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Analysing Budget to make Decision.

Budgetary control is the setting out of plans, called budgets, for which all managers are responsible to make decision at controlling the firms resources.

Budget and Forecast are not the same The difference between a budget and a forecast is perhaps a subtle one, as the cash-flow forecast is often quoted as an example of a budget. Yet their distinct applications must be clarified if they were to be correctly used in financial management.

The cash-flow forecast was used to indicate how the flows of cash in and out of the business in the foreseeable future would affect the bank balance and thus determine how much cash might be needed or be available to finance a particular project.
A typical cash-flow forecast is set out month by month and comprises four parts: _ The total cash receipts for the month. _ The total cash payments for the month. _ The net inflow or outflow of cash. _ The bank balance, either at the month end or at the start and end of the month.

The simple cash-flow forecast, while obviously a plan, cannot be regarded as a management tool for control of resources. The cash-flow forecast is based on figures estimated for the foreseeable future and does not make any comparison with the actual cash received or spent.
It is only when comparative figures are introduced into a budget that any measure of control operates. This is essentially the difference between a budget and a forecast. The budget can be a tool for planning & control, A forecast cannot be used to control resources.

Using Variances to analyse Budget The difference between the budgeted figures and the actual figures, are called the variances.

Favourable variances occur when actual costs are lower than budget or actual income is higher than budget. Adverse variances are the opposite: actual costs are higher or income is lower than budget.

The following comparison shows the budget and actual figures for the profit and loss account of a bar in a university students union. Budget 5,000 3,000 2,000 200 1,000 100 1,300 700 210 950 120 1,280 220 Actual 4,000 2,500 1,500 Variance

Sales Cost of sales Gross profit Expenses Rent Wages Other Net profit

REQUIREMENT: Show the variances in the third column, putting adverse variances in brackets, and ensuring that the total variance is correct.

Your variance column should look as follows: Budget Actual Sales 5,000 4,000 Cost of sales 3,000 2,500 Gross profit 2,000 1,500 Expenses Rent 200 210 (10) Wages 1,000 950 50 Other 100 120 (20) 1,300 1,280 Net profit 700 220

Variance (1,000) 500 (500)

20 (480)

budgets do not exist in isolation, There may be several in one control system.

Fixed and flexible budgets A budget may be adjusted throughout the year to allow for the behaviour of costs at different levels of activity. If a budget is changed in this way it is known as a flexible budget, whereas if the original budget is used, this is a fixed budget

Example: A fixed budget for the monthly activity of a manufacturing Organisation might look something like this: Activity level Fixed budget Actual results (100%) (85%) Variances 000 000 000 Direct materials 27 23.7 3.3 Direct labour 33 31 2 Overheads (all variable) 36 34.1 1.9 Total 96 88.8 7.2 All the variances in this month are favourable, since total costs were budgeted at 96,000 but were actually 88,800. A flexible budget for the same month would give the figures for different levels of activity based on the 100% level.

Complete the following table, showing the budgeted activity at different levels for the fixed budget in the example above. Activity level 70% 80% 90% 100% 000 000 000 000 Direct materials 18.9 27 Direct labour 23.1 33 Variable overheads 10.5 15 Fixed overheads 21 21 Total 73.5 96 Notice that the overheads are split between variable and fixed. The fixed overheads remain constant at 21,000 regardless of the level of activity:

Activity level Direct materials Direct labour Variable overheads Fixed overheads Total

70% 000 18.9 23.1 10.5 21 73.5

80% 000 21.6 26.4 12 21 81

90% 000 24.3 29.7 13.5 21 88.5

100% 000 27 33 15 21 96

When a flexible budget system is used, the results would be compared with the budget for the results at that level of activity. Requirement: The company worked at the 85% level of activity. Work out a table to report the budget analysis at 85% level of activity

Your table should look like this


Activity level
Direct materials Direct labour Variable overheads Fixed overheads Total

85% 000 22.95 28.05 12.75 21 84.75

Actual results 000 23.7 31 12.6 21.5 88.8

Variances 000 (0.75) (2.95) 0.15 (0.5) (4.05)

Using the flexible budget, the firm has incurred more costs during the month than were budgeted for at that level of activity, since the total variance was adverse.

This table of calculations is called a budget report.

EXCERCISE The budgeted annual costs for a company, at a production level of 1,000 units, are as follows: Direct costs 20 per unit Variable costs 3 per unit Semi-variable costs (variable portion) 2 per unit Semi-variable costs (fixed portion) 2,000 per annum Fixed costs 5,000 per annum The actual results were as follows: Units produced 800 Direct costs 15,750 Variable costs 2,450 Semi-variable costs 3,500 Fixed costs 5,000

Requirement: 1. A flexible budget for activity levels at 60%, 70%, 80%, 90% and 100%. 2. A budget report, comparing the actual results with the budgeted results for that level of activity.

YOUR ANSWER SHOULD LOOK LIKE THIS: Activity level 60% 000 Direct costs 12 Variable costs 1.8 Semi-variable costs (variable portion) 1.2 Semi-variable costs (fixed portion) 2 Fixed costs 5 Total 22 The budget report is as follows: Activity level

70% 000 14 2.1 1.4 2 5 24.5

80% 000 16 2.4 1.6 2 5 27

90% 000 18 2.7 1.8 2 5 29.5

100% 000 20 3 2 2 5 32

Budget 000 Direct costs 16 Variable costs 2.4 Semi-variable costs (variable portion) 1.6 Semi-variable costs (fixed portion) 2 Fixed costs 5 Total 27

Actual 000 15.75 2.45 1.5 2 5 26.3

Variances 000 0.25 (0.05) 0.1 Nil Nil 0.3

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