budgeting

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

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

• 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

Constructing and analysing budgets

Steps to set budgets

1. 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

2. 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

3. 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

4. Allocate and share budgets

   • Divide agreed figures among departments or projects

   • Communicate these numbers clearly so everyone knows their limit and target

5. 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

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