Budgeting & Variance

Lesson Objectives

What are budgets? How do businesses use budgets? - Variance Analysis How do businesses benefit from budgets? How are budgets produced?

Types of budgets

Almost all activities of a business can be budgeted. These include: Sales budget Expenditure budget Profit Budget

What is budgeting?

Budgeting involves defining financial objectives, assessing finances and using this information for financial planning.

Once the financial manager has an understanding of how the business stands financially he can set budgets.

Benefits of Budgeting

It helps to predict what will happen in the future It sets targets They help monitor performance They help control performance They help in business planning They can be used as a source of motivation as they

involve a consultation process They are a form of communication

Past, Present, Future

The process of budget setting

The business is broken down into a series of control centres

Each manager has responsibility for managing the budget for their control centre

Each manager is kept informed of their own performance and that of other budget holders

How are the Budgets decided?

Managers will look at: Past results & costs Planned Output How money has been allocated in the past Business Objectives for the coming period Consultation with managers Forecasts for markets and prices

Variance Analysis Variance analysis is

used to calculate the difference between any actual and budgeted figures.

After calculation the variance should be interpreted as follows:

Favourable variances mean that the actual performance of the organisation has been better than expected – likely to increase profit

Adverse variances mean that the actual performance has been worse than expected -likely to reduce profit

Profit Variance

The difference between budgeted profit and actual profit

This can be broken down to revenue variances and cost variances

These variances can in turn be broken down further

Sales Variance

Sales variance – the difference between actual sales revenue and budgeted sales revenue

This can be broken down into:- Sales volume variance (how sales differed from

target)- Price variance (how actual price differed from

expected price)

Cost Variances Material price variance – the difference between the

budgeted cost of raw materials and the actual costs Material usage variance – the difference between the

budgeted quantities of raw materials & supplies against the actual quantities used

Labour rate variance – the budgeted wage bill compared to the actual wage bill

Labour efficiency variance – the budgeted number of man-hours to complete tasks compared to the actual time taken