[Music] in this topic we're going to take a look at budgeting we're going to try and run you through the budgetary process we're going to have a look at the advantages and limitations of using budgets in your organization and crucially we're going to try and teach you how to conduct something known as variance analysis now budgets are essentially a financial plan they're a tool that allow managers to plan out the future finances of their organization and they can use them to set targets for different parts of their organization could be different branches could be different profit centers could be different departments of the organization but budgets are financial targets for different aspects of the organization to try and stick to or to try and achieve now voting is particularly useful for larger organizations where the people at the top of the organizational structure have had to delegate a lot of autonomy or control or authority to different people in the organization because the business is so large it's developed so big that the senior owners the senior managers of the organization can't maintain control of every aspect of that business so they may have split it down into different branches departments or profit areas but they can still try and retain some direction some control over those different areas of the business by setting them budgets to try and work with it now those budgets can come in three different parts they can be budgets that set targets for how much sales revenue different areas of the business are meant to try and achieve so they can set sales revenue targets for different branches or department or profit centers in the organization and try and govern or retain some control over the performance of those different centers by setting them sales revenue targets to work towards they can also try and keep control of their spending by setting them expenditure budgets to work within as well so by allocating different departments or profit centers budgets for their expenditure that they've got to stick within it just allows senior people in the organization to carry on maintaining some control over the activities of those different aspects of the business well finally we've got our profit budgets as well which are literally just the difference between the sales revenue budgets we set for different parts of the business and the expenditure budgets as well so let's talk you through what's known as variance analysis which is where we have a look at the different figures that parts of an organization have been budgeted to try and achieve or stick to and we then look back at the end of the budgetary period to see how they have actually performed and we can calculate the difference between the two known as a variance we've got a budget behind us on a board we're going to imagine that this is an organization that's split into two different branches or profit centers so we've got the London aspect of our business and we've got the Manchester aspect of our business and we've set for each of those two profit centers uh a revenue budget for them to try and achieve an expenditure budget for them to try and stick within and then the difference between the two which is known as the profit budget so if we have a look at the figures behind us on the board there we'll show you how you calculate what's known as the difference or the variance between what we budgeted to happen and what actually occurs during the budgeting period and what we're going to try and do is work out whether these differences these variances whether they are favorable for the business so that they end up making the business more money or whether they're adverse variances adverse differences and end up costing the business money so let's start with our old friends down in London here and for their sales revenue and we had set a budgetary figure for them to try and achieve 900,000 pounds sales revenue for the organization now when we look back at the end of the budgetary period which would usually be a year and see how they've actually performed we'll see that London have only actually achieved £800,000 sales revenue now the difference between the two is clearly £100,000 but we're going to label this as an adverse variance because this is sales revenue and the the branch the profit center hasn't made as much sales revenue as we've targeted for that's cost the business money that's cost the business £100,000 so we label it up as an adverse variance we contrast that with those rascals in the north and have a look at the Manchester branch there and you'd see that we targeted them a budgeted sales revenue of £700,000 they've only gone and exceeded that figure and hit £800,000 it's a £100,000 variance again but this time Manchester has recouped more sales revenue than we had budgeted for so that variance is actually favorable when we do the expenditure budgets we actually flip around what we mean by a favorable or an adverse variance we'll show you how that works in a second first of all we'll take a look at London and we can see that when a business or a facet of the organization a profit center a branch when it comes in exactly on budget so London we budgeted 400k expenditure and they actually did spend £400,000 we just say that there's no variance there there's no difference we put the zero in there they've come in on budget for Manchester we budgeted for them to spend £300,000 and they've actually gone and spent £350,000 now up here when Manchester had a higher actual figure than their budgeted figure because we were talking about sales revenue and they were making more for us than we budgeted that was a favorable variance but this time when Manchester's actual figure is higher than budgeted figure we're talking about expenditure so they have actually spent more money than we had allocated to them so they've cost the business money so again this actual figure is higher than the budgeted but this time because we're talking about expenditure the £50,000 variance is adverse because it has cost the organization so when these figures are higher than budgeted and it's expenditure it's an adverse variance but when these figures are higher than budgeted and it's sales revenue that we're meant to try and achieve it's favorable and that's worth remembering and revising for the organization now the profit budgets are the easiest of all because that's just looking at the difference between the two so for London we budgeted for them to make 900K and for them to spend £400 so we were looking for them to make £500,000 profit but you will see that because we had that £100,000 variance that was adverse on their sales revenue unfortunately they've not hit their profited budget figure so they've come in 100,000 short it's an adverse variance for Manchester well they had a favorable sales revenue variance but an adverse expenditure variance so for Manchester we budgeted for them to make 700K budgeted for them to spend 300K so the profit that we budgeted for them to make was £400,000 they've actually come in at £450,000 profit so it's a £50,000 variance and because it's more than we had budgeted for and the organization benefits from that it's a favorable variance we can even throw in the total variances if we want so we were £100,000 adverse for the London branch some of that's canceled out by the £50,000 favorable for the Manchester branch but for the entire organization when we compare our budgeted figures to our actual performance there is a £50,000 adverse variance let's just quickly talk about a couple of things to do with budgets first of all we may think that uh Manchester here being budgeted £700,000 sales revenue and coming up with £800,000 sales revenue we may think that that's a positive for the organization and in terms of their finances it absolutely is it's always a good thing for an organization to make more revenue than they had budgeted for but in terms of our budgetary process this actually reveals some inaccuracies in our budgeting and for the people constructing these budgets we can ask questions of them and say why is it that they were unable to foresee that the Manchester branch would be capable of making £800,000 revenue and the business may still have lost out here because if we'd have had a better budgeting process with more accurate budget setting and if we'd set £800,000 for Manchester as their targeted sales revenue that figure could even have been higher if they'd have been budgeted to try and achieve £800,000 that might have acted as a motivational target to send them beyond that figure maybe they might have achieved £810 820 £850,000 so although it's great that they have actually made more sales revenue than we had budgeted for from an accuracy of our budget point of view that 100,000 variance even though it's favorable reveals some of the limitations of our budgeting process we probably should have been able to foresee that and we'd be disappointed that we weren't budgeting more accurately another great advantage of the budgetary process is it allows you to dissect where different areas of your business might perhaps have underperformed so we might just be dragging in the you know the the the managers of this London branch and just holding them to account here and saying well we budgeted £900,000 what was the problem here is it an inaccuracy again in our budgetary process did we set a target that was never realistic or has there been some aspect of underperformance in the sales of the London branch that we can try and rectify and we can try and improve next year just before we finish we'll throw in one of the uh limitations of the budgetary process i mean first of all if you are setting in accurate budgetary targets can be a little bit of demotivational for the people who are responsible for achieving or sticking within those targets for example if the Manchester branch never thought it would be achievable to keep within a £300,000 expenditure budget that could have been quite demotivational for them or if the London branch never thought it was plausible to try and achieve £900,000 worth of sales they might have not used that as a target to motivate them spur them on but might have seen that as a source of demotivation something they never thought that they could achieve another limitation of budgeting maybe just lies in the expenditure budget for the London branch here one of the one of the ongoing criticisms of using budgets in your organization is in expenditure budgets it's quite common for departments or profit centers or branches of your business to always make sure that they spend at least as much as they have been budgeted out of fear that they might have their expenditure budgets reduced in the next budgetary cycle so here we've budgeted for the London branch to have £400,000 to spend on their expenditure budget it might be that the owners or the uh the managers of that branch could have come in under budget they might only have had to spend £300£350,000 to run that branch but because they were concerned that if they didn't spend their full allocated expenditure budget they might have it reduced next year and the owners of that the managers for that branch weren't sure whether they might need that full budget in the next budgetary year they might have started spending on things that were unnecessary weren't really needed for the operation of their branch just to make sure they spent the full 400k that they were allocated to try and preserve that figure as their allocated expenditure budget for the next year when they might require more funds so budgets can sometimes be guilty of encouraging overspending in the organization so there you go we've run you through the budgetary process had a look what budgets are a couple of uh differences between or couple of advantages and limitations of the different types of budgets one important thing to make sure you revise is how we calculate those variances and make sure that you can recognize what an adverse variance is what a favorable variance is as well and you will be ready for your exams if you got any questions about budgeting or A-level business comments section below otherwise we'll see you soon for another revision tutorial