Budgets and budgeting

Budeting is the process of setting targets, covering all aspects of costs and reveues. A budgeting system shows how much can be spent per time period, and gives managers a way to check whether they are on track. Most firms use a system of budgetart contol as a means of supervision. The process is as follows:

• Make a judgement of the likely sales revenue for the coming year
• Set a cost ceiling that allows for an acceptable level of profit
• The budget for te whole company's costs is then broken down by division, department or by cost centre
• The budget may then be broken down further so that each manager has a budget and therefore some spending power. 

In a business start-up, the budget should provide enough spending power to finance vital needs such as building work, decoration, recruiting and paying staff and marketing. If a manager overspends in one area, she or he knows that it is essential to cut back elsewhere. A good manager gets the best possible value from the budgeted sum.

For a start-up, setting budgets will be a much tougher job. They are fundamental to the business plan. To succeed, the entrepreneur will need to rely on:

• a 'guesstimate' of likely sales in the early months of the start-up
• the entreprenenur's experience and expertise, which will be better if the entrepreneur has worked in the industry before
• the entrepreneur's instinct, based on market understanding
• a significant level of MR.

The best criteria for setting budgets are:

• to relate the budget directly to the buiness objective; if a company wants to increase sales and market share, the best method may be to increase the advertising budget and thereby boost demand. 
• to involve as many people as possible in the process; people will be more committed to reaching the targets if they have had a say in how the budget was set.

Variance is the amount by which the actual result differs from the budgeted figure. It is usually measured each month, by comparing the actual outcome with the budgeted one. It is important to note that variances are referred to as adverse or favourable - not positive or negatie.

A favourable variance is one that leads to higher than expected profit. An adverse vriance is one that reduces profit, such as costs being higher than the budgeted level.

The value of regular variance statements is that they provide an early warning. If a product's sales are slipping below budget, managers can respond by increasing market support or by cutting back on production plans. In an ideal world, slippage could be noted in March, a new strategy put into place by Many and a recovery in sales achieved by September. Clearly, no firm wishes to wait until the end-of-year to find out that things went badly. An early warning can lead to an early solution. 

When significant variances occur, management should first consider whether the fault was in the budget or in the actual achievement. 

When adverse variances occur, senior managers are likely to want to hear an explanation from the responsible 'line manager'. He or she will need to have a clear explanation of what has gone wrong. Clearly, if recession has hit sales throughout a market, it will be easy to explain adverse income variances. Far tougher is when the blame lies with falling market share rather than market share.