Business Management

Section 1 Accounts & Finance Sub Section 3.4 Budgeting
Budget refers to a financial plan of expected revenue and expenditure for an organisation or a department for a given period of time usually on a monthly, quarterly or annual basis. Budget holder refers to a person, usually a middle or senior manager, placed in charge of a budget, who is responsible and accountable for all revenue & expenditure within allocated budget. Budgetary control refers to the use of corrective measures taken to ensure that actual outcomes equal to the budgeted outcomes, by regular monitoring of budgets & investigating the reasons for any variances.

The purpose & importance of budget
1. Planning and guidance – During the planning stage of budgeting, question such as, how much should he firm spend on marketing; how many workers are needed & how much do they cost to the organisation; how much money to be kept aside for contingency fund; etc might be asked. These questions help in allocation of budgets top different departments & division of the organisation. They also can help to provide some guidance for managers & budgets holders in decision making. Coordination – The marketing department might unknowingly budget sales revenue beyond the firm’s productive capacity. Likewise, the production department might budget to expand beyond the firm’s financial means. Without proper budget control, budget holders might make decisions that conflict with those made in other departments. Hence coordinated & controlled budgeting leads to consistent & complementary decision making. Control - Many businesses do not have proper cost control & therefore end up overspending. By budgeting, budget holders are constrained by what they can do & are held accountable for their actions. Having a tighter financial control can prevent a business going into debt. Budgetary control & variance analysis help to identify areas where a department is perhaps overspending. Motivation – Recognition, responsibility & employee participation are the sources of motivation. Delegating budgetary control to budget holders can therefore boost their level of morale since they feel valued & trusted. Involving staff in budgeting process also helps to promote teamworking. Motivated workforce is more productive.

2.

3.

4.

Types of Budgets
a. Marketing budget (involves amount planned for advertising & sales promotion)

Compiled by Dr. Sachin Sachdeva: Resource: Business and management by Paul Hoang

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b.

Production budget (involves amount and cost of stocks that needed to be purchased & overhead costs) Sales budgets (involves volume of sales & value of sales revenue) Staffing budget (involves number of staff and costs of labour including labour costs) Flexible budget (involves the budgeting of various levels of activity as a proportion to total capacity of the business, it also enables a business to adapt changes in the business environment) Zero budgeting (under this each budget holder’s account is set to zero at he end of each time period. The budget holder must seek prior approval for any planned expenditure for every time period.) Master budget is the overall or consolidated budget, comprised of all the separate budgets. The chief financial officer has general control and management of the master budget.

c. d. e.

f.

g.

Setting Budget – Factors to be kept in mind while fixing budget
a. b. c. d. e. Available finance (greater the financial strength more the more the amount of budget expenditure can be allocated) Competitors allocations (can be used as benchmarking) Historical data (based on trends of last years) Organisational objectives (For example if business is planning for external growth marketing & production budget need to be accordingly) Negotiations (between budget controller & senior manager who is incharge of master budget)

Limitations of Budgeting
1. 2. Unforeseen can cause large differences between the budgeted figures & actual outcomes. Managers have tendency to overestimate their budgets because it is easier to meet targets by inflating budgets, but this may cause complacency and wasteful expenditure. Budgets can be set by senior managers whereas they are implemented by budget holders, this can cause resentment & discontent. Therefore senior managers & budget holders should discuss to set budgets together. The process of budgeting is time consuming. Budgeting is a quantitative management tool and thus ignores qualitative aspects such as CSR, brand development, staff motivation through non-monetary factors etc. Budgeting can limit degree of staff cooperation, because budget holders will compete to increase their own budget at the expense of their colleagues. If any budget holder under spends, the surplus is not permitted to be carried forward to the following year, this creates disincentive for the budget holders to control costs. 2

3.

4. 5. 6. 7.

Compiled by Dr. Sachin Sachdeva: Resource: Business and management by Paul Hoang

Variance Analysis
Variance refers to any discrepancy between actual outcomes & budgeted outcomes. Favourable variances mean the variance is beneficial for the business whereas adverse variance means it is financially detrimental for the business. Variance analysis involves the investigation of the cause of variances by the budget holders; it helps them in monitoring & control budgets. Adverse variances provide warning of falling revenues/rising costs. Managers can implement corrective measures to offset these unfavourable variances. In addition, variances analysis helps in the review and revision of annual budget. For example, if there is adverse variance in the production budget due to increase in the cost of raw material then more funds can be allocated to the production department. Numerical Example: a. Complete the table below for Lenovo Laptop and identify variances as adverse or favourable: Variable Sales of Laptop A (units) Sales of Laptop B (units) Production costs ($’000) Output per worker (units) Labour costs ($) Budget 250 250 120 20 100 Actual 180 260 150 22 115 Variance

b.

Use your answers form above to explain why variances are referred to as favourable or adverse rather than as positive or negative variances. Calculate the variance, in financial terms, for each of the cases below. Show your working. i. Lenovo laptops had budgeted for $ 6000 operating costs in 100 machine hrs. However, actual operating costs totalled $ 5850 in 100 machine hrs. Lenovo laptops had budgeted production of 250 units of Laptops A in 10 machine hrs. Variable costs are $100 per machine hr. In fact 250 units are produced in 8 machine hrs.

c.

ii.

SMART budgeting refers to budgets that are specific, measurable, agreed, realistic & time constrained. This helps to ensure that budgets are appropriately set in order to facilitate budgetary control. Contingency fund is a reserve budget that is set aside for emergency & back-up use. ____

Compiled by Dr. Sachin Sachdeva: Resource: Business and management by Paul Hoang

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