Illustrate the use of budgets as a means of exercising financial control of a company

by ellouise1997hotmailcom (student)

A budget is an estimate of income and expenditure for a set period of time. This will allow or provide a particular amount of money.

There are many advantages for a business to use a budget. Firstly, budgets are good to see where they are succeeding and where they may be failing. If a business do not have enough funds to meet budgeted targets they will need to follow their contingency plan. However a budget may be able to identify where they can save money before they need to follow their back up plan. This can be done especially if business decide to use zero-based budgets. This is because everyone in each department will have to justify why they need money, therefore business will be able to highlight the departments that who don’t need as much money as they may have been given in the past.

However, budgets can also become a problem. Sometimes budgets can be inaccurate and unreasonable and can cause problems to a business. This is because if they are unrealistic the company are going to be over spending. In addition, if budgets are unrealistic it can unmotivated employees; this is because they will have to work hard to ensure they don’t go over the budgets, but this may be impossible and could lead to lots of stress. Nevertheless, if budgets are too high staff may spend up to budget. Staff will want to use all the money they are budgeted or they may feel that they will lose it at the end of the year. Furthermore, Managers can become too preoccupied with setting and reviewing budgets and forgetting to focus on things that could award them more customers. Also, budgeting is a time consuming process, this time could be used on other things that could improve the businesses performance. Budgets need to be changed as circumstances change which means more effort and more time needs to be put into correcting the budgets. This will cost businesses more money and time used on this could have been used in other important areas.

There are many different types of budgets. First there is sales budgets, this forecasts how much stock will be sold. There is also production budgets which forecast how much stock needs to be made. Additionally, purchases budgets outline the material requirements of production budget and labour budgets outline the labour requirements of production budget. Furthermore, there is capital expenditure budgets which summaries new assets that may be needed and cash budgets forecasts the money flowing in and out of the business. Lastly, there is master budgets which is a summary of all budgets to forecast profit and loss.

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A business can control a budget by using variance analysis. Variance analysis involves comparing budgeted figures with actual figures. Variance can be calculated by the actual level minus the planned level. If the variance is better than planned it is called positive variance and if it is worse than planned it is a negative variance. Mangers of businesses will need to look at the variance and find reasons for the negative variance so that they can escape future problems.

Break-even occurs when the total costs are equal to the total revenue. To work out a business’s break-even they will need to use break-even analysis; this is a way of determining the point of profitability. To do this they will need to use the formula: fixed costs divided by contribution (contribution cost is the selling price divided by the variable costs per unit). Nintendo will need to work out their break-even point in order to determine how many products they will need to sell in order to make a profit. However if they cannot reach break-even point then Nintendo may need to cut costs by finding cheaper raw materials or making some staff redundant. Nintendo may also need to raise the prices of their products. However they will need to ask them self’s if customers will be willing to pay a higher price and do research within competitors in order to higher their prices. From break-even analysis Nintendo will be able to see how changing costs and sale prices will affect how much they need to sell. They can see this by using a spreadsheet or chart which highlights clearly the break-even point. If the fixed costs increase Nintendo will need to sell more products to break-even. Whereas if fixed costs decrease they won’t have to sell as much. In addition, if Nintendo increase the selling price they will need to sell less however if they lower the price they will need to sell more to meet break-even.

Unit 34