5.5 BUDGET

• Budget


  A detailed & financial plan for a future time period

  
• Budgeting


  Business organisations plan for the future, including long term & short-term goals, expressed in financial terms

  
• Budgets


  • Are set for both sales revenue and costs
  • It is usual for each cost and profit centre to have budgets set for the next 12 months, broken down on a month-by-month basis
• Forecast


  A prediction of what could occur in the future given certain conditions
• Budget


  Not simply a forecast, although much of the data on which it is based will come from forecasts, since we are looking into the future. Budgets are plans that organisations aim to fulfill

  
• 7 purposes for setting budgets

  • Planning
  • Effective allocation of resources
  • Setting targets to be achieved can lead to motivation
  • Co-ordination
  • Monitoring and controlling
  • Modifying
  • Assessing performance

  
• Budgeting


  • Budgets may be established for any part of an organisation (i.e., sales budgets, capital expenditures budgets, labour cost budgets), as long as the outcome of its operation is quantifiable
  • Co-ordination between departments when establishing budgets is essential otherwise there will be conflicting plans
  • Setting of budgets should be an exercise in participation
  • Decisions regarding budgets should be made with the subordinate managers who will be involved in putting them into effect (delegated budgets)
  • Budgets will be used to review performance of departments, thus, successful and unsuccessful managers can be identified

  
• How budgets are commonly prepared

  1. Set organisational objectives

  2. Identify key or limiting factor that is most likely to influence the growth or success of the organisation

  3. Set sales budget

  4. Cash budget, admin. budget, labour-cost budget, material-cost budget, selling and distribution budget

  5. These budgets are co-ordinated to ensure consistency

  6. A master budget is prepared

  7. Presented to the board for approval

  
• Ways to set budgets

  • Incremental budgeting
  • Zero budgeting
  • Flexible budgeting

  
• Zero budgeting


  Setting budgets to zero each year and budget holders have to argue their case to receive any finance
• Flexible budgeting


  It is designed to change as business changes, for example the sales budget may be changed if there is a sudden increase in demand resulting in much higher sales levels
• Potential limitations of budgeting

  • Lack of flexibility
  • Focused on the short term
  • May lead to unnecessary spending
  • Training needs must be met
  • Setting budgets for new projects
• Variance analysis


  Assists in analysing the causes of deviations from budgets, identifying potential problems early so that remedial action can be taken, and understanding the reasons for the deviations from the original planned levels can be used to change future budgets in order to make them more accurate
• Adverse variance


  Exists when the difference between the budgeted and actual figure leads to a lower-than-expected profit
• Favourable variance


  Exists when the difference between the budgeted and actual figure leads to a higher-than-expected profit
• Possible causes of adverse variances

  • Sales revenue is below budget, Actual raw material costs are higher than planned for, Labour cost are above budget, Overhead cost higher than budgeted
• Possible causes of favourable variances

  • Sales revenue is above budget, Actual raw material costs are lower than planned for, Labour cost are below budget, Overhead cost lower than budgeted
• Flexing the budget


  Flex the budget for the following levels of output: 240 units, 300 units
• Budgets & budgetary control – an evaluation