Asad Mahmood

CLE unit 1
M2
M2 – Why control costs and budgets?
Controlling costs are important for a business because businesses need
to be able to break-even; therefore they need to make the expenses
that meet their finance. Also they would want to gain a profit therefore
they would need to save a little income on the side or they can put it
away with the capital of the business. Financial planning is important for
all businesses as they’d be planning how they would make their
spending and whether if they would have any surplus aside as this
would benefit the future expenditure also if they do have surplus, they
would need to decide on how much they would put aside and the safest
place they can put that surplus as it could get spent if it gets noticed if it
is left with the business accountants or it could get lost or stolen, they
could put it as part of the business capital, this way it would show that
the surplus is part of business revenue. Or they could put it into another
account that would keep the surplus saved and helpful for future
references.

Advantages of controlling your costs and budgets.

• First, if costs are controlled, you would have the knowledge of your
spending, therefore you would know what the finance in the
business is being spent on, this is important because you would
know where your business is financially and how it is doing as a
business.
• You’d be planning ahead, therefore you’d know if your business is
going to do well or not therefore you could make changes to your
financial plan (budget) if it needs any changes or it could get
expanded.
• By controlling your costs, you can update your resources, as you’d
know whether you’d have that spare money aside therefore you
can use that ‘spare money’ to update your resources.
• By controlling your costs, you’d be using your money more
efficiently; this shows that your business isn’t risk-taking as it
manages its finance appropriately; this is a significant thing as you
are managing your business appropriately.
• There are a lot of easy decisions made as you aren’t making those
decisions based on what to purchase or what to do to improve a
department with more resources, instead that money is kept safe
and you aren’t making any big decisions based on expenditure.
• By controlling your costs, you are enable to identify any possible
problems in your business for instance, you’d notice where the
money is going and by looking at the financial document (cash
flow forecast) you can see whether there’s any mistakes in your
Asad Mahmood
CLE unit 1
M2
spending (you may have paid more or you may not have even
purchased that product)
• It helps a business set targets. By setting targets, a business has
new motives, to accomplish those targets. A new target could be
to improve resources, so to improve you resources, you can
achieve that target if your costs are managed as you would know
whether you should do it as soon as possible or in the future as
you would know how your finance are doing.
• It’ll prevent you from being bankrupt. This is a great advantage as
it doesn’t require you to take out any source of finance; therefore
you’d be in debt with the supplier of finance. So by controlling
your costs, you won’t require the need of asking for a source of
finance as you are managing those expenditures effectively.

Disadvantages of controlling your costs and budgets.

• By controlling your costs, you are only predicting your future,

therefore it isn’t certain and precise. Also it is a time-consuming
task as there would be problems and mistakes whilst planning out
your financial plan.
• If costs aren’t controlled properly, you could go bankrupt which
would lead to you applying for a source of finance therefore it
would mean that you are in debt with financial supplier. For
instance if you borrow a loan, there would be a lot of charges
involved such as the commission charge and there would be
interest charged on that financial source.
• If you don’t budget accurately and if there’s a mistake in your
budgeting and it doesn’t get noticed, this could affect the way you
might follow that budget because you are going to make mistakes
as you are following an inaccurate budget. For example if the
income is £250,000 and instead by mistake you write down
£280,000, then the total income would be increased in that budget
by £30,000, that means that you would make that £30,000
spending when it isn’t even there, so you would go into a debt and
ask for financial help due to negligence whilst doing the budget.
• You could lose your money easily if you don’t manage your costs
correctly. This would mean that you will then have expenses that
aren’t required also that money could have helped you in financial
problems if the costs were managed appropriately.
• Controlling costs would mean that you would need to ask for a
specialist that can manage the costs or you would need to give
more and efficient training for the staff that do manage the costs.
They’d need this training to give them more knowledge and
understanding in how to manage the costs and to keep costs
under control.
Asad Mahmood
CLE unit 1
M2
• Also a lot of information is going to be needed to keep costs under
control as they are going to give the best training they can to the
staff. Also they would need to understand the financial position of
the business as they would need the financial documents to
compare with the financial plan.

Why control costs and budgets?

Businesses need to have control on their costs and budgeting as that

shows that the business is being prudent and that it shows that the
business isn’t rushing into making decisions that could affect the
business status financially.
Budgeting is important because it shows that the business is prudent
and is looking out for any problems that could come when making
expenses that may not be required for the business. Making decisions
on expenditure is important because it affects the break-even point and
also the position of the business as it could go bankrupt or out of
finance. By controlling your costs and budgeting, you’re having control
on the business expenses therefore you know where the money is being
spent and how money may be coming into the business. If costs are
being kept control, you’re being prudent on your spending, this shows
that you are a good businessman therefore you have good ability and
skill in understanding the outcome of doing something imprudent, so
you’re enabled to notice any problems that the business could face for
instance having a debt, if you’re imprudent, you might have problems in
getting financial help (loan) because the lender would give the money
depending on whether you are enable in returning the finance with
interest and whether you are good with handling you finance. If you
aren’t good at handling your finance then from the lenders point of view
you might not be able to return that finance back.

What happens if you don’t control costs?

If you don’t control your costs, it shows that you have lack of control in
your business therefore you’d be seen as an irresponsible entrepreneur
and probably wont be able to do business with other businesses as they
might not trust you and your business.
By not controlling your costs, you could overspend, this could lead to
you going into debt or it could lead to you not being able to make
payments for those that are important (utility bills etc). You won’t be
able to recognise whether if there’s any problem cropping or not as your
overspending and you can’t recognise that you might need to ask for
some financial help (loan). If you don’t receive financial help, then you
are unable to deal with financial problems because you won’t have the
finance to be the solution for the problem.
Asad Mahmood
CLE unit 1
M2

Break-even

Break-even is the way of working out whether if your income meets

expenditure. This can be shown by working out the break-even point
using the graph or using the formula. By working out the break-even
point, you know whether you are gaining a profit or whether it’s a loss or
whether income meets expenditure and there is no profit or loss. By
working out the break-even, you can see whether if you need to change
the costs of your products as they may be getting sold less due to the
price and maybe by decreasing the costs of the products, you’d get a
high profit and more sales. It also helps you see the optimal of fixed and
variable costs. Break-even helps by determining the financial charisma
of different strategic options for your company. If you increase your
number of sales then the number of income is going to gain but if you
also increase the number of expenditure then you’re likely to have lower
income than the expenditure. By keeping expenditure low and income
high, you’re likely to have a profit or they may be a point where there
isn’t anything gained or lost. It is important for businesses to do break-
even because it shows that the business is being careful on their
expenditure as the break-even shows whether too much expenditure
meets their income or not, if not, they are going to have to find a
solution to allowing the expenditure be within the income as they’d want
a profit earned. To do an accurate break-even, you’re going to have to
do your budgeting first as you need to make sure that you have the
figures therefore you can compare the figures with the break-even with
the budget. The problems of break-even are that, it’s a prediction
therefore it isn’t a precise so it isn’t giving exact figures so if the break-
even shows that you are going to attain a high profit, you shouldn’t get
your hopes high as that is only a prediction and is showing that you
need to do that certain requirement shown in the breakeven graph or
formula (decrease expenditure, increase income). To attain a high profit,
you need to achieve it yourself (as a business) otherwise its more likely
that it isn’t going to be achieved, so you’ll need to make sure
expenditure isn’t too high and that income is controlled. Also the figure
of expenditure and income can change as you may need to face
unexpected expenditure that may arise due to negligence at work for
example, if a customer comes and asks for a haircut from a hair dresser,
and the hair dresser starts giving a haircut but on the way accidentally
cuts the persons eye brows off and gives a hair cut that the person
didn’t ask for or spoils his hair, then it is more likely that person is going
to ask for some compensation from that hair-dresser, The compensation
is the unexpected expenditure.
So overall, you as you make expenditure and as more income comes in,
you are going to keep on making changes throughout time. This is
important because it shows that your keeping up to date with your
Asad Mahmood
CLE unit 1
M2
business activities and your going to have more knowledge of the
business, also you’d be able notice any errors that may be in the budget
or break-even then you’d be able to make those changes.

Assignment Task.

Headliners Hair salon are launching a beauty treatment and need to

know how many treatments they need to sell in order to break-even.
The following data is available:
Variable production costs
• Direct material - £2.50 per unit
• Direct labour – £5.50 per unit
• Variable overheads - £1.00 per unit
Planned selling price - £15.00 per unit
Fixed overheads specific to the new product – £10,000 pa
• Calculate the break-even point and produce a break-even graph
What effect would the following changes have on the break-
even point?
• An increase in direct material costs to £3.00 per unit
• A reduction in selling price to £14.00
• An increase in fixed costs to £11,000 pa
• A decrease in variable overheads to £0.75 per unit

To work out the break-even point, the formula is fixed costs ÷ (selling
price – average variable costs). 10,000 ÷ (15 – 9) = £1666.66

If direct materials cost was increase from £2.50 to £3.00 per unit, you
would have a break-even point of £1818.18. There would be an
increase in the break-even point. There’s a 50 pence increase in variable
costs.

If there was a reduction in selling price from £15.00 to £14.00 per unit,
the break-even point would be £2000. There would be an increase in
the break-even point as you have reduced your expenditure by £1.00.

If there was an increase in fixed cost from £10,000 to £11, 0000, the
break-even point would be £1222.22. There would be a decrease in the
break-even point. This wouldn’t benefit the business, so I would suggest
the salon to leave fixed costs to £10,000.

If there was decrease in variable overheads from £1.00 to £0.75, the

break-even point would be £1142.85. There would be a decrease in the
break-even point as there’s a decrease in the variable overheads by 25
pence.
 Asad Mahmood
CLE unit 1
M2

Sales Budget

• In this budget, the monthly budget was predicted higher than

the actual budget in all months as in January there was £8,500 therefore
the loss was £1,500 as he had predicted £10,000.
In February, the actual monthly was £9,000 and the loss was £1000 as
he had predicted £10,000.
In March, his actual budget was £10,000 but he predicted £12,000, the
loss was £2,000.
In April, his actual budget was £10,500 but he predicted £12,500, the
loss was £2,000.
In May, the actual budget was £11,500 but he predicted £13,000, the
loss was £1,500.
In June, the actual budget was £13,000 but he predicted £15,000, the
loss was £2,000.
The cumulative budget figures were too highly predicted than the
actual cumulative figures. In January, the actual cumulative figure is
£8,500 but he predicted £10,000, the variance of this is £-1,500.
In February, the actual cumulative figure is £17,500 but he predicted
£20,000, the variance if this is £-2,500.
In March, the actual cumulative figure is £27,500 but he predicted
£32,000 the variance of this is £-4,500.
In April, actual cumulative figure is £38,000 but he predicted £44,500,
the variance is
£-6,500.
In May, the actual cumulative figure is £49,500 but he predicted
£57,000, the variance is
£-8,000.
In June, the actual cumulative figure is £62,500 but he predicted 72,500,
the variance is
£-10,000.

• The likely causes from these figures are that the business is likely going
to ask for financial help as the figures are negatives and the business is
using more money than they actually have. Or they could be more
prudent and use less money and try to make expenditure less and on
useful expenses such as utility bills and other main expenses and try to
keep other expenses low.

• These problems could be avoided by keeping costs at an ‘actual’ figure

and not predict it at a higher value. Also keeping expenditure low would
also help as you are saving money by not making expenditure that isn’t
helpful for the business, for example making expenditure on hair gel,
shampoo, blades, trimmers etc are useful but buying too much trimmers
or too much blades for the trimmer would be useless expenditure as a
 Asad Mahmood
CLE unit 1
M2
trimmer would last at least 2 years but buying a trimmer every 2 weeks
in a year would be useless expenditure.

Solutions to stop negative cash flow

To stop negative cash flow, they can make changes to the ways their
expenses carry out. Firstly, instead in paying total sums for the light and
heating, they can spread their expenses in small monthly instalments,
this way they would have a lot left over plus they can have it as direct
debit so the payments would take place and over time, they’d not really
feel the effect of money leaving their account. Another change they can
make is, instead of buying their equipment, they could hire purchase
them, this way they would have the equipment without paying a huge
sum of money to attain them. Another change they can make is on the
insurance payments, they can also pay in monthly instalments, this way
a lot would be saved over a period of time. The main change they can
make is on the owner’s drawings, instead of taking out a lot of money,
they can keep it in the business and let it stay there, if they need to take
money, they should take less than they currently do.

• In the cash-flow forecast, the expenditure has been higher than income.
In this cash-flow forecast, the main problems are that the owner is
withdrawing too much money for personal use; he should reduce it
instead of doubling it, after June he has doubled it and this has affected
the business massively, h could use that money for other uses in the
business as it is a large amount.
The company is suffering with losses in January, February, April, June,
September, October, November and December. But as accumulative,
the business suffered losses in January, February, April and December.

• These problems were caused due to overspending. Ways of improving

the cash inflow/outflow can be improved by handling the finance
sufficiently and prudently. In January, the equipment should be reduced
from £5,000 to £3,000, if they do this, they’d have £2000 saved then the
loss would be £-2,800, but then February the equipment could be
reduced from £3,000 to £2,000, they would save £1000, but the
accumulative deficit would be £-2100 due to January and if it is reduced
by another £1000 then it would be £-1100. In March the expenses could
remain as they are but the accumulative would increase from £100 to
£3100. In April the equipment could reduce from £5000 to £3000 the
business would save £2000 then the monthly £700 but if you add the last
month accumulative it would be £3800 profit. I would leave May as it is
but add the profit to the accumulative then it would be £7300 profit. In
June, I would leave the expenses as they are as it isn’t a major loss and
with the profit of £3800, the accumulative would be £3000. I would leave
July and August as they are but the accumulative surplus would be
 Asad Mahmood
CLE unit 1
M2
different, in July it would be £5400 and in August it would be £6000. In
September, i leave the expenses as they are as they aren’t major
expenses, the accumulative surplus would be £5100. In October, I would
reduce the owners drawings to £1500 as there may be some problems in
the future so more finance would be required, if it is saved, then the total
expenditure would be £13,900, the monthly loss would be £-900 but the
accumulative profit would be £4200. In November, I would cut the
owners drawings by £400 because it could help the business financially
and the business needs to keep a little from the owners drawings also
the business is doing well so the drawings don’t need to be massively cut
so the minimum I would recommend is £400, so the total expenditure
would be £13,000, there would be no deficit or surplus so the
accumulative surplus would be £4200. In December, I would reduce the
owner’s drawings by £500 because it may be required for business
expenditure and it won’t affect the owner majorly as it is a small amount,
the total expenditure would be £13,400, so the monthly surplus would be
£1,600 and the accumulative surplus would be £6,200.