Budgets and Budgeting

• Budgets are forecasts or plans for the future finances of a business
• Budgets can be set for the business as a whole or a set of specific functions (Eg. HR, Operations)
• Budgets can be set for Income, Expenditure and profit
• Income budgets are a target set for the amount of revenue to be achieved in a set time period
• Income budgets can be split by products, services or departments
• Income budgets may be translated into individual sales targets for staff
• Income budgets are informed by market research and sales forecasts
• Income budgets inform projected cash inflows in the cash flow forecast
• Expenditure budges are a limit on the amount to be spent in a given time period
• Expenditure budgets can be split by department, function or product
• Expenditure budget allows for the monitoring under spending and overspending
• Profit budgets are a target set for the surplus between income and expenditure in a given period of time
• Profit budgets are calculated based on income and expenditure budget
• Profit budgets inform decision making as well as what products to include in the business portfolio
• Process of setting clear budgets:

  1. Set clear objectives
  2. Carry out market research
  3. Produce sales forecast
  4. Set income budget
  5. Set expenditure budget
  6. Set profit budget
  7. Set diversional targets
  8. Review against objectives
• Problems in setting Budgets: Budgets are dependant upon predictions and forecasts which may be subjective
• Problems in setting budgets: Costs are subject to change
• Problems in setting budgets: Competitor actions are unknown
• Advantage of budgeting: Allow for monitoring of performance
• Monitoring performance is achieved by comparing the budget to the actual
• The difference between the budget and actual is known as variance
• Adverse Variance is where Expenditure is higher than budget, Income is lower than budget and profit is lower than budget
• Favourable variance is where Expenditure is lower than budget, Income is higher than budget and profit is lower than budget
• Possible causes of variance: Actions of competitors
• Possible causes of variance: Action of suppliers
• Possible causes of variance: Internal inefficiency
• Possible causes of variances: Internal decision making
• Advantages of setting budgets: Quantifiable target against actual outcomes can be measured, Informs decision making, Motivates staff due to increased responsibility
• Disadvantages of setting budgets: Potential for conflict, may be restrictive and is time consuming