Topic: Costs and Budgets (2)Learning Outcomes:By the end of the session, all students should be able to:

• Identify business costs items associated with budgets and most learners will be able to classify costs and some learners, explain why costs are important to businesses.

 • Identify types of budgets and most learners will be able

to explain the purpose of budgeting.  • Construct a business related budget. Some learners

should be able to calculate variances without help.  • Calculate budget variances and some learners should be

able to recommend options that businesses could use to control adverse variances.

What is a budget? A plan which outlines expenses (costs) and

income (revenues) over a stated period of time i.e. 1 - 5yrs.

It also identifies the sum of money allocated towards a business expense.

Businesses often use budgets to help achieve their overall goals and monitor and control their costs.

Importance of budgets?• Establishes priorities and sets

targets• Turn objectives into practical

reality• Provide direction and co-

ordination• Help assign responsibilities• Allocate resources• Communicate targets

• Improve efficiency

• Motivate staff

• Forecast outcomes

• Monitor performance

• Control income and expenses

• Manage costs better

• Delegate without loss of control

Example of a Budget

Example of Budget Variances

Budget VariancesThe difference between actual and budgeted figures. Favourable - actual figure better than budgeted figure e.g.

where costs are lower than expected. where revenue are higher than expected.

Adverse – actual figure is worse than budgeted figure e.g. where costs are higher than expected. where revenue are lower than expected.

Why do variances occur?

Internal matters:performance of individuals (ordering)wastage of materialsslow workingequipment faults.

External issues:change in supply and demandshortage of materials and labourchange in economic conditions.

Incorrect budgets:Where budgets are based on incorrect information.

Variances are differences between actual expenses and the planned budget. There are numerous reasons for variances in a budgets, which could include:

Approaches to BudgetingHistorical budgeting

• Use last year’s figures as the basis for the budget

• Seen as realistic as it is based on actual results

Issues• Change in circumstances• Does not encourage

efficiency

Zero-based budgeting

• Budgeted costs & revenues are set to zero.

• Budget is based on new proposals for sales and costs.

Issues

• Makes budgeting more complicated and time-consuming, but potentially more realistic

Benefits and Limitations of budgeting

Advantages May motivate staff by

providing them with targets

Helps cash flow planning Helps coordinate

activities Enables managers to see

the consequences of their actions

Performs a co-coordinating role

Provides a control facility Creates a framework Acts as a plan

Limitations Budgets are only

estimates They may be restrictive if

managers feel they have to follow them too closely

Can de-motivate if targets are too hard to meet

Targets can be set too low if this makes them easier to achieve

Time consuming Inflexible Can meet with resistance Increased paperwork