Budgeting and Variance Analysis Lecture

Overview

• Introduction to budgeting and its process.
• Examination of the advantages and limitations of using budgets.
• Explanation of variance analysis and its importance.

What is a Budget?

• A financial plan used by managers to plan future finances.
• Sets financial targets for different parts of an organization (e.g., branches, profit centers, departments).
• Especially useful for large organizations where authority is delegated.

Types of Budgets

1. Sales Revenue Budgets
   • Targets for sales revenue for different branches or profit centers.
2. Expenditure Budgets
   • Budgets set for spending, helping maintain control over departmental activities.
3. Profit Budgets
   • Difference between sales revenue budgets and expenditure budgets.

Variance Analysis

• Comparing budgeted figures to actual performance.
• Calculating the difference, called a variance.
• Variance can be:
  • Favorable: Benefits the organization (e.g., higher sales revenue than expected).
  • Adverse: Costs the organization (e.g., higher expenditure than expected).

Examples

• London Branch:
  • Budgeted sales revenue: £900,000
  • Actual sales revenue: £800,000
  • Result: £100,000 adverse variance (less revenue than budgeted).
• Manchester Branch:
  • Budgeted sales revenue: £700,000
  • Actual sales revenue: £800,000
  • Result: £100,000 favorable variance (more revenue than budgeted).

Expenditure Variance

• A higher actual expenditure compared to budgeted is adverse, indicating overspending.
• London Branch:
  • Budgeted: £400,000
  • Actual: £400,000 (no variance)
• Manchester Branch:
  • Budgeted: £300,000
  • Actual: £350,000
  • Result: £50,000 adverse variance (overspending).

Profit Variance

• London: Adverse due to lower sales revenue.
• Manchester: Favorable due to higher sales revenue and despite overspending.

Total Variance for Organization

• Overall: £50,000 adverse variance.

Limitations of Budgeting

• Inaccurate budgets can lead to unforeseen performance issues.
• Potentially demotivational if targets are unrealistic.
• May encourage overspending to preserve future budget allocations.

Conclusion

• Understanding variances is crucial for financial control in businesses.
• Recognizing and revising adverse and favorable variances is important for exams.

Questions

• Address any queries about budgeting or business-related topics in the comments section.