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A
budget is a target for cost, revenues and/or profits that a firm or
department must aim to reach over a period of time.
There are a number of different types of budgeting.
Objective Budgets
These
are based on finding the best way of achieving a particular objective.
They will contain information on how to achieve the objective, e.g., a
sales budget might show how to meet a sales target.
Flexible Budgets
These
are designed to change as a business change.
Changes in business conditions may result in very different outcomes
than those budgeted for, e.g., the sales budget may be altered if there is a
sudden increase in demand.
Zero Budgeting
This
approach sets each department’s budget at zero and asks that each budget
holder justify every pound that is asked for.
This helps to prevent the common phenomenon of budgets creeping up
each year, thus reducing the overall costs.
It does have the problem of wasting a large amount of managerial time
and failing to prevent managers trying to obtain larger budgets than
necessary.
Variances
A
variance is the difference between the actual and budgeted figure.
They can be favourable or adverse. Favourable variances occur when the actual figures are “better”
than the budgeted ones:
- If sales revenue for
a month was budgeted at £10,000, but it turned out to be £13,000, there
would be a favourable variance of £3,000.
- If costs were
planned to £7,000, but the actual costs were £5,000, then there is a
favourable variance of £2,000.
Adverse
variances occur when the actual figures are worse than the budgeted ones.
Variances
can provide a warning of slipping revenues or rising costs.
This should then allow management to implement a new strategy to
offset the variance.
Overview
The
way that budgets are used can tell you a lot about the firm’s culture.
Firms with a strict autocratic culture will tend to use a tightly
controlled budgetary system. Organisations
with a more open culture will use budgeting as an aid to discussion and
empowerment. Whatever the
culture, the manager has the responsibility to meet the budgetary
requirements.
There
are a number of advantages of budgeting:
- Help to control
income and expenditure, helping to draw attention to waste, losses and
inefficiency.
- They can emphasise
and clarify responsibilities.
- Enable delegation
though the organisational structure, as subordinates have clear budget
targets.
However
there are some disadvantages:
- If the budget is too
rigid then the business may suffer as it won’t be able to react to
internal and external changes.
- If the actual
business results are very different to the budgeted ones then the budget
can lose its importance.
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