Budgets are financial plans that set targets for a business's revenues and costs over a given period. Managers are responsible for costs within their budgets and must take action if actual spending differs significantly. Variances occur when actual figures differ from budgets, and can be favorable or adverse. While budgets help control costs and monitor performance, they can also lead to inflexibility and departmental rivalry if not implemented carefully.

1. Using Budgets

2. What is a budget?
A financial plan for the
future concerning the
revenues and costs of a
business

3. Reminder from Unit 1 – a Budget…
• Is a financial plan
• Sets out financial targets
• Is expressed in money
• Contains agreed plan of action over a
given period expressed in numerical
terms

4. Budgetary control
• The process by which financial control is
exercised within an organisation
• Budgets for income/revenue and expenditure
are prepared in advance and then compared
with actual performance to establish any
variances
• Managers are responsible for controllable
costs within their budgets and are required to
take remedial action if the adverse variances
are regarded as excessive

5. Management use budgets to…
• Establish priorities & • Delegate without loss
set targets of control
• Turn objectives into • Motivate staff
practical reality • Improve efficiency
• Provide direction and • Forecast outcomes
co-ordination • Monitor performance
• Assign responsibilities • Control income and
• Allocate resources expenditure
• Communicate targets

6. Principles of good budgetary control
• Managerial responsibilities are clearly
defined
• Managers have a responsibility to adhere to
their budgets
• Performance is monitored against the budget
• Corrective action is taken if results differ
significantly from the budget
• Unaccounted for variances are investigated
• Departures from budgets are permitted only
after approval from senior management

7. Approaches to Budgeting
• Historical budgeting
– Use last year’s figures as the basis for the budget
– Realistic in that it is based on actual results
– However, circumstances may have changed (e.g. new
products, lost customers, credit crunch)
– Does not encourage efficiency
• Zero budgeting
– Budgeted costs & revenues are set to zero
– Budget is based on new proposals for sales and costs –
i.e. built from the bottom-up
– Makes budgeting more complicated and time-
consuming, but potentially more realistic

8. “Management by exception”
• Focusing on activities that require attention, not
those that are running smoothly
• Budget control and analysis of variances facilitates
management by exception since it highlights areas of
the business which deviate from predetermined
standards
• Items of income or spending that show no or small
variances require no action. Instead concentrate on
items showing a large adverse variance

9. Variances
• A variance arises when there is a
difference between actual and budget
figures
• Variances can be:
– Positive/Favourable (better than expected) or
– Adverse/Unfavourable ( worse than expected)

10. Favourable and adverse
• Favourable - actual figures are better than
budgeted figure
– costs lower than expected
– revenue/profits higher than expected
• Adverse - actual figure worse than budget
figure
– costs higher than expected
– revenue/profits lower than expected

11. Illustration of Variances
Sales of standard
Item Budget Actual Variance Favourable
product are £15k
£'000 £'000 £'000 or Adverse higher than budget –
Sales revenue this is a positive
Standard product 75 90 15 F (favourable) variance
Premium product 30 25 -5 A
Total sales revenue 105 115 10 F Actual wages were £3k
higher than budget –
Costs i.e. an adverse
(negative) variance
Wages 35 38 3 A
Rent 15 17 2 A
Marketing 20 14 -6 F
Other overheads 27 35 8 A Overall, the profit
Total costs 97 104 7 A variance was positive
(favourable) – i.e.
better than budget
Profit 8 11 3 F

12. Do variances matter? It depends on...
• Was it foreseen?
• Was it foreseeable?
• Size
– absolute size in money terms
– relative size in percentage terms
• Cause
• And whether it is a temporary problem or
the result of a long term trend

13. What to do about a variance?
• Act only if the variance is outside an
agreed margin – don’t waste time
• Investigate the cause of a significant
variance
• Was it avoidable or unavoidable?
• Act to remedy the problem – if
appropriate

14. A point to remember
An adverse variance might result from
something that is good that has
happened in the business...
e.g. higher production costs than
budget (adverse variance) that occur
because sales are significantly higher
than budget (favourable budget)

15. Problems and limitations: budgets...
• Are only as good as the data being used
• Can lead to inflexibility in decision-making
• Need to be changed as circumstances change
• Take time to complete and manage
• Can result in short term decisions to keep
within the budget rather than the right long
term decision which exceeds the budget

16. Some behavioural implications
• Budgets are de-motivating if they are
imposed rather than negotiated
• Setting unrealistic targets adds to de-
motivation
• Budgets can contribute to departmental
rivalry - battles over budget allocation
• Spending up to budget: it can result in a
“use it or lose it” mentality - spend up to
the budget to preserve it for next year

17. Test Your Understanding
http://www.tutor2u.net/business/quiz/usingbudgets/quiz.html

18. Using Budgets