3.4 Budgeting HL

Chapter 21

What is a Budget?

A budget is a detailed financial plan for the future.

A budget holder is the individual responsible for setting the budget and achieving the budget.

A budget time frameis usually 12 months.

7 Stages in Setting Budgets

Stage 1: Objectives are set for the year.Considers previous performanceExternal changes that are likely to affect the

businessSales forecasts based on research and past

sales data

7 Stages in Setting Budgets

Stage 2: Key factors to next year’s growth must be identified – usually sales. All other budgets will be based on this data so it is

important that it is as accurate as possible.

Stage 3: Sales budget is prepared. All other budgets will be based on this data so it is

important that it is as accurate as possible.

7 Stages in Setting Budgets

Stage 4: Subsidiary budgets are prepared. Cash budget Materials cost budget Selling and labor cost budget Administration cost budget

Stage 5: Subsidiary budgets are coordinated with others. Budgets will be reviewed by management

7 Stages in Setting Budgets

Stage 6: Master budget is prepared. Contains all details of subsidiary budgets Includes budgeted profits and loss accounts

(Income Statement) Includes budgeted balance sheet

Stage 7: Budget is presented to Board of Directors for approval.

Budget Levels

Incremental BudgetUsing last year’s budget as a basis for this year’s budget making needed adjustments.

Zero BudgetSetting budgets to zero each year and starting over justifying each new budget.

Limitations of Budgets

Lack of flexibility: what happens if something unforeseen occurs?

Focused on the short term: Managers may make decisions for the short-term without considering the long-term interests of the business.

Unnecessary spending: If there is extra money in the department budget, it may be spent for fear of not receiving the same resources next year.

Training: Mangers must be trained to set and manage budgets.

Setting Budgets for new projects: One-off projects may be difficult to set and follow a budget; frequent revisions may be necessary.

Variance Analysis

Throughout the budget period the actual performance needs to be compared with the budgeted performance.

Differences need to be investigated. This process is known as variance

analysis.

Variance Analysis

Measures differences between actual and budgeted amounts (month-by-month and by year)

Helps locate causes of deviation from the budget.

An understanding of issues so changes in future budgets are more accurate.

Each subsidiary budget can be reviewed and evaluated in an objective way.

Variance Analysis

Adverse VarianceWhen the difference between the

budgeted and actual figure leads to a lower than expected profit.

Favorable VarianceWhen the difference between the

budgeted and actual figure leads to a higher than expected profit.

Budgetary Control & Strategic Planning

Without a detailed plan to allocate money resources who would decide “who gets what?”

Without a sales budget how would we know how much to produce or how many people to employ?

How would we measure performance without clear targets?

Without a budget to measure our progress how would know if we were on track or where changes were needed to be successful?

Budgets gives responsibility and a sense of direction.