Understanding Budgets: Types and Uses

Budgets

• A budget serves as a roadmap, outlining projected costs and revenues for a specific period.
• Budgets can be customized for the entire organization or specific cost/profit centers.
• Budgets are planned in advance (monthly, quarterly, annually) and monitored regularly.
• Budgets align with the overarching business objectives.

Why Businesses Use Budgets

• Budgets encourage proactive planning.
• Budgets help in identifying and preemptively addressing potential issues.
• Frequent budget monitoring enables managers to maintain precise control.
• Budgeting supports defining and evaluating organizational goals.
• It enables different business areas to operate as a whole company.
• Budgets facilitate effective communication and decision-making throughout the organization.
• Budgets encourage good performance.
• Budget allocation promotes empowerment, motivating managers through team input.
• Delegating budgets frees up time for senior managers.

Types of Budgets

• Budgets use historical results and the zero based method
• Historical budgets use prior sales and costs
• Historical budgets accomodate inflation
• Historical budget delegate respsonsibility to departments
• In zero based budgeting all spending must be justified
• Skilled and confident employees required to make persuasive spending and revenue generation decisions
• Zero base budgeting is useful for controlling costs closely

Constructing a Budget

• A master budget consolidates all budgets.
• Master budgets are managed by the Finance Director

Common Types of Delegated Budgets

• Sales
• Marketing
• Production
• Staffing

Factors Affecting Budget Construction

• Historical Data: Prior performance informs budget setting; positive economic outlooks may increase budgets.
• Availability of Finance: Profitable firms or those able to raise capital can implement more generous budgets.
• Benchmarking: Budgets influenced by competitor activities
• Negotiation: Budgets undergo discussion involving budget holders/managers and the Financial Controller.

Understanding Budget Variances

• A budget variance reflects the difference between budgeted and actual figures.
• Variance analysis aims to justify differences.
• A favorable variance results when the actual figure is better than budgeted.
• In revenue/profit budgets, it means the real result exceeded expectations.
• In cost budgets, it means actual spending was less than planned.
• Examples: wages were less than budgeted.
• An adverse variance occurs when the actual result is worse than planned.
• In revenue/profit budgets, it signifies a lower-than-expected result.
• In cost budgets, it indicates higher-than-budgeted spending.
• Examples: fuel costs exceeded the budget.

Responses to Budget Variances

• After recognizing budget variances, a business should explore why.
• Businesses should identify alternative suppliers or enhance efficiency when there are adverse cost variances.
• Businesses should improve the results of thier marketing.
• Businesses should review quality controls following good results.
• Businesses should reward hard working customer facing staff to reward favourable results

Using Budgets & Variances in Decision-Making

• Budgets and variance analysis have a main roll in financial management

Planning & Allocating Resources

• Budgeting establishes support for resource allocation.
• Budgets can identify need for capital investment
• Budgets determine performance and reallocation of resources

Controlling & Monitoring

• Budgets prevent overspending
• Budgets maintain focus on generating profit
• Adverse variances can indicate poor manager performance
• Can take early steps with training

Measuring Performance

• Budgets help evaluate cost/revenue generation
• Budgets compare finacial performance using geography
• Budgets track financial plans

Motivation

• Budgets reward effective action
• Budgets provide metrics
• Budgets increase interest

Difficulties of Constructing Budgets

• Budgeting needs skill
• There many difficulties

Difficulties

• Budgets can make businesses compete
• Budgets can encourage managers to focus on the short term
• Budgets take time and skill
• Unachievable budgets have a negative impact
• Good budgets need data