Business – 5.5 Budgets – Meaning and purpose of budgets | e-Consult
5.5 Budgets – Meaning and purpose of budgets (1 questions)
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Budgets serve as a control mechanism by establishing standards and providing a basis for ongoing monitoring.
- Setting performance standards: The budget defines the expected output (10,000 units) and cost (£5 per unit).
- Monitoring actual performance: Management compares monthly results with the budgeted figures.
- Identifying variances: In the scenario:
Metric Budgeted Actual (Month 1) Variance Units produced 10,000 (quarterly) 3,200 (month 1) -6,800 units (unfavourable) Cost per unit £5.00 £5.40 £0.40 higher (unfavourable) - Taking corrective action: Management might investigate higher material costs, renegotiate supplier terms, or improve production efficiency to bring costs back to the budgeted level.
- Feedback loop: The variance analysis informs future budgeting cycles, leading to more realistic cost estimates or adjusted production targets.
Overall, budgets enable continuous oversight, prompt identification of problems, and systematic corrective measures, thereby enhancing control and ensuring that the business stays on track to meet its strategic goals.