CIE As Level Business | 5.5 Budgets - Finance & Accounting

Budgeting

Planning future activities by *performance targets*, especially finances.

What are the *methods of budgeting*?

1. Incremental budgeting

2. Zero budgeting

3. Flexible budgeting

Incremental budgeting

Incremental budgeting is a budgeting method where *last year's budget* is used as a *starting point* and *adjusted slightly* for the new period, such as for inflation or expected growth.

What are the *advantages* of *incremental budgeting*?

1. *Simple and quick to prepare*

→ Based on last year's budget with small adjustments

→ ✅: Saves *time + effort* → easy for *managers* to use

2. *Stable and predictable*

→ Uses existing data and trends

→ ✅: Reduces *uncertainty* → supports *planning*

3. *Less conflict between departments*

→ Budgets change only slightly

→ ✅: Maintains *consistency* → improves *coordination*

What are the *disadvantages* of *incremental budgeting*?

1. *Encourages inefficiency*

→ Inefficient spending is carried forward

→ ❌: Leads to *wasted resources*

2. *Lack of innovation*

→ No incentive to rethink spending

→ ❌: Limits *improvement + change*

3. *Assumes past data is relevant*

→ Conditions may have changed

→ ❌: Reduces *accuracy + competitiveness*

Zero budgeting

Sets budget to *zero* each year + budget holders must *justify all spending* to continue receiving finance.

What are the *advantages* of *zero budgeting*?

1. *Eliminates waste*

→ Every expense must be justified from zero

→ ✅: Improves *cost control* → increases *efficiency*

2. *Encourages critical thinking*

→ Managers review all activities

→ ✅: Leads to better *resource allocation*

3. *Focuses on business objectives*

→ Spending linked to priorities

→ ✅: Improves *strategic planning*

What are the *disadvantages* of *zero budgeting*?

1. *Time-consuming*

→ All expenses must be reviewed

→ ❌: Increases *administrative effort*

2. *Complex to implement*

→ Requires detailed analysis

→ ❌: Needs *skilled managers*

3. *May reduce morale*

→ Managers must justify budgets constantly

→ ❌: Causes *frustration*

Flexible budgeting

Cost budgets for each expense are *allowed to vary* if *sales* or *output* vary from budgeted levels.

What are the *advantages* of *flexible budgeting*?

1. *Encourages realistic target-setting*

→ Budget adjusts with output levels

→ ✅: More *realistic* → reduces *frustration*

2. *Better cost control*

→ Can see whether variable costs rose more at a given activity level.

→ ✅: Helps *reduce waste*

3. *Adapts to changes in activity*

→ Figures are updated from demand rises.

→ ✅: Helps the business to *respond quickly* and reduce chances of *missed opportunities* (i.e. turning down orders).

What are the *disadvantages* of *flexible budgeting*?

1. *Reduces pressure to meet targets*

→ Managers may feel budgets will always be adjusted

→ ❌: Less *cost-cutting innovation* —> reduced *competitiveness* if other firms do

2. *Complex + time-consuming*

→ Needs regular updates

→ ❌: Increases *admin time + costs*

3. *Requires accurate data*

→ Depends on correct cost classification

→ ❌: Can lead to *misleading conclusions* → waste

Variance analysis

Calculation of the differences between *budgets* and *actual figures*, and analysis of the *reasons* for such differences.

What are the two types of variance?

1. *Favourable*

—> Actual figure is better than the budgeted figure.

2. *Adverse*

—> Actual figure achieved is worse than the budgeted figure.

Formula for *revenue variance*

Actual revenue - budgeted revenue

Formula for *cost variance*

Actual cost - budgeted cost

Formula for *profit variance*

Actual profit - budgeted profit

Overall, what are the *advantages* of budgeting?

1. *Motivates managers and staff*

→ Sets financial targets and forecasts

→ ✅: Guides *business direction* → *motivating*

2. *Better control of finances*

→ Compares actual vs budget

→ ✅: Identifies *problems early* + *reduce waste*

3. *Improves decision-making*

→ Better assessments about the business's financial position.

→ ✅: Useful for deciding whether a *project / opportunity is affordable*.

Overall, what are the *disadvantages* of budgeting?

1. *Time-consuming*

→ Takes effort to prepare and monitor

→ ❌: Uses *management resources*

2. *Unnecessary spending*

→ Managers may *rush to use up unused funds* at the end of a period so their *future budgets are not cut*.

→ ❌: *Waste + reduced efficiency*.

3. *Can reduce flexibility*

→ Rigid budgets + *sudden changes* in market (i.e. demand/interest rates)

→ ❌: Budgets unrealistic to hit → *demotivate staff*