budgeting as

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Exam code:7131

The value of budgeting

A budget is a financial plan that a business (or department in the business) sets regarding costs and revenue
- The budget is usually closely aligned with the business objectives
Budgets can be used to guide decisions

Using budgets to guide decisions

Use in decision-making	Effect	Example
Planning and resource allocation	Decide how much each department can spend and which projects get funded	A supermarket chain allocates £10m of its marketing budget to TV, social media and loyalty-card offers after comparing projected returns
Performance control during the year	Compare actual figures with the budget Overspending or shortfalls trigger action	If the clothing division is 5% over its wage budget by March, HR freezes new hires and revises staffing rotas

Types of budgets

Budgets are usually set annually and then monitored on a monthly basis
Businesses may set budgets to monitor the financial performance of three key aspects

Three coloured boxes titled Revenue (blue), Expenditure (red) and Profit (green), with definitions of each term related to business finances. — **Businesses can set revenue, expenditure and profit budgets**

Revenue budget
- A plan for how much money a business expects to bring in from its normal activities (mainly sales of goods or services) over a set period of time
- It sets management targets for sales volume, selling price and any other income streams (e.g. service fees or subscriptions)
Expenditure budget
- A plan for how much the business is allowed to spend in a set period of time
- It covers direct costs, such as raw materials, components and wages, as well as indirect costs, such as rent, marketing and utilities
- It may be split by department or project, keeping spending under control
Profit budget
- A financial plan that combines revenue and expenditure budgets
- It forecasts the expected profit by subtracting planned expenditure from planned revenue for the period
- It gives managers a clear profit target and a basis for judging overall financial performance

Advantages and disadvantages of budgeting

Advantages	Examples
A budget shows every department how much they can spend and what sales targets to hit, so activities line up with overall business objectives	Gathering data, negotiating figures and revising budgets can take up management time, especially for smaller firms
Preset spending limits highlight overspending quickly and encourage managers to look for savings	Once set, budgets can discourage managers from seizing unexpected opportunities or reacting quickly to market changes
Comparing actual results with budgeted figures pinpoints good and poor performance and can provide evidence for bonuses, promotions or identifying training needs	Managers may overestimate cost forecasts or understate sales to make targets easier to beat, reducing the budget’s accuracy

Constructing and analysing budgets

Steps to set budgets

A coloured diagram showing a five-step financial process: 1. Set objectives (blue), 2. Project income (green), 3. Project expenses (red), 4. Allocate budgets (purple) and 5. Track and amend (orange). — **The steps involved in setting budgets**

Set objectives and gather information
- Decide what the business wants to achieve (e.g. growth, cost saving, cash flow objectives)
- Pull together last year’s sales and cost figures, plus any market forecasts
Project the money coming in
- Estimate how many units or services a business expects to sell and at what price
- Get input from sales and marketing teams so the targets feel realistic
Project the money going out
- List all expected spending: materials, wages, rent, marketing, etc.
- Ask each department to spell out what it needs and challenge any obvious padding
Allocate and share budgets
- Divide agreed figures among departments or projects
- Communicate these numbers clearly so everyone knows their limit and target
Track, compare and amend
- During the year, measure actual results against the budget
- Investigate big gaps, and revise the budget if market conditions change

Analysing budgets

Once budgets have been set, managers carry out variance analysis to compare actual performance to the targets set in the budget
- A budget variance is a difference between the figure budgeted and the actual figure achieved by the end of the budgetary period
Variance analysis seeks to determine the reasons for the differences between the actual figures and the budgeted figures

Types of variance

A budget variance is calculated by subtracting the budgeted figure from the actual figure

$space Revenue space variance space equals space Actual space revenue space minus space Budgeted space revenue$

$space Cost space variance space equals space Actual space cost space minus space Budgeted space cost$

<img alt=”space Profit space variance space equals space Actual space profit space minus space Budgeted space profit” data-mathml=”<math ><semantics><mrow><mo>&#16

Business AS AQA