A budget is a financial plan for the future concerning the costs and revenues of a business. It contains an agreed plan of action over a given period of time.
The process by which financial control is exercised within an organisation.
Budgets for income/revenue and expenditure are prepared in advance and then compared with actual perfomance to establish variances.
Managers are responsible for controllable costs within their budgets and are required to take remedial action if the adverse variances are regarded as excessive.
Use of Budgets
- Establish priorities and set targets
- Assign responsibilities
- Allocate resources
- Delegate without loss of control
- Monitor income and expenditure as well as performance
Good budgetary control includes..
- Clearly defined managerial responsibilites
- Unaccounted for variances are investigated
- Action is taken if results differ significantly from the budget
Approaches to budgeting:
- Historical Budgeting:
Using previous years figures for the basis of the new budget. Realistic as based on real data, however, circumstances may have changed and so these figures may be unreliable.
- Zero Budgeting
Budgeted costs and revenues are set to zero. budget is based on new proposals of sales and costs. This makes budgeting more complicated and time consuming but potentially more realisitic.
Management by exception
Focusing on activities that require attention
Budget control and analysis of variance facilitates management by exception since it highlights areas of the business which deviate predetermined standards.
Items of income or spending that show no or small variance require no action, concentrate on large adverse variances.
Variances arise when there is a difference between bugeted costs and revenues and actual performance.
They can be favourable or adverse
Matter more depending on size, cause and long term
Act only if the variance is outside agreed margin and investigate significant variance.
Adverse variance can be as a result of something good, e.g. higher production costs due to increased sales.
Problems of Budgets
- Only as good as data used
- Can lead to inflexibility
- Need to be changed with circumstances
- Time consuming
- Can result in short term decisions to keep within budget rather than the appropriate long term one.
- Can be demotivation-through forced rather than negotiations, and if budget is unrealistic