2.2.4 Budgets

• What is a budget?

  A budget is an estimate of income or expenditure for a set period of time
• Purpose of Budgeting:

  • Planning

  A business owner can use a budget to help them plan for any expenses in the year – for example tax (see video)

  • Forecasting

  Sales or revenue forecasts are typically based on a combination of the business sales history and how effective they expect their future trading to be

  • Communication

  Setting a budget in a small or large business is an ideal opportunity for the owners to communicate their objectives of the business in a financial plan

  • Motivation

  Budgets can be used to motivate staff to be more careful with the finances
• Types of Budgets - Historical:

  • This is a budget set for the business using current financial figures and based on historical performance of the business
  • The previous year’s income and expenditure are used as a base on which to build the budget figures for the next year
  • Realistic in that it is based on last year’s sales
• Types of Budgets - Zero Based Budgeting:

  • This is a budget set for a business by using figures based on potential performance
  • This method takes away all historical assumptions and starts with a clean slate
  • May also be used by a start-up with no historical data
  • Managers must justify levels of expenditure based on the number of customers they are likely to serve in the next year
• What are variances?

  Analyse the budget figures against what actually happens – there might be a variance
• Favourable Variances:

  • Actual figures are BETTER than budgeted figure
  • Costs lower than expected
  • Revenue/profits higher than expected
• Adverse Variances

  • Actual figures are WORSE than budgeted figure
  • Costs higher than expected
  • Revenue/ profits lower than expected
• Difficulties of budgeting:

  • Budgets are often fixed and difficult when business is dynamic
  • Tendency for managers to spend up to the limit
  • Time consuming to prepare, monitor and control
  • Unrealistic budgets can be demotivating
  • Budgets can cause inter-department rivalry as some departments get more money than others
  • Can make managers short-term and short-sighted, they become budget driven rather than customer driven