Unit 5 :
Finance &
Accounting
A2 - Chapter 33: Budgets
Budgets and budgetary control
Budgeting – the process Budget – a detailed and Essential – if no plans
of planning for the short financial plan for a are made, the
AND long term that are future time period that organisation drifts
usually expressed in organisations aim to without real direction or
financial terms fulfill purpose
Managers not able to Employees likely to feel
If no targets set, difficult
allocate scarce resources demotivated when they
for business to review its
effectively without a have no targets to work
progress
plan to work towards towards
Key Terms
Budget holder Variance analysis Delegated budgets
Individual responsible for the initial Calculating differences between Giving some delegated authority
setting and achievement of a budgets and actual performance, over the setting and achievement
budget and analysing reasons for such of budgets to junior managers
differences
Advantages of
setting budgets
1. Planning :
• Translates objectives into intentions for
achievement
• Gives a sense of purpose to the workforce
2. Effective allocation of resources :
• Scarce resources will not allow for all projects
• Need to prioritise
3. Settings targets :
• People work better when there is a realisable
target to aim for
Advantages of setting budgets
4. Co-ordination :
• People will have to work effectively together if targets are to be achieved
5. Monitoring & Controlling :
• Check regularly that the objective is still within reach
• Conditions may change, do not assume everything remains the same
6. Modifying :
• If objective is now beyond reach, adjust accordingly
• Change the plan or the way of working towards it
7. Assessing Performance :
• Once budgeted period has ended, variance analysis will be used to
compare actual performance with the original budgets
• Budget : A detailed and financial plan for a future time
period that organisations aim to fulfill
• Much of the data is based on forecasts
• Each department has own budget – must be quantifiable
Key • E.g. Sales budget, capital expenditure budget, labour cost
budget
features of • Coordination is essential
budgeting • Departments avoid making conflicting plans
• Decisions should involve managers
• Those who are to be held responsible for fulfilling a budget
should be involved in setting it
• Sense of ‘ownership’ helps to motivate the department to
achieve the targets, establishment of more realistic targets
• Used to review performance of department and managers
How budgets are
prepared
• Stage 1 :
• Organisational objectives are established based on :
• Previous year’s performance
• External changes that are likely to affect the organisation
• Forecasts based on research
• Stage 2 :
• Key or limiting factor that is most likely to influence growth/success
is identified
• Usually sales budget is the first to be prepared – key factor budget
• Every other budget hinges on this one – has to be as accurate as
possible
How budgets are
prepared
• Stage 3 :
• Sales budget is prepared
• Stage 4 :
• Subsidiary budgets are prepared
• Usually based on the plans in the sales budget
• Stage 5:
• Budgets are coordinated – ensure consistency
• Essential that budgets between departments do not conflict
with each other
How budgets are
prepared
Stage 6 :
• Master budget is prepared :
• Main details of all other budgets
• Budgeted Profit & Loss account and Balance Sheet
Stage 7 :
• Master budget is presented to the Board for approval
• Upon approval, budgets will become operational plan of each
department.
• Overall plan is usually broken down into shorter periods –
weekly, monthly, making it easier to achieve
Setting budgets –
incremental
budgeting
• Uses last year’s budget as a basis and an
adjustment is made for the coming year
• Adjustment is made for the coming year, from last
year’s budget
• Usually lower costs budget, raise sales budget
• Adds pressure on staff to achieve higher
productivity
• Does not allow for unforeseen circumstances
• Using last year’s figures as a basis means each
department does not have to justify its whole
budget for the upcoming year – only the change or
‘increment’
Setting budgets – zero
budgeting
• Setting budgets to zero each year and budget holders have to
argue their case to receive any finance
• Requires all departments to justify the whole budget for the year
• Time consuming
• Review of the work and importance of each department done
every year
• But allows each manager to defend the work in their own
department
• Changing situations are reflected in the (very different) budgets
each year
Setting budgets –
flexible budgeting
• Cost budgets for each expense are allowed to vary if sales
or production vary from budgeted levels
• Flexed budgets are more realistic
• Flexible budgets make it easier to produce valid & accurate
variance analyses
• Highlighting changes in efficiency, not changes in output
Potential limitations of budgeting
• Sudden & unexpected changes in the external environment can
Lack of flexibility make budgets very unrealistic if budgets are not flexible
Focused on the short • Managers may take a short-term decision to stay within budget
term that may not be in the long-term interests of the business
Lead to unnecessary • So that same level of budget can be justified next year
spending
Training needs must be • Not easy and requires extensive training
met
Setting budgets for new • Setting realistic budgets may be difficult
projects • Frequent revisions budget might be neccessary
Budgetary control
– variance analysis
Variance analysis :
• Variance : Difference between budgeted and actual
figures
• At the end of the budgeted period, actual
performance needs to be compared to with the
original targets
• Reasons for differences must be investigated
• The reasons for the differences can be used in
future budgets so that they are more accurate
Budgetary • Adverse variance
• Exists when the difference between the budgeted and actual
control – figure leads to a lower-than-expected profit
variance
• Favourable variance
• Exists when the difference between the budgeted and actual
figure leads to a higher-than-expected profit
analysis
Final evaluation
Setting, agreeing and controlling budgets – time
consuming
Budgets can fail to reflect changing circumstances and
become inflexible
Departments look upon a budget as how much they
can spend, even if they need to or not
Final evaluation
So is it the budgetary process necessary?
Need to decide ‘who gets what’
Departments must know how much to produce or to
spend on promotion activities or how many people to
employ?
Access how well each department has performed by
comparing targets to performance
Monitor progress during the budgetary period –
adjust along the way
Gives responsibility, sense of direction
