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Purpose of Budgeting
A budget is simply a financial plan for the forthcoming year, that is drawn up to help a business
achieve its objectives.
Budgets are often used to exert a degree of control over the costs of the business, in an attempt to
achieve gains in efficiency.
When a business draws up its budget, it is essentially a series of smaller budgets covering all areas of
operation. The main budgets that are drawn up are :
1. A sales budget. This forecasts the number of units of each product that the business aims
to sell next year, the price level that will be charged, and the corresponding amount of sales
revenue that is likely to be received.
2. A production budget. This forecasts the number of units of each product that the business
aims to produce over the next year. It will include the materials budget, which will indicate
the raw materials that need to be purchased.
3. A staffing budget. This will specify the direct and indirect staff that are required throughout
the business for the forthcoming year, in terms of the number of staff and their wages.
4. A production overhead budget. This attempts to forecast the fixed overheads that the
business will incur in the forthcoming year, which can be related to production.
5. An administrative expenses budget. This forecasts a wide range of expenses for the
forthcoming year (e.g. managerial salaries, office expenses, utility bills, and rent or mortgage
6. A selling expenses budget. This represents the various costs associated with selling the
products of the business (e.g. advertising, sales promotions and distribution).
These budgets are then consolidated into the master budget. This also includes several other
forecasted documents specifically, a profit & loss account, a balance sheet, a cash flow and a
capital expenditure budget (showing the fixed assets which the business forecasts that it will
purchase in the forthcoming year).
It is vital that each department involves all their staff in the planning and budgeting process, firstly in
order to identify their needs for the forthcoming year and secondly to act as a motivator, by making
the employees feel valued by the business.
It follows on from this, therefore, that each budget that a business sets must be realistic and
achievable, since any which cannot be met may leave the workforce with low levels of morale and
Common mistakes that many businesses make when preparing their budgets for the
forthcoming year include:.
1. Repeating last year's figures.
2. Each department ignoring the overall objectives of the business, and concentrating instead
on their own goals.
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Setting unrealistic and unachievable budgets.
4. Sticking rigidly to the budget, (i.e. forgetting the fact that it is only a plan and a guide for the
next year, and consequently it can be changed accordingly).
It is vital that a business regularly reviews and revises its budgets. Any discrepancies that exist
between the budgeted figures (i.e. for sales, costs, etc) and the actual results are known as
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This is a variance of £ 20,000 (or 10% of the budgeted figure). This is an unfavourable or adverse
variance (A), because it results in the business spending more money than it budgeted for.
Similarly, the business budgeted to spend £ 100,000 on its labour costs (wages and salaries). It
actually spent £ 110,000 on its labour costs.
This is a variance of £ 10,000 (or 10% of the budgeted figure).…read more