WHAT IS BUDGETING??
Budgeting is when you allocate the amount of money you would like to spend on each part of the business...
This is to make that the business runs smoothly and so that the boss can find a way to allocate money to the employees so that they can make spending decisions themselves. But the boss does not want to bankrupt the firm so they will use a budget to allow the employee to decide what to spend, and making sure they have a limit so as not to overspend.
For example; if you own a hair salon and want to open another one, then you would need a manager so you are not travelling back and forth from each shop. You would need to make a budget for that manager so that they know what to spend on what and have a clear idea of how much they can spend so that they don’t overspend.
HOW TO USE IT TO MEASURE PERFORMANCE!
When a budget is in place for each department, the management has criteria against which success can be measured...
Budget holders will try to exceed revenue budgets or stay under cost targets. Budgeted figures will be compared with what actually happens in store so that the owner can make a judgement on the businesses performance. They will use variances which tell you the amount by which the result differs from the budgeted figure. They are referred to by ADVERSE and FAVOURABLE variances. An ADVERSE variance is one which is performing lower than expected profit and a FAVOURABLE variance is one which is performing higher.
If the business has regular variance statements then they can monitor the bad parts of the business and put a strategy into place which will help to improve the business over the year. For example; they could find something wrong in April, put a strategy in by May and you may see improvements by September. But that’s only if it’s that easy in your business. It could take longer!!
ADVANTAGES OF BUDGETING!
- It can help to motivate employees. If they keep reaching their targets then they may be motivated to keep improving.
- It can show if a business is organised and this would make them appealing to investors because they would want to know that the business is planning their money efficiently.
- It can give them an idea of where they need to allocate more or less money to each part of the business.
- It shows how well the business is doing with money!!
DISADVANTAGES OF BUDGETING
- The business could have an unpredictable income – you don’t know what you are going to earn overall and this could be difficult to tell especially with weather and economic changes all the time. So you will never know if you’re going to make a profit or not.
- Unpredictable expenses – you never know if something is going to break down or go wrong in the future so you may end up spending more than what you wanted to in the first place.
- Unforeseen opportunities - You may have a chance to buy a truckload of materials at a reduced cost or you may be offered a special opportunity to break into a new market with an endorsement that you could not have foreseen.