2.2.4 Budgets

• Purpose of Budgeting

  -prevent departments from spending too much

  -provide a measure for a manager's success

  -delegate spending to local managers who know best how to use the money

  -to motivate the staff in a department
• Construct a Budget

  -Predict sales revenue

  -Set a cost ceiling that allows for enough profit

  -Divide the budget between departments

  -Divide further to each manager
• Historical Budget


  Budgets based on previous performance of sales and costs with adjustments for planned changes in spending and inflation
• Zero Based Budget


  Managers justify all of their expenses in a given period independent of the previous period
• Difficulties of Budgeting

  -Budgets are inflexible

  -Managers deliberately spend up to the limit

  -Time-consuming to make and monitor

  -Unrealistic budgets are demotivating

  -Inter-department rivalry if some get more money

  -Managers focus on the short-term and budget

  -It is difficult to plan in some industries
• Variance Analysis


  Difference between budgeted and actual figures
• Favourable Variance


  Leads to higher than expected profits
• Adverse Variance

  Lead to lower than expected profits