video where the CEO of BA defends the first day of T5 You will need access to the internet to watch this video? BUSS2.1 Using Budgets

The drawbacks of using budgets • 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 “ The budget evolved from a management tool into an obstacle for management.” Frank C Carlucci, American Secretary of Defence BUSS2.1 Using Budgets

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 BUSS2.1 Using Budgets

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 BUSS2.1 Using Budgets

Adverse 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 Variances can be Adverse or Favourable BUSS2.1 Using Budgets

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 Use either the internet link or word doc to read about overspending at the BBC What is the cause, effect and possible solution? BUSS2.1 Using Budgets

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 Possible causes of variances 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 What factors prompted NZ Tourism board to increase its budget? Do you think this was a wise decision? You need access to the internet to watch this video BUSS2.1 Using Budgets

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? Can you think of an adverse or favourable variance where each of these might be an appropriate course of action? Biz24 offers guidance to small businesses on variance analysis BUSS2.1 Using Budgets

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. He decides it is time to sit down and look at the books. • 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 BUSS2.1 Using Budgets

Finance Using Budgets