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 provide a financial benchmark against which actual results can be compared, allowing managers to assess performance through variance analysis.
- Identify the budgeted amount: The planned figure for a specific period (e.g., sales revenue, production costs).
- Record the actual amount: The figure that was actually achieved.
- Calculate the variance: Variance = Actual – Budgeted. A positive variance indicates a favourable outcome (e.g., higher sales), while a negative variance indicates an unfavourable outcome (e.g., higher costs).
- Analyse the causes: Investigate why the variance occurred (market conditions, efficiency changes, pricing strategies, etc.).
- Take corrective action: Adjust operations, revise forecasts, or implement cost‑control measures as needed.
Examples:
- Positive variance in sales: If the budgeted sales were £500,000 and actual sales were £550,000, the £50,000 favourable variance may be due to a successful marketing campaign or unexpected market demand.
- Negative variance in production costs: If the budgeted production cost was £200,000 but actual costs were £230,000, the £30,000 unfavourable variance could indicate waste, higher material prices, or inefficiencies in the production line.